Federal Reserve surprises the financial markets

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The Federal Reserve (Fed) triggered movement on the financial markets at the end of week by unexpectedly hinting about a rate hike. Bond yields climbed, particularly in the United States, while share prices fell. The financial markets were startled by the implication in the minutes of the meeting of the Fed’s policymaking committee that the Fed is seriously considering another rate hike. How should this development be interpreted?

The turbulence on the global stock markets earlier this year, and later the awareness of other factors that render a rate hike impossible. Ben Steinebach Ben Steinebach Head of Investment Strategy

The Fed Funds Rate remains exceptionally low, in a bandwidth between 0.25% and 0.5%. The US economy is improving steadily, and given the situation higher interest rates would be logical. Since the initial rate hike in December of last year, however, the Fed has made no further moves, in light of international developments: first the turbulence on the global stock markets earlier this year, and later the awareness of other factors that render a rate hike impossible. For example, the volume of dollar debts outside the United States has increased (particularly in emerging markets) and various emerging markets have pegged their currencies to the dollar. Raising the Fed Funds Rate would force the dollar up, rendering the dollar debts untenable and diminishing the competitiveness of the US. This might harm the US economy. However, the Fed’s minutes might be interpreted as an attempt to test the markets: the more unfavourable the responses are, the more likely it will be that the rate hike will be pushed back. It would be wise to delay such a move until July. The Fed’s next meeting in June will be the start of a condensed period of great uncertainty, which will include the UK’s referendum about the country’s membership of the EU and the parliamentary elections in Spain. In any event, the Fed does not seem to wish to suddenly alarm the financial markets. All in all, the response now was minor: a rise in the US 10-year yield by 11 basis points, with an even smaller increase in Europe. The stock markets also fell slightly, though they were already under pressure before the minutes were published. Although we still believe that the Fed will not raise its rates further this year, the chances that it will do so have become slightly greater. In Europe, the focus was on the European Commission’s decision to grant the Spanish and Portuguese governments more time to cut their deficits. This accommodation is undoubtedly based on the political difficulties that those countries are experiencing, which might be amplified under too much pressure.

A slow week on the stock markets

With the exception of the minutes published by the Fed, little happened to trigger movement on the stock markets. Bayer’s plans to take over seed producer Monsanto continue to draw much of the markets’ attention. With the earnings season just about over, our focus needs to shift to other developments: the plans of German pharmaceutical and chemical giant Bayer to take over Monsanto in the US, for example. With Bayer’s revenue reported at EUR 46.3 billion, some 3.5 times as high as Monsanto’s, the merger will make it the world’s largest agrochemical company. However, Bayer will need to be very careful that its image does not suffer too much: some of Monsanto’s products are drawing very unfavourable headlines, such as its herbicide Roundup, as well as many of its genetically modified products. Presumably as a result of these issues, Bayer’s stock has fallen significantly since rumours about the takeover first emerged.

Apple, whose stock has been on the decline for a while now, was given a boost last week when it was announced that Warren Buffett’s Berkshire Hathaway had bought an interest of around USD 1 billion. Usually Buffett ignores technology companies, focusing instead on understated value stock. Apparently he now finds the stock very interesting at its present price. In the Netherlands, Delta Lloyd published its Q1 results last week, at the tail end of the earnings season. Like Aegon the week before, Delta Lloyd reported that it had been affected by the extremely low interest during the first quarter of the year. As low interest rates mean higher future obligations, this puts the company’s solvency at risk. Delta Lloyd’s recent share issuance – though still a controversial move – helped to limit the consequences somewhat.

The stock markets were buoyed slightly by the rising oil prices, which stabilised at around USD 48 per barrel (Brent) last week. As a result, the stock markets fell no more than 0.1%-0.5% in the United States and 0.5%-1.5% in Europe last week. In Amsterdam, the AEX closed at 428.27 points on Thursday, down by 1.2% relative to the Friday before. On Friday morning the Amsterdam exchange was fluctuating at around 434.

End of the earnings season

A few companies have yet to publish their Q1 results this week. The focus will shift back to macroeconomic events. Those final companies are Hewlett Packard, Marks & Spencer and Best Buy. In the Netherlands, following the announcements by Aegon and Delta Lloyd, the earnings of NN (formerly Nationale Nederlanden) are anticipated with some concern.

More macroeconomic news is expected than last week, and about more important data. The main focus will be on business and consumer confidence. Firstly, various countries are set to announce their initial estimates of the sentiment among purchasing managers for May, both in industry and in the services sector. Belgium and Germany (Ifo) will report their actual business confidence data. In addition, Germany will publish the ZEW index for May, giving an indication of how investors view the investment opportunities in Germany’s and Europe’s economies. New consumer confidence data for May will also be released this week for the European Union, Germany, the Netherlands, France, Italy and the United States (University of Michigan). Details of actual consumption will be released in Germany (April), the Netherlands and Italy (March) and Japan (March). New reports of industrial orders in the United States in April and in the Netherlands and Italy in March are also eagerly anticipated. New estimates of Q1 economic growth are expected from the United States, the United Kingdom and Germany and of industrial output in Belgium in March. Lastly, the US will announce new home sales data for April.

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