Financial markets skip to a happier beat

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Financial markets kept calm and carried on over the summer, not knowing quite what to make of the many ‘known unknowns’. The bottom line, in my view, is that political risk is now on the wane: the difficulty President Trump is having in implementing any sort of reform is not, in the short term, going to have any negative impact on US economic growth. In fact, he may actually reach agreement on a new fiscal policy.

In France, the new government is implementing its reform programme and the upturn in the eurozone economy offers scope for a little less austerity, which should in turn push back populist tendencies as a result of the euro gaining momentum in foreign exchange markets.

In my opinion, the euro’s rally will only pose a problem if it rises above 1.25 against the US dollar (see Exhibit 1 below). In that case, the ECB would adjust its policy to counter the rally.

Exhibit 1: Change in the EUR/USD exchange rate between 21/03/2005 and 21/03/2017 (the graph shows the number of US dollars for one euro)

comebackKey to graph:

  1. In the spring of 2008, the euro/USD rate approached 1.60 as the US Federal Reserve reversed its interest-rate policy, while the ECB continued to raise interest rates
  2. After oscillating at around 1.10 since 2015, the euro has rallied to 1.20 recently after the ECB signalled a possible slowdown of its asset purchase programme

Source: Bloomberg, BNP Paribas Asset Management, as of 19/09/2017

The real uncertainty for me concerns the Fed’s monetary policy in the face of lower-than-expected inflation, although the latest US economic indicators look beter than the data of the first half of 2017.

Investment, along with consumption, should support  economic activity in the US. This would pave the way for NICE (non-inflationary, constant expansion) growth globally supported by cautious central banks.

Overall, looking at financial markets, the environment remains favourable for risky assets and poses little threat to bond markets: the volumes of liquidity to be invested will be particularly attracted to bonds as they continue to be perceived as intrinsicly low-risk investments.

Written on 19/09/2017

This article was originally published in Option Finance ©Option Finance

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