Global Weekly: In the rebound

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Equity markets rebounded significantly this week. This was a reaction to the positive tone during trade talks between the US and China and to remarks from US Fed Chairman Jerome Powell suggesting that the US central bank would be more flexible with its monetary policy.

The rebound followed after one of the worst Decembers for US equity markets since 1931. All sectors in the MSCI World were in positive territory. The largest percentage gains were posted by trade-sensitive sectors such as consumer discretionary, materials and industrials.

Equity valuations and markets sentiment indicators have improved recently. US market valuations have come down sharply with trailing P/E falling to 15, down from 21 a year ago. Investment sentiment surveys, such as the bull/bear ratio, have fallen close to the lower bound, generating a buying signal. Those indicators suggest an equity bottoming process. Stronger macro and micro data prints are still needed, however, to support a sustainable equity rally.

In fact, despite strong US payroll data, the latest global economic metrics have continued to deteriorate. In China, PMIs have fallen below 50, sparking the Chinese central bank to cut the banks required reserve ratio to stimulate economic growth. In Europe, data remained weak with German industrial output falling for the third month and posting the biggest drop since the financial crisis. This confirms that the largest European economy is suffering from the Chinese slowdown. In the US, last but not least, the ISM manufacturing print fell to 54 in December from 59.3 in November, fueling the idea that US growth is slowing.

Bonds: Fed more patient

The most recent communication by the Fed policy committee emphasizes the flexibility of the Fed to leave the door open for further rate hikes. Several voting Fed members assume that they can afford to remain patient as long as both growth and inflation are not overheating.

Currently, Fed fund futures are pricing in zero rate hikes for 2019. This is also our new forecast. Ten-year US Treasuries, currently yielding around 2.7%, should – for the time being – not exceed the 3% threshold quickly and the interest rate curve is expected to reassess its future path. Besides the speculation of further rate hikes, the Fed has also signaled some flexibility on the reduction of the balance sheet. A clear target for the final level, although, was never highlighted. With a more accommodative Fed, the sentiment for risk-takers should generally become more positive in the near term.

The factor that probably may cause (severe) headaches to market participants, is the Brexit vote. With less than three months ahead of us, the current chaotic situation makes it quite difficult to give a clear prediction. This may be a reason why Bund yields remain at their lower bandwidth around 20-30 basis points (bp). And why they have not corrected after the seemingly endless quarrel between the European Commission and the Italian government. Italian government bond spreads, that rallied at the end of last year, are currently consolidating around 250 bp. Further spread tightening in peripheral bonds may be triggered by a sound demand for new corporate and financial issues and by a gradual improvement in risk sentiment, particularly highlighted by tightening high yield spreads, led by the energy sector.

In Brazil, the new President Jair Bolsonaro has held his inauguration. He had been labelled as the “Trump of Latin America”, but he made clear that this label is misleading and eased some uncertainty in emerging markets. Unlike Donald Trump, Bolsonaro supports the central bank’s independence, fiscal austerity and free trade.