From the desk of Geraldine Sundstrom, Friday 12th July 2019.
This week was relatively quiet as summer starts to set in and the main events were around Central Bankers’ speeches.
The overall tone has not changed. Stimulus is on the horizon. That is a given but questions are starting to emerge on the nature and/or quantum of the easing: In Europe, for example, the release of the European Central Bank (ECB) minutes pushed the market-implied probability of a rate cut lower, but lifted market expectations of a new round of quantitative easing (QE). A new psychological floor for Eurozone interest rates led to a major bund sell-off, with German sovereign debt now yielding -20 basis points (bp), more than the -40 bp seen just a few days ago. In the US, attention is on the timing of the widely expected 2019 cuts (of about 50 or 75bps). Overall, yield curves mostly steepened: the US 10yr yield rose by 9 bp to 2.12%, while its German equivalent gained 15 bps to -0.21%.
To further fuel the repricing of fixed income, we had a few better data releases on the heels of a strong US payroll last week. Eurozone Industrial Production surprised markedly to the upside, printing +0.9% m/m in May and reducing the year-on-year (y/y)contraction to -0.5% y/y, less than the -1.5% expected. The US Consumer Price Index (CPI) also surprised to the upside, with core CPI at 2.1% y/y, above consensus expectations of 2.0% - hardly a case of the US Federal Reserve (Fed) undershooting its 2% inflation target... Finally, and while Chinese data continues to print in the slow lane, Credit activity surprised on the upside; everything else being equal, this could be a leading indicator of better things to come.
The soup is still at a pretty good temperature and Goldilocks remains happy - but as data continues to print in the next few weeks and months, we could have meaningful repricing ahead. This week, for instance, data led fixed income markets to erase the overshoot of the past weeks. Looking forward, earnings releases will give a better picture of second-quarter earnings, helping us assess whether Earnings Per Share (EPS) growth is on recessionary territory, or managed to escape it.
In DMAF portfolios, we continued to emphasise our carry theme and added to our Emerging Market Foreign Exchange (EM FX) carry basket. The basket now represents about 9% of the portfolio and is diversified across 7 currencies. EM FX has not had a meaningful change in valuations, contrary to other asset classes, and is also liquid. The asset class offers a real and nominal carry that pretty much beats anything else available, and is also supported by dovish major Central Banks. Finally, and in light of the better data, we adjusted our duration again, lowering it to 2.8 years.
We will be taking a break over the next couple of weeks and will return after the earnings season is over and the Fed and the ECB have had their July meetings. Until then, we would like to thank our readers for their time and attention and wish you all an enjoyable summer.