Developed and Emerging Markets
The month of June started on a positive note with a US employment data-set showing an 18-year low in unemployment, a solid amount of new jobs created and a greater than expected increase in average wage earnings, which is a key measure for the Federal Reserve. Strong output surveys also indicate that the US expansionary theme is ongoing, despite ongoing trade fears. Trade tensions were high and action followed threat with US President Trump announcing tariffs on China and entering into a volatile back and forth with major partners, such as the EU. The US Federal Reserve increased rates as expected, forward gudance being that of a more upbbeat and hawkish stance from Chairman Powell. The“Fed Funds Rate” now ranges from 1.75% to 2%, which is the highest level since 2008.
In Europe, the European Central Bank set a cautious tone citing the threat of global protectionism, rising oil prices and heightened financial market volatility. Mario Draghi announced asset purchases will finish by year end but rate changes will not be made until at least mid-2019. Italian political woes subsided as a newly formed coalition was sworn in, ending the country’s longest postwar political crisis. Two of the populist parties have joined forces and have vowed to boost the Italian economy through fiscal changes. Political infighting now raises issues in Germany with the threat of Angela Merkel being forced to meet the populist views of her coalition partners, in an attempt to repair the shift in public opinion and confidence in her leadership.
Capital markets responded accordingly. A flight to government bonds, weak equity markets and trade tensions paired with a strong US Dollar taking their toll on Emerging market assets. A signal of caution has also been observed in a further flattening of the US Treasury yield curve. The spread between 2-year and 10-year notes narrowed to levels unseen since 2007, as longer-term debt is being bought on corncerns of long-term growth and the belief being this is a signal of a looming recession.
The US Dollar has led gains through the month as economic data and moetary policy tightening have supported it’s strength. However, this has faded somewhat on news of trade wars and implementation of trade tariffs, ultimately adding to speculation that the US could struggle to maintain it’s expansion as a result. The European Central Bank’s delivery of guidance was seen as a soft, dove-like approcah whhich forced the Euro lower for most of the month. Larger casualties could be found amongst the Emerging Markets as the current risk-off momentum exists. The Turkish Lira.
Energy and other commodities
Oil oversupply concerns ensured volatile crude markets through the month. Saudi Arabia and Russia planned to raise output and agreed a deal with OPEC members and allies, given the risk of less supply later in the year. The agreed output measures were less than what was foreseen and as a result forced the Energy sub-sector to appreciate sharply. The wider asset class suffered on trade tension announcements.
Global Bond Markets
The second quarter has proven difficult for global bond markets. Investors have observed higher government bond yields, a cheapening of global credit markets and a depreciation in Emerging market debt, forced by monetary policy tightening and trade tariff announcements.
The US Federal Reserve increased rates, however, due to cautious investor sentiment the price/yield moves were somewhat muted. This is due to a flight to saftey by investors, in the main through the purchasing of high quality government bonds. Major global sovereign bonds were also sought by investors as the sense of risk aversion continued late in the month.
Global high grade credit outperformed high yield junk bonds. Emerging market weakness continued through the month. Tighter liquidity conditions have also weighed heavily on the region
Global Equity Markets
Trade war concerns defined the world’s equity markets in June. All regions were affected and switched between risk-on and risk-off phases. Hardest hit was the Asian region led by China and its proxy Hong Kong as well as Global Emerging Market countries. The U.S. and Europe managed to close the month almost unchanged albeit large price swings, which worked their way into a higher volatility reading.
In terms of world sector performance, major shifts happened from cyclical (e.g. Financials, Industrials, Materials) to defensive (e.g. Consumer Staples, Health Care, Utilities) sectors.
It remains to be seen if the aggressive US trade protectionist rhetoric will have meaningful adverse economic consequences. We are taking the view, that actual trade restrictions will be less severe than threatened and will not derail the global economic expansion.
Financial markets will remain choppy until trade uncertainties recede and global growth momentum bottoms. While the threat of protectionism has risen in recent weeks, we do not expect trade restrictions to derail the global expansion. Accordingly, we remain moderately pro-growth in our investment stance.
Volatility in global bonds should ease through the remaining of the year. Emerging market debt valuations have cheapened and look attractive on a relative basis versus High Yield. Central Banks will continue to normalize monetary policy and yields should creep higher, however, investors should be compensated by credit spread contribution. Uncertainties and looming risks will continue to be an anchor on major government yield curves. We continue to position selectively across the US Dollar denominated High Yield and Emerging Market sub-sectors whilst maintaining a bias to short duration and a heavy weighting to BBB credit.
We expect the equity market to remain range-bound in the near run as a strong corporate earnings outlook is offset by ongoing trade tensions, overseas growth concerns, and geopolitical uncertainties. The 6-12 month outlook for the global economy remains constructive, and rising earnings will enable stocks to resume their uptrend later this year. Against this backdrop, we maintain a moderately pro-growth positioning stance.
The US Dollar has found support in recent weeks and it’s appreciation has only moderated by careful delivery of guidance by central bankers and the difficulties expected from trade difficulties. We believe the US Federal Reserve will stay on it’s normalisation path (supporting the strength) and trade difficulties to relax. The Euro should remain accommodative until in to 2019 and the Japanese Yen will strengthen in times of uncertainty and caution, acting as a haven. Emerging Market currencies will falter on trade tension and US Dollar strength.
Energy prices will continue to be led by OPEC meetings and negotiations of output through to 2019. Metals may suffer further on trade tariff announcements and implementation. Precious metals will remain supported in times of uncertainty.
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