Global Weekly: Positive momentum

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Equity markets continued their positive momentum, with the S&P 500 Index trading above the 3,000 point mark once again. The ECB announced a deposit rate cut of 10 basis points and said it will restart open-ended bond purchases. In addition, a two-tiered deposit rate system will be introduced, where part of bank excess liquidity will be exempt from negative rates.

European bank stocks retreated somewhat after a strong rally earlier in the week. Meanwhile, China and the US expressed some good will towards each other in the ongoing trade war. The US will postpone implementing additional tariffs by two weeks, while China lifted some tariffs and is said to be considering importing US agricultural products again. Trade talks are expected to be restarted in the next couple of weeks.

We observed a remarkable dispersion between the performance of the different equity sectors this week. So far, in this quarter, the best performing sectors have been the defensive sectors, such as consumer staples, utilities and real estate. This week was different. With US and eurozone government bond yields rising from their lows and market participants anticipating the outcome of Thursday’s meeting of the European Central Bank, the financials sector and other cyclical sectors as well, exhibited relative outperformance. At the moment, we prefer the information technology, communication services and health care sectors, while the industrials, consumer staples and financials sectors are out of favour. A neutral stance is taken toward the remaining sectors.

On a company level, luxury-brand Hermes International published strong results for the first-half of the year. What especially stood out was that despite the protests in Hong Kong, Hermes did not see a deceleration in performance in greater China. On Wednesday, Prosus NV, which holds a 31% stake in Chinese internet giant Tencent (among other investments in online companies), was listed on Euronext Amsterdam. The stock closed 26% higher, and most of the discount that had been present when Prosus was listed in Johannesburg (under the umbrella of mother company Naspers) was erased. The largest beer brewer in the world, Anheuser-Busch Inbev, announced that it is relaunching a plan to list a minority stake of its Asian business on the Hong Kong stock exchange. A successful IPO could possibly assist the company in exploiting growth opportunities and bolster its balance sheet.

ECB in action

On Thursday, the European Central Bank (ECB) announced an additional package to support the eurozone’s gloomy economy and to show its commitment to improve the inflation outlook.

The ECB announced that it will decrease its deposit facility by 10 basis points to -0.50%. In addition, the central bank will restart its asset purchasing programme at a monthly rate of EUR 20 billion, starting on 1 November and will continue it as long as necessary. This amount was below market expectations for monthly purchases ranging from EUR 30-40 billion.

In addition, ECB President Mario Draghi made it very clear that the ECB’s accommodative policy needed to be supported by further fiscal policy action from Brussels to support Europe’s weak economy. The eurozone could be expected to start to rebound if there is a combination of monetary and fiscal policies which support each other.

This was President Mario Draghi’s last ECB meeting, and it was challenging. (Christine LaGarde becomes the ECB president when he steps down at the end of October.) Draghi tried to come with a strong message to a committee that has been under pressure from more vocal hawks, who favour more aggressive policies. During the press conference, Draghi let it be known that he was able to convince the committee to come with a strong view, supported by all the members.

The ECB was the first on the list of central banks to introduce adjusted monetary policies. The next central banks to hold meetings are the US Federal Reserve (18 September), Bank of Japan (19 September) and the Peoples Bank of China (20 September).

When the Fed policymaking committee meets next week, we expect that it will announce a 25 basis point cut at every meeting remaining in 2019. This results in a policy rate of 1.25% at year-end. The Bank of Japan will probably keep rates accommodative. In China, we expect that the central bank will continue targeting a clear loosening approach to monetary policy. With the major central banks all taking a more accommodative approach, policymakers in emerging markets could see an opportunity to cut their official rates as well. This had not been possible in 2017 or 2018.

Impact of the ECB’s move

The ECB’s actions this week will further support duration trades and corporate investment-grade assets. During the period of the asset purchase programme, investors will also likely look for other opportunities. Emerging markets could then come into focus. And, if the US Federal Reserve continues to lower interest rates, US high-yield bonds could also be an opportunity.

Overall, with such strong support from leading central banks, it is likely that fixed income sub-asset classes will move closer to zero (or, even, lower) rate levels. Bond market segments capable of generating clearly positive yields are diminishing. In such an environment, it is challenging to strike the appropriate risk/return balance. Central bankers need to provide regular and active information to guide markets and investors. It would, of course, be helpful if European countries supported their own economies with fiscal policies. It is a time for vigilance, as we are entering into new territory and that can be uncomfortable. Central banks should take steps to comfort investors so that they remain invested in bonds, even though the yields are close to zero or even negative.

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