Federal Reserve depresses the dollar

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Federal Reserve

The trend on the global financial markets that was set during the initial months of the year continued last week. The only difference was that share prices in the United States outperformed those in Europe. Bonds continued to climb.

The reasons for postponing and slowing any increase in the federal funds rate are clear. Ben Steinebach Ben Steinebach Head of Investment Strategy

One factor contributing to the marginally stronger performance by US share prices was a slight recovery by the euro relative to the US dollar (from USD 1.05 to USD 1.07). This was caused primarily by the publication of a report by the Federal Reserve’s monetary policy body, the Federal Open Market Committee (FOMC). Although the Fed appears to be becoming slightly less patient (as indicated by the non-appearance of that word in the report) about raising interest rates, the wording remains very guarded. In the interpretation of the financial markets, this appears to mean that any interest rate hikes will come later and will be more gradual. For the same reason, we have also modified our views and now expect the first interest rate hike to come in September, with further increases every three months initially and every six weeks during the latter half of 2016. This will bring the federal funds rate to 0.75% by the end of 2015 and to 2.25% by the end of 2016. These figures are higher than the average numbers projected by the markets.

The reasons for postponing and slowing any increase in the federal funds rate are clear. Despite having fallen slightly last week, the dollar has appreciated much faster than expected, causing an effect similar to a rate hike. At the same time, recent data about the US economy are less encouraging and the Federal Reserve will prefer to wait and see whether this setback is temporary or the beginning of a new trend. As matters stand, we feel that temporary factors (poor weather conditions, strikes in the ports on the west coast that are disrupting trade) have the upper hand at present. Nevertheless, some disappointing data were released last week. The Philadelphia Fed Index and the Empire State Manufacturing Index – two indicators of current developments in the economy (in this case for March) – were down and fell short of projections. Similarly, the number of housing starts had plummeted, though this can presumably be attributed largely to the bad weather across large parts of the country. A rapid rate hike would also raise question marks while many other central banks around the world are still easing their policies.

The ECB continued to buy up bonds last week, and the market is gradually beginning to feel the scarcity. The yield on 10-year government bonds in Germany fell to below 0.2%, and rates continued their slow decline in other countries as well – for example in Sweden and Denmark, where bond-buying programmes were intensified and/or rates were cut (or forced further into negative figures). Against the backdrop of these developments, the fact that the US stock markets slightly outperformed their European counterparts is remarkable; the dollar’s slight fall last week must be the main cause.

Court rules against Boskalis

A further reason for the slight underperformance of Europe’s share prices was the renewed concern about Greece. Without additional support, the country risks becoming unable to fulfil its payment obligations shortly, and a bank run seemed likely. However, a step was taken in the right direction last week. ECB President Draghi, Chancellor Merkel, President Hollande, Eurogroup President Dijsselbloem and Greece’s Prime Minister Tsipras met separately during the summit of all (or nearly all) European government leaders in Brussels, and during the small hours of Friday morning reached a consensus about further austerity measures by the Greek government. Although these technically still need to be approved by the ECB, the IMF and the European Commission, this represents a step in the right direction. The risk of a Greek bankruptcy within a fortnight appears to have been averted, at least for the present. Europe’s markets responded with guarded optimism on Friday morning.

Europe’s stock markets were somewhat subdued last week, mostly waiting to respond to reports from the Federal Reserve on Wednesday and news about the Greek situation. The markets climbed between 0% (Germany’s DAX) and 0.7% (the AEX), which was slightly less than we have come to expect over the past months and also fell short of the performances of the US markets, which were up between 1% and 2.5%. Apart from the Swiss exchange the AEX achieved the strongest increase in mainland Europe. Little in the way of corporate news was published last week. Fugro won the legal proceedings brought by Boskalis to have one of Fugro’s three anti-takeover constructions eliminated. However, Boskalis has not given up, and reports that it intends to hold on to its stake in Fugro for years and that it does not rule out the possibility of further legal action. On Wednesday construction company Ballast Nedam announced that the A-15 Maasvlakte-Vaanplein project is costing it more money than foreseen. This comes as yet another indication that the Dutch construction industry is in serious trouble, in particular the operators working on government contracts. DSM reported that it has managed to spin off part of its operations (polymers and resins) into a joint venture with CVC (which has a 65% stake in the joint venture). The revenue will become visible in DSM’s earnings for Q3.

Macroeconomic news continues to dominate

No corporate earnings are expected to be announced this week, or in fact until the Q1 earnings season begins in mid-April. As such, the markets will need to rely on news from the macroeconomic arena. This week will likely shed more light on the status of the US economy: in particular through data about the US housing market (sales of existing and new homes) in February, which is slightly less dependent on the weather than housing starts. Other important indicators from the United States will include the number of orders for durable goods (also for February) and consumer confidence as measured by the University of Michigan. This latter indicator fell in February, in part as a result of the stronger dollar and the port strikes, and it remains to be seen whether the trend of gradual recovery will resume in March. Data from the eurozone will include producer confidence in Germany (the Ifo Index), and we look forward with particular interest to any confirmation of the strong rise of the ZEW Index that was announced last week. Several countries will be releasing new data about the sentiment among purchasing managers. China will also do so this week. Lastly, of course, we will continue to keep a close eye on the developments surrounding the ECB’s bond-buying programme, and above all whether any real scarcity of suitable securities seems to be arising in individual countries.

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