Equities rallied in March for the third consecutive month, but seem to be running out of steam now that the major indices have made up almost all their losses from the fourth quarter of 2018. Global growth fears are making central banks very cautious; this is one of the factors behind the fall in the yields of long maturity G3 sovereign bonds.
- This was the strongest first quarter in global equity markets since 1998
- Bond markets rose, with the yield of the 10-year Bund falling to below 0% again
- Central bankers stuck in "Hotel California"?
- Bond and equity markets are sending contradictory messages. Which one is right on growth and inflation?
Time for markets to catch their breath?
Global equities held up well in March, but traded far more erratically than in January and February. On 21 March, the MSCI AC World (in US dollar terms) hit its highest level since 8 October and ended the month up by 1.0%.
Emerging markets underperformed, at +0.7% for the MSCI Emerging index (in US dollar terms) due to some tough going in Latin American markets.
Crude oil prices rose further with WTI up by 5.1% to USD 60 per barrel, but this did not suffice to trigger an oil shares rally. The first quarter saw OPEC and its partners achieve a stronger consensus, which paved the way for a cut in production. The oil rally ran out of steam late in the month after President Trump objected to the new price levels.
Currencies including the Argentine peso, Chilean peso and Brazilian real all lost ground to the dollar.
There were two dips in developed equity markets, the first early in the month and the second on 22 March. These moves highlighted investor anxiety over the increasingly uncertain economic environment including fears over growth, particularly in the eurozone, in the wake of disappointing economic indicators, and central bank concerns over economic activity and risks.
Investors had to reconcile their trepidation with a configuration that is normally favourable to risky asset classes – central bank forward guidance suggesting that interest rates will stay on hold for a long time along with a further heavy dose of non-conventional support measures.
Against this challenging backdrop, US equities were the top performer (+1.8% by the S&P 500), followed by Europe (+1.6% by the EuroStoxx 50, +2.1% by the CAC 40, and +0.1% by the DAX).
The FTSE 100 rode a weak pound to a 2.9% gain. The Japanese market fell (-0.8% by the Nikkei 225). Financials were negatively impacted by the prospect of lower for longer interest rates (in Europe and Japan) and a flattening yield curve (in the US).
Techs and consumer non-cyclicals outperformed, suggesting the markets are having trouble establishing their base case economic scenario.
Chart 1: Equities - sector performance in the eurozone
Lots to take into account
The liquidity glut had been priced in early this year, triggering the equity rally. In March, with no meaningful upturn in survey data, growth concerns worsened, driven by downgraded growth forecasts by several major central banks including the Bank of Japan, the Bank of Canada, the ECB and the US Federal Reserve. After another unexpected dip in eurozone PMI indices, global equities fell by 1.5% on 22 March (-1.8% for the EuroStoxx and -1.9% for the S&P 500).
Earlier, a decline in Chinese exports had once again put the spotlight on concerns over Chinese growth. Chinese authorities reassured the markets with corporate tax breaks and pledges that additional measures could be forthcoming, if judged necessary, to meet the 6%-6.5% GDP growth target.
Discussions on Sino-US trade were quite optimistic, with President Trump pledging that a “good agreement” would soon emerge. A cycle of “constructive talks” ended in late March with no final agreement, but discussions are set to continue into April. It appears investors are prepared to be patient. However, they seem to have given up on any meaningful Brexit scenario after weeks of unprecedented developments in the UK Parliament, which has been unable to pull together a majority for any of the options.
Cautious central banks and doubts on growth
The yield on the 10-year US T-note slid from 2.72% at the end of February to below 2.50% on 22 March in the wake of slumping equity markets and then fell further, ending the month at 2.41%. Bond yields were in fact reflecting developments in US monetary policy. Chair Jerome Powell’s comments (“This is a good time to be patient”) and the policy decisions announced on 20 March convinced observers that the Fed would be cautious and patient over the coming months in dealing with external risks to US growth.
Chart 2: The yields of 10-year US and German sovereign bonds fell sharply in March
The yield of the 10-year German Bund suddenly dropped below 0% in March and ended the month down by 26bp at -0.07%, its lowest since October 2016. It fell in two stages – after the 7 March ECB meeting on president Mario Draghi’s dovish language and then after the 20 March FOMC meeting when Fed announcements sent long US bond yields lower. The second leg down was spurred by PMI survey data pointing to a new slowdown in the eurozone. This sent the 10-year German yield into negative territory. Thereafter, long yields continued to fall on market expectations of an ever-receding horizon for key rate increases.
Doubts over growth in the eurozone, inflation that is still far below the ECB's 2% target (at 1.5% YoY for headline inflation in February and 1.0% for core inflation) and ECB language have convinced investors that monetary policy will remain dovish. In late March, Draghi even left the door open to another postponement of policy tightening.
Will central bankers have to stick to accommodative – or, in the worst case scenario, neutral – monetary policies forever? It would appear so. Based on the conclusions of policy meetings of the Fed, the ECB, the Bank of Japan, the Bank of Canada and others, QE (quantitative easing) seems as impossible to leave as the Hotel California (as the Eagles sang).
However, these trends in traditional monetary policy (adjusting key interest rates) and non-conventional policy (adjusting the central bank's balance sheet size) reflect current concerns and should not be misconstrued as firm commitments, even for the Fed, which has now set off down a far more dovish path.
In other words, central bank caution and patience could be the cause of greater market volatility, either because the banks will have to do another about-face or because focusing on economic risks could end up spooking investors.
The lull in the Sino-US trade conflict has been one factor in the equity rally so far this year, but the two sides have actually decided nothing. While Donald Trump has repeatedly cited headway in the negotiations and promised a “good agreement” as early as April, he has also threatened to impose customs duties on European products. Protectionism could therefore rear its ugly head again.
With global equities up by 11.6% in the first quarter and bond yields low – very low in the case of German bonds – financial markets could experience a knee-jerk reaction to any unexpected developments, much as they did in December.
When equity and bond performance reflects mutually incompatible scenarios and the risks are asymmetric, highly responsive asset allocation is essential and, to achieve that, it is crucial to track technical and market-sentiment indicators.
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