Coffee Break 10/3/2016

September's BoJ and FOMC meetings confirmed that central banks remain dovish:

• The pace of Fed rate hikes will continue to remain gradual, but the probability of a December hike has increased.
• The BoJ has changed its strategy by setting a target for the 10-year yield. This new measure could set the tone for other central banks' decisions, notably the ECB. It should allow a steepening of yield curves, in order to mitigate the negatives for the banking sector.

Should the ECB follow the same path, these actions would have two implications in our view:

• We have possibly reached a bottom on core government bond yields just after the "Brexit "vote.
• We remain nevertheless in a low yield environment, but with less volatile interest rates.

Those globally still supportive policies allow us to remain constructive on high-income assets, such as emerging bonds.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : new change

EQUITIES VERSUS BONDS

We currently have a neutral stance in equities vs. bonds:

• The macro news flow is in line with low but positive growth.
  • In the US, we expect accommodative monetary policy to prevail while Chinese authorities will continue to offer a supportive policy mix.
  • Europe is showing resilience following the "Brexit" referendum.
  • The stabilisation in commodity prices mitigates downside risks on a global scale.
• The medium to long-term economic risks have increased due to the various political events:
  • For the time being, global growth indicators are little affected by the "Brexit".
  • The UK appears to be quite resilient in the immediate aftermath.
  • Political risks are looming by the end of the year: US presidential elections, Italian constitutional referendum, probable new general elections in Spain and, of course, "Brexit" negotiations.
• Central banks keep a dovish stance, providing ample liquidity to the markets.
  • Markets have started to price one Fed hike by the end of the year, which is our base scenario.
  • The Bank of Japan innovates with a yield curve targeting, while the ECB remains accommodative and keeps its policy rates anchored in negative territory and pursuing QE.
• Oil market continue its rebalancing, leading to a stabilisation of the commodity markets. This is supportive for risky assets, particularly emerging debt, high yield and inflation-linked bonds.
• Emerging markets face fewer headwinds, thanks to a stabilisation of commodity prices, a working Chinese stimulus and a cautious Fed.

REGIONAL EQUITY STRATEGY

• We have re-evaluated our positioning in euro zone equities and decided to maintain our neutral stance (since mid-August).
  • We see the European political uncertainty as the main reason of relative underperformance of euro zone equities against US ones. Euro zone equities have underperformed by 15% since the beginning of the year, which is, according to our models, in line with the rising political risks.
  • The current risk premium of euro zone equities is attractive, but can be largely explained by the level of political risk.
  • This underpins our relative caution on European assets while we could still tactically benefit from shorter periods of re-rating (implementation of options strategies).
  • We currently have a relative value strategy in favour of the DAX against the FTSE 250, while staying neutral. We anticipate a struggling domestic UK economy following "Brexit".
• We have maintained our underweight in UK equities.
• We have a neutral stance on US equities, as sound consumer expenditures, stable oil prices and a weaker USD should lead to an improving US economy in the second semester.
• We have a neutral stance on Japan.
• Emerging markets remain our main conviction. Fundamentals are improving and valuation is attractive, while a positive turn in flows and an attractive technical set-up shows a re-rating potential.
  • Within emerging markets, we favour India. Economic fundamentals are improving, both structurally and cyclically and the resilience of the Indian economy is supported by a domestic reform agenda, which makes the country less vulnerable to external influences

BOND STRATEGY

• Following the OPEC deal, that set the production ceiling between 32.5 and 33 mb/day, and a bullish technical signal on the NOK/CHF, we have decided to implement long position on the NOK against the CHF:
  • The NOK partially benefits from the oil price rebound, while the central bank's interest rates should remain unchanged.
  • The CHF is overvalued.
• We continue to diversify out of low/negative yielding government bonds:
  • We remain overall slightly short duration and have increased this underweight recently.
  • We remain positive on US corporate bonds and emerging debt, both in local and hard currency. Emerging bonds are benefiting from inflows, as they provide an attractive yield compared to developed markets.
  • We are positive on high yield, but have started to take some profit. The significant spread tightening this summer has reduced the potential. Only the carry is still attractive.
  • We are positive on inflation-linked bonds. We view the subdued inflation expectations as a temporary phenomenon and expect wages and consumer price inflation data to rise gradually. This implies a further re-rating of inflation-protected bonds over the course of the coming quarters.

Our long positioning on emerging market currencies is based on our conviction that the peak in the USD and the low in commodity prices are behind us.

• In the US, new home sales fell by 7.6% in August, according to the Commerce, though the trend remains positive. Sales were nevertheless up by more than 20% from a year ago.
• Durable goods orders were unchanged (-0.4% excluding transportation), while economists expected a decrease.
• In the euro zone, economic sentiment came in much better than expected in September thanks to a rebound of confidence in the biggest economies, such as Germany, France, Italy and Spain. The economic sentiment index rose to 104.9, beating expectations and moving further above the long-term average of 100.
• Inflation ticked-up slightly in September with a rise in consumer prices (+0.4%), twice as fast as in August, Eurostat reported.
• In Germany, business morale recovered from the "Brexit" in September with a rise of the Ifo business climate index to 109.5, the biggest monthly increase since July 2010 and the highest level in more than two years. 

