Global Weekly: Focus on Fed and oil attack

News item -

This week was dominated by the Fed’s interest rate decision but also by (the aftermath of) the attack on Aramco’s Abqaiq oil facility. This attack resulted in a 5% decline of the global daily oil production, which is massive. Much smaller imbalances between demand and supply have shaken the price development in the past.

This time, the first effect was a price hike of 20%, which quickly levelled off to an increase of around 13% (from USD 60 per barrel to USD 68). The main question was how soon production could be resumed at more normal levels. With various sources saying various things, uncertainty was high. Oil major stocks won, whereas companies in need of oil-based fuel (for example, airlines) lost. Later in the week, more comforting news emerged that the production gap would likely be limited and not disturb the economy too much. The price of Brent oil retreated to USD 63.

The Fed on Wednesday decided to lower its key interest rate by 25 basis points, in line with our own expectations and the market consensus. In our view, this is not the last step. Fed decisions are very much data-driven, and whereas the consumer is showing resilience we see signs of decreasing growth in the US. This is for a good part driven by the trade conflict and increased tariffs. FedEx, for example, lowered its outlook again this week, citing slower trade and weaker pricing stemming from the trade conflict. Investors have increasingly become frustrated with FedEx’s inability to keep up with even its own weakening expectations. For more than a year, the company has made a habit of cutting its earnings forecast or missing analysts’ diminished estimates. The stock fell more than 10% in response to the outlook cut.

Another trend we have been witnessing recently was a rotation from growth to value stocks. The Russell 1000 Growth Index declined by 2.6% on 9-10 September, which was the second biggest loss over two days in 10 years. Since 1992, such declines of more than 2.5% occurred 13 times for the Russel 1000 Growth Index. Value stocks outperformed growth stocks during the half year following such a shift. Generally, after six months, growth stocks recover in part. Despite the recent decline, however, we believe it is too soon to declare the end of the long-term bull market in growth stocks.

Aftermath of central bank actions

Markets are still digesting the consequences of the clear signal from the recent ECB press conference: not only does the central bank appear to have less room for manoeuvre but perception in markets is also that the ECB’s stimulus programme could be less effective, particularly in case of an economic downturn. That was probably one driver, amongst others, putting pressure on the German Bund yield curve and accordingly on our long duration positions.

On the other hand, both peripheral government bonds and corporate bonds could benefit from the recent announcement; spreads in both segments tightened. However, looking forward, ECB Chair Draghi’s call for more fiscal spending could become more prominent once his successor Christine Lagarde takes the helm. Then government bond yields in core eurozone countries could get under pressure, again. For better or worse, European policymakers are less inclined to find a common path, which will leave rates lower for longer. As expected, the US Fed has delivered another ‘insurance cut’ of its policy rate. Trump’s call for negative interest rates was not well received by the market and the Fed, as there is hardly any strong evidence that negative rates have revived economic activity.

While the trade dispute between the US and China appears to become a sideshow and lingering recession risks may not be the focus of attention in the coming weeks, the biggest longer-term risk for the US economy next year could actually be that Trump will not get re-elected.

We keep our relative overweight in emerging markets, where valuations of both external sovereign debt and corporate bonds look reasonable in terms of spreads. The growth outlook in emerging market countries also appears more supportive. Moreover, any risk-off event in emerging markets tends to be short-lived. Next week, the German Ifo Business Climate Index will be released. As there are growing signs that some parts of the German economy might face more challenges, the release of this business confidence indicator could keep Bund yields at the current low level of around -50 basis points.