Markets swing between fundamental and liquidity drivers

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In February, news of a halt in US interest-rate rises and the prospect of resolution of the US-China trade negotiations were the dominant themes.

  • Fundamentals to be key in the medium term – While investors have recently centred on the pause in the US Federal Reserve’s policy tightening cycle, we believe the focus will ultimately swing back to the economic and corporate fundamentals as the main drivers of markets. We are monitoring corporate earnings trends closely.
  • Worse risk-adjusted returns ahead – Despite the year-to-date rally in equity markets, we expect a regime change towards lower investment returns and more market volatility as the era of quantitative easing (QE) by the main central banks eventually winds down.

Two hot topics affected the markets: the Fed’s suggestion of a pause in monetary policy tightening and progress in Sino-US talks on a trade accord.

  • On the first, policymakers left US interest rates unchanged at their meeting on 31 January, released a dovish meeting statement and, importantly, dropped any references to further rate rises.
  • With respect to the trade war fears, reports that the talks between the US and China were progressing fuelled new hopes of an agreement between the two leading economies.

Both drivers buoyed equity markets, but compared to January’s strong rebound, February’s returns were less stellar. Regionally, the US market rose further, with the S&P 500 index flirting with 2 800 points (a roughly 4% gain MoM). In Europe, EMU and UK equities rose in line with other developed markets. European markets were bid up especially after comments on a new round of TLTRO liquidity in an interview with ECB board member Benoit Coeur. These were later confirmed by chief economist and board member Peter Praet (even though a decision still has to be taken). European banks outperformed on this news.

Exhibit 1: February 2019 cross-asset returns – risk-on mood lingers on in many markets

Markets swing between fundamental and liquidity drivers

Source: Bloomberg and BNPP AM, as of 28/02/2019

Given the risk-on mood in stocks, major government bond markets traded broadly sideways to slightly higher, with the dovish central bank stances providing important support. EMU ‘peripheral’ bonds underperformed (posting a negative MoM return, but still up so far this year) amid uncertainty over the outcome of Spanish elections and the impact of Italian populism. German Bunds did well, on the other hand.

The Brexit saga continued, even as the UK is getting closer to the end-March deadline for departure from the EU. PM May suffered another defeat in Parliament. Further votes are on the calendar, and the situation remains fluid, although Brussels seems reluctant to discuss new conditions for Britain’s exit.

In currency markets, the USD was seemingly not affected by the Fed’s move to pause. It gained marginally over the month amid weakness out of Europe. The JPY, typically a risk-off asset, fell, but its historically positive correlation with gold turned negative. Since the start of the year, gold has been boosted mainly by lower real rates rather than risk sentiment.

Elsewhere, in commodities, energy outperformed. Oil rallied amid political and social tensions in Venezuela, strong Chinese demand and OPEC output cuts led by Saudi Arabia.

Macroeconomic data pointed to a robust US economy. Weaker signals came from Europe, mainly the UK and Germany. The UK economy is clearly at risk of a no-deal Brexit, while the slowdown in Germany is a source of concern for the entire European economy given that Germany has been its growth engine for many years.

The latest corporate results were mixed: US companies generally surprised to the upside, whereas Europe disappointed. With positive surprises overall, Japan fell somewhere in between the US and Europe.

This is an extract from the asset allocation monthly by the MAQS team at BNP Paribas Asset Management. For the full version, click here >

Views expressed are those of the investment committee of MAQS, as of March 2019. Individual portfolio management teams outside of MAQS may hold different views and may make different investment decisions for different clients.

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