EUROPE

Slightly negative performance for European equities with the Stoxx 600 closing at 343 down by 0.70% for the week.

• While financial stocks led markets along a downward slump on Friday, energy stocks experienced a brief bump earlier in the week, after news of the OPEC's agreement to curtail oil supply.
• Concerns over Deutsche Bank, one of Europe's biggest banks, jolted most financials stocks as investors feared that the bank would be significantly weakened following a large fine issued by the US Department of Justice.
• The UK’s Office for National Statistics issued that the domestic economy grew faster during Q2 than previously estimated. This support the view that the "Brexit" would not be as weakening to the UK economy as earlier believed.
• At a sector level, Basic resources, Oil & Gas and Utilities outperformed the benchmark (1.62%, 1.56% and 0.92% respectively) while Telecoms
  (-1.46%), Insurance (-2.50%) and Health Care (-2.55%) underperformed.

US

Slightly positive week for US equities with the S&P 500 closing at 2168 last Friday.

• US stocks finished slightly higher for the week after a Friday rally helped erase most of the steep losses of the previous day.
• Smaller-cap stocks, which are typically more volatile, lagged their large-cap counterparts.
• Concerns over Germany’s Deutsche Bank, a reassessment of the previous week’s central bank actions, and increasing concerns over the terms of the UK's exit from the European Union weighted on US markets.
• Oil stocks boosted markets on Wednesday following the agreement reached by the OPEC to cut output.
• Markets, particularly banks stocks, fell back on Thursday as worries intensified over Deutsche Bank and Wells Fargo.
• At a sector level, Energy, Industrials and Materials outperformed the S&P 500 (4.64%, 1.02% and 0.85% respectively) while Health Care (-1.44%), Real Estate (-1.83%) and Utilities (-3.85%) underperformed.

EMERGING MARKETS

Another slightly negative week for Emerging markets equities, with the main index losing 1.5%.

• Better-than-expected US economic data bolstered bets that the Fed would raise interest rates by year-end and commodity stocks got a boost after OPEC’s agreement to cut production boosted demand for riskier assets.
• India had a difficult week as the Indian government attacked terrorist camps in Pakistan late on Wednesday in retaliation for a deadly strike on Indian soldiers earlier in September.
• At a sector level, Energy, Materials, Consumer Staples outperformed the benchmark (0.39%, -0.18% and -1.19% respectively) while Real Estate (-2.48%), Health Care (-3.01%) and Utilities (-3.71%) underperformed. 

RATES

Risk sentiment continues to be driven by headlines on Deutsche Bank and political risk in Europe, driving core sovereign yields lower over the week.

• The news flow related to Deutsche Bank and the OPEC agreement for an output cap continued to drive risk sentiment.
• On the political front, the probability of a PP-led minority government in Spain has increased on the back of the latest events related to the Socialist Party PSOE poor results in the September 25 regional elections. In Italy the date of the referendum has been set on 4 December.
• Core sovereign yields turned lower, with Italian yields lagging.
• 10Y US, UK, Japan and German yields now stand at respectively 1.59%, 0.75%, -0.12% and -0.09%. Spanish and Italian 10Y yields stand at respectively 0.88% and 1.19%. 

CREDIT

As for other main asset classes, the main drivers of spreads last week were concerns over Deutsche Bank.

• IG credit widened by 2bp (from 111 to 113bp over Government bonds) and Non-financials were stable (100bp) but Financials were hit by the turmoil over Deutsche Bank (from 130 to 135bp).
• Subordinated debt suffered the most with LT2 indices widening by 7bp (to 203bp).
• Slow week for new issue market: €8.8bn across all markets in non-financials (ex. Total and ENBW Hybrids, Veolia, Vodafone, Hutchison and Amadeus) and just €1.1bn for financials (SocGen and Blackstone).

FOREX

Commodity-related currencies were the top performers last week.

• Besides headlines surrounding Deutsche Bank, the performances of FX markets last week were mainly driven by a surprise agreement from OPEC members, designed at reducing oil production.
• The MXN appreciated by 2.17% against the EUR, a performance further supported by a rate hike from the Central Bank of Mexico.
• The NOK, CAD, AUD and NZD followed as main performers of the week, with the NOK benefitting from strong economic momentum and revised expectations surrounding the Norges Bank monetary policy.
• The USD remained range-bound against the EUR, despite better-than-expected economic releases.
• The CHF, JPY and SEK were the main underperformers of the week. 

COMMODITIES

Over the past week, commodities rebounded modestly, as the GSCI Light Energy rose by 1% and posted a positive return for the year (+2.3%).

• Both crude oil and Brent prices jumped last week, as optimism over an OPEC plan to limit output was offset by questions over its ability to rebalance a heavily over-supplied market.
• Natural gas prices fell last week, as expectations that cooler weather is approaching outweighed a bullish inventory report. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES