Graduate Market Update

Fixed Income

A lot of attention right now is on the shape of the US Treasury yield curve. Short rates have risen sharply this year driven in large part by a sharp increase in the perceived probability of aggressive monetary policy from the Federal Reserve for the rest of the year. Three ‘Fed Funds’ rate rises are seen as very likely, and four seem more probable than ever before. The current ‘Fed Funds’ rate is in an interest rate range of 1.50% to 1.75%.

Such interest rates are set by the FOMC (Federal Open Markets Committee) which meets approximately every 6 weeks. The ‘Fed’ is on a mission to raise interest rates this year so as to ‘normalise’ interest rates. Note: The average key ‘Fed Funds’ rate (the rate at which banks lend to each other via deposits placed at the Federal Reserve) is 5.95% looking at the last forty years but it is perceived that 3% is the ultimate target for ‘Fed Funds’ in the current business cycle.

As the US economy remains robust and inflation approaches the Fed’s 2% target measure, yields in the US have risen this year. 10-year US Treasuries have risen from 2.5% yield-to-maturity to 3% YTM. However, short-term 2-year US Treasury yields have risen more sharply than this taking the 2-year yield to 2.5% on the back of the harder or ‘hawkish’ interest rate outlook. As a result of this, the yield curve has flattened. The difference between two- and ten-year Treasury note yields, at 50 basis points, is the narrowest for this important relationship since 2007.

Traditionally, such curve flattening would signal the probable onset of a pronounced economic slowdown. The yield curve is saying that it does not expect interest rates to rise above 3% for the next 10 years suggesting a less than robust economic environment. This of course has implications for the outlook for stocks prices.   

Stocks

Global stock markets have rebounded from the sell-off in February but below the highs seen earlier in the year. Sentiment remains mixed with continued volatility expected unlike the persistently rising equity markets of 2017. The sell-off in February, in itself, has created that air of uncertainty. Rising bond yields are of significant concern for the stock market.

 

Foreign Exchange

The US Dollar has generally been weak over the last 16 months

  • as US rate rises have turned out to be more gradual than anticipated
  • growth has returned to countries outside of the US 

However, over the past month the US Dollar has just enjoyed its best month since Donald Trump was elected boosted by a rise in US inflation and a stronger short-term interest rate outlook.

 

Commodities

Oil: Brent Oil is trading around $75 per barrel – a 40-month high boosted by

  • continued tension in the Middle East
  • the OPEC agreement with Russia to limit supply to the market remaining intact
  • low level of US crude inventories

 

Miscellaneous

Investment Management: According to Morningstar, passive US equity funds attracted $220 billion inflows last year, taking their total to almost $7 trillion, whilst active funds shed $207 billion continuing the investor preference for passive investment management over the past several years.  

M&A: This week J Sainsbury announced a takeover offer for Asda, owned by US retailer Walmart, for $10 billion. This will create the UK largest grocery chain. This has added to the record pace of takeover deals in 2018 with $1.7 trillion of deals agreed this so far this year, beating the pace of 2007’s pre-financial crisis high. High stock prices (enabling companies to use stock as part of an acquisition offer) and relatively low bond yields on an historic basis (enabling cheap debt financing) remain the drivers.

 

Equities

S&P 500: 2672

Nasdaq: 7100

FTSE 100: 7500

Bonds – 10 Year Government Yields

US 2.95

EU 0.55% 

GB 1.42%

Foreign Exchange 

EUR/USD  1.2100 (1 euro buys 1.2100 dollars)

GBP/USD  1.3800 (1 pound buys 1.3800 dollars)

Commodities

OIL: Brent: 74.00 (dollars per barrel)

GOLD: 1320 (dollars per ounce)

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About Paul McCormick

Paul McCormick is the founder of Opening City Doors and is a Financial Market Specialist having worked for several leading Investment Banks and financial technology institutions additionally.He therefore provides a unique insight, and unusually broad perspective, into the opportunities available in London Financial Markets and related sectors and how to launch your career in the ‘City’.