The strength of the economic recovery has been the subject of concern in Europe for some time, and in August inflation even fell to 0.3% (against 0.4% in July). Even Germany regularly released disappointing indicators of confidence among businesses and consumers, while the harder economic data were also often discouraging. This trend was broken last week by two highly encouraging sets of data from Germany’s industry. Compared with June, in July factory orders rose 4.6% and industrial production rose 1.9%, figures which were much stronger than expected.
The ECB was expected to announce measures to avert the threat of deflation. The markets in the United States were less positive.
Ben Steinebach Head of Investment Strategy
When the measures announced by the ECB on Thursday also went beyond what had been predicted, the mood on the stock markets became slightly euphoric. Most European stock indexes climbed 2-3% from the Friday before, with half the increase coming on Thursday. In the absence of much meaningful corporate news, the principal factors driving the markets were this macro news and to a lesser extent the geopolitical situation.
Last week saw several new developments in Iraq, where once more a US journalist was beheaded, and in Ukraine, where Russian tanks appear to have invaded the country’s eastern parts. However, the fact that Russia and Ukraine entered into talks to resolve the conflict, combined with the news of further sanctions from the West to increase the pressure on Russia, allowed the stock markets to move past the reports of invasion with relative ease.
The AEX climbed more than 2% to 421.59 on Thursday, reaching its highest point since late June 2008. Within the index we have lowered our estimation of Boskalis to hold, in light of the concerns about the quality of the enterprise’s order book, and we welcome Wolters Kluwer back to our universe with a recommendation to buy. Unlike the European markets, the stock markets in the US showed little movement last week. The principal reason was that the strength of the US economy is so great that concerns are growing that interest rates in the US (i.e. the Fed Funds Rate) will be raised sooner than projected. However, we stand by our prediction that the Federal Reserve will not raise interest rates until mid-2015.
ECB seeks to accelerate increase in lending
The optimism in Europe buoyed interest rates on the capital markets. However, the measures proposed by the ECB will force them down again, increasing the difference with interest rates in the US and possibly giving the dollar an additional boost. The most striking news from the ECB is surely the decision to further lower the official rates by 0.1% point to 0.05% for refinancing interest, 0.3% for marginal lending interest and -0.2% for deposit interest.
The ECB evidently hopes to tempt banks to make more use of the TLTROs (targeted long-term refinancing operations) announced in June. TLTROs are cheap long-term lendings that may not be used for mortgages or for government bonds, and so are intended exclusively as additional financing for the business sector. Participation in these TLTROs is open in September and December, and the interest rate is based on the refinancing rate. With that refinancing rate at what Mario Draghi claims is the lowest level imaginable, it is more attractive for banks not to await the December operation.
The ECB also announced a buyback programme for asset-backed securities and covered bonds, the details of which will be announced early in October. With the TLTROs being used in part to repay the LTROs from 2011-2012, the net proceeds will be less than the total issuance. This also makes it uncertain what the total value of the programme will be (the suggested range was €600-700 billion), though so far the response from the markets has been encouraging. Nevertheless, 10-year interest rates in Europe’s core countries rose slightly (as a result of the improving economic indicators), though less than in the United States. In Southern Europe, however, 10-year interest rates continued to fall, forcing both Italy (2.37%) and Spain (2.18%) even below the US (2.45%).
Our prediction is that the capital market interest rates in the principal countries will remain very low for the time being, in fact somewhat lower than we had believed until recently. The difference between interest rates in the US and the euro zone countries is likely to increase, though, which will result in a stronger US dollar. On the morning of 5 September the euro fell below $1.30 for the first time since July 2013. This is a positive development both for Europe’s growth prospects and in terms of averting deflation, and was undoubtedly what the ECB had in mind.
Markets driven by macroeconomic indicators
No corporate earnings will be published this week: we will have to wait until mid-October for the next reports. Developments will therefore be determined by macroeconomic news and of course the geopolitical situation. We should perhaps wait and see whether any new conclusions can be drawn from the NATO summit in Wales, which ended on 5 September. The talks between Russia and Ukraine will also affect how the situation develops, as will President Putin’s response to the increased intensity of sanctions from the West.
In macroeconomic terms, we are eagerly anticipating data about industrial production in the European Union as a whole and in various individual countries, including the United Kingdom, Italy and the Netherlands. The question is whether these countries will mimic Germany’s performance in July. New data will also be released about inflation in China and in France. Near the end of the week details of US consumer confidence in September (preliminary data from the University of Michigan) and about US retail sales in August will be published. First, though, the latest US employment figures for August will be announced. They will be out by the time you read this, but I expect that between 225,000 and 250,000 new jobs will have been added and that unemployment will have again dropped slightly. We are looking forward to this news!