It has been an eventful period for markets with news from the European Central Bank (ECB) and the UK election. In the US all eyes were on former FBI director James Comey as he testified before the Senate Intelligence Committee on 08/06/17. The Federal Open Market Committee (FOMC) met on 14/06/17 when, as was widely anticipated, they decided to raise the federal funds rate by 25 basis points.
Against this backdrop, risk assets have performed very well with equity markets moving higher and credit spreads getting tighter. The S&P 500 Index remains near an all-time high at 2432 helped by a rally in bank stocks (see Exhibit 1 below).
Exhibit 1: Risk assets have been performing well with equity markets moving higher - the S&P 500 Index remains close to an all-time high at 2432 (as of 16/06/17) - the graph shows changes in the S&P 500 Index from 17/12/2007 through 16/06/17Source: BNP Paribas Asset Management, Bloomberg as of 16/06/17
At the ECB’s meeting on 08/06/17 the Governing Council left things fairly static with no change to key interest rates and no changes in their asset purchase program.
ECB interest rates are expected "to remain at their present level for an extended period of time, well past the horizon of the net asset purchases". The Governing Council upgraded their outlook for economic growth but also downgraded their outlook for inflation. As was widely anticipated the Governing Council removed their easing bias for policy rates citing that risks to the growth outlook were now balanced. Furthermore, domestic developments could pose an upside risk to the growth outlook.
While the discussion around the growth was somewhat hawkish, there was plenty of dovish talk around the inflation outlook. In Mr. Draghi’s press conference, he stated that the economic expansion has yet to translate into stronger inflation dynamics. In fact, the ECB’s forecast for inflation was revised downward from 1.6% to 1.3% in 2018 and to 1.6% in 2019. Clearly the risk of a scale back in assets purchases or of a rate hike have diminished. So the asset purchase program continues with no formal discussion of a taper. Meanwhile, we all know that a taper is coming as the ECB is rapidly running out of bonds to buy.
In the UK, Theresa May’s decision to call for an early election to help strengthen her positon in the Brexit negotiations with the European Union (EU) backfired. May’s Conservative party lost its governing majority and the UK now has a hung Parliament. The Conservatives previously held 330 seats and a slim majority. After Thursday’s defeat, the Conservatives only hold 318 seats and will need to rely on the Democratic Unionist Party to form a coalition government. While May’s future as Prime Minister is very much in doubt, she has for now vowed to stay on and says she intends to start working with European leaders on Brexit negotiations as scheduled on June 19.
Written on 16 June 2017