Although the situation in the Middle East and Ukraine is not showing signs of lasting improvement, the apparent prevailing opinion on the financial markets this week was that prices had adjusted sufficiently in the previous weeks. The prices on the stock exchanges bounced back a little, and only the market for German government bonds still showed a trace of risk aversion.
The situation on the financial markets this week was dominated by diminishing geopolitical tensions and macroeconomic data.
Ben Steinebach Head of Investment Strategy
The deployment of the US Air Force, supported by French and British food drops, has improved the situation of the trapped Yazidis and has weakened the position of IS (Islamic State). With Iraq's Prime Minister Maliki resigning, the way will also soon be open for the US to provide more military aid. The ceasefire between Israel and Hamas, although uncertain to continue, is also having a calming effect on the international climate for the present.
The situation in Ukraine is still surrounded by numerous uncertainties, not the least of which is what President Putin's exact intentions are with the column of trucks containing relief goods for the separatist-occupied Luhansk region. Nevertheless, we do not judge the risk to be particularly high that the tension between the West and Russia will escalate: neither side would benefit much, considering the economic outlook. In Russia the economic outlook is already deteriorating rapidly with the existing sanctions, and in Europe it was recently announced that the Q2 economic growth this year stagnated.
Although the cause lies in significant statistical interference (between countries and between Q1 and Q2), it has nevertheless impacted the mood on the European bond market. In particular because the German economy shrank by 0.2% during the second quarter (following a 0.7% growth in Q1, however), German 10-year interest rates show a slight further decline, even briefly falling below 1% after the GDP data were released. Nevertheless, they fell less than in previous weeks, while interest rates on Europe’s periphery fell further. Combined with the slight recovery of the stock markets, it is fair to venture that the risk aversion diminished considerably this past week.
Favourable situation despite less encouraging economic indicators
Most regions published less encouraging macroeconomic data this week. Most of these were caused by statistical interference, and the outlook has not actually worsened. We believe that the stock markets were not deceived by this interference. In the United States, contrary to expectations retail sales did not rise in July. This came as a disappointment considering that incomes did in fact increase that month. However, with the improving consumer confidence the outlook remains favourable.
Japan announced a significant economic contraction during the second quarter of the year. However, this followed a strong Q1 expansion, when in anticipation of the introduction of a higher VAT rate effective 1 April Japan’s population recorded substantial consumption figures. The understandable result was a rebound in Q2. In China lending suddenly fell quite significantly in July, feeding speculation that the country’s growth is slowing down faster than anticipated. However, the drop appears to be linked to the increased regulation of shadow banking, and should instead be seen as a positive development. This is supported by the fact that the Chinese authorities are capable of compensatory measures, and generally in fact do so.
Europe saw industrial production fall in June and the ZEW index (an indication of how investors view the economy) fall in August, while the economic growth stagnated in the second quarter. The primary reason for these developments lies in the weaker German economy. After a very solid first quarter, with problems in some areas, Germany is experiencing a slight adjustment – which we believe will be temporary – in the second quarter. Most stock markets were buoyed by the diminishing geopolitical tensions and the fact that the economy has not fundamentally deteriorated in any of the regions concerned. The most important international exchanges rose by 1% (Dow Jones) to 3.6% (the Nikkei in Japan), while the DAX in Germany also realised a creditable climb of 2.4% last week. The AEX was also on its way up again last week and by Friday morning was at 399 points, more than 2% higher than the Friday before.
Discussion about quantitative easing flares up
Germany’s 10-year interest rates reached new lows, in part because of the economic growth data, which at a glance appear disappointing. It is uncertain whether this will give the European Central Bank (ECB) reason to launch a large-scale bond buyback programme (quantitative easing, or QE). Considerable arguments can be put forward against this plan; yet Europe’s Q2 economic growth data were disappointing and were one of the factors causing German capital market interest rates to drop.
However, because the drop was a minor one and corresponding interest rates in Spain and Italy – not generally the safest of harbours – fell even further, the conclusion cannot be that this represents another large-scale shift to safe harbours.
The poor economic development during the second quarter has fanned the discussion about a programme of quantitative easing by the ECB. In our opinion, it is improbable that the ECB will introduce such a programme, which would involve buying back government bonds on a large scale. On the one hand the underlying strength of the European economy is healthier than the data suggests, and we expect to see it a recovery during the latter half of the year. On the other, the ECB will wish to first assess the impact of the programmes already announced (such as the TLTROs, intended as a stimulus for bank lending to corporate clients). A small-scale buyback programme for asset-backed bonds therefore seems more likely to us.
Last few Dutch earnings yet to be reported
Last week the situation on the financial markets was dominated by macroeconomic data and the diminishing geopolitical tensions. Next week fewer macro data will be reported and only a small number of interesting companies have yet to report their earnings. The question is whether geopolitics will spoil the mood.
In macroeconomic terms we are looking forward to the inflation data from the US, the UK and Germany. The last of these, in particular, might cast a new light on the debate about the ECB’s policy. We also expect provisional data from various countries about the mood of purchasing managers in August. The Philadelphia Fed Index for the same month will be published too, giving an indication of business confidence in the region around Philadelphia. Lastly, we expect data about consumer confidence in the Netherlands, Belgium and the European Union as a whole. In terms of corporate earnings, besides Home Depot in the US, the most important results expected are from Dutch companies: Heineken, Ahold, Vopak and TKH.