Italy’s December 4th referendum vote on reform of the Italian political system to give more power to central government to, in turn, make it easier to pass legislation was seen as a major event for the markets. It was believed that if Prime Minister Renzi lost the vote the market would react badly, especially the Italian banks. This was because a new general election could see the election of the anti-EU Five Star Alliance, threatening Italy’s membership of the EU and even the fabric of the Euro currency. A Renzi defeat was also seen as negative for Italian banks who are in desperate need of financing and any political uncertainty would hamper this.
In the end, once again, we had a surprise move by the markets similar to the unexpected Brexit and Donald Trump market movement reactions. Renzi, and his political reform, was defeated. Equity markets opened lower but a sustained rally has followed. Since the ‘no’ vote the Italian stock market is up 9.2 % led by the banks. Indeed, the Italian banking index is up over 13%. UniCredit up almost 30%.
Investors are taking the view that, in the event of Italian banking difficulty, the European Central Bank would step in and provide support i.e the ECB is providing underlying support to the banks and the market.
The ECB has indeed been in the news recently: It met last week and made changes to its Quantitative Easing programme. This was expected after the ’negative’ Italian referendum news. The current programme is due to expire in March 2017, at present the ECB buys EUR 80 billion of government and corporate bonds each month. The ECB announced it would extend the programme by 6 months but reduce monthly purchases to EUR 60 billion. The markets viewed the news as a little mixed but ECB Chairman Mario Draghi has said he ‘will do whatever it takes’ (to stimulate European growth) and this again provides support to bond and equity markets.
Indeed European equity markets continue to perform well and are close to their highs for the year.
The German DAX is up 5.5% over the last fortnight and the FTSE 100 up 2.3%. Such markets have generally benefitted from solid economic data.
The US Federal Reserve is widely expected to raise interest rates when it meets later today. The key rate is the ‘Fed Funds’ rate which currently trades in the 0.25-0.50% range. Fed Funds is the rate that banks lend to each other overnight with money deposited at the US Federal Reserve (the Central Bank) and sets the benchmark for all other interest rates. It is worth remembering that US interest rates are still on post financial crisis ‘emergency’ levels and the US Federal Reserve wishes to ‘normalise’ interest rates, perhaps bringing Fed Funds back to 2-3% over the next two or three few years. A higher Fed funds rate would then give the central bank more room to manouvre should there be another financial crisis or similar.
Donald Trump stimulus policies around
- Increased infrastructure spending
- Lower corporate and personal taxes
- Less regulation (especially within banking)
has provided major support to US equity markets. The main US S&P 500 index hit another all time high last week.
At the same time, the prospect of stronger economic growth/ higher inflation/ higher interest rates has led to a significant rise (up to 1% or 100 basis points depending on bond maturity) in bond yields – so prices falling sharply accordingly. US Government bond yields rose further last week – rising 8 basis points (0.08) to 2.47% – the highest in 18 months. 30 year Govt bond yields are above 3%.
Foreign Exchange (FX)
The combination of Trump’s expansionary policies, with higher US interest rates looming, are supportive of the US Dollar as is the softer monetary policies in Europe i.e. further QE.
As a result the US Dollar is back to a 14 year high versus the Euro.
The US Dollar is similarly strong versus the Japanese Yen currently around 1 $ equals 115 Yen. Not that long ago 1 $ bought 100 Yen only.
The Japanese Yen is also regarded as a ‘safe haven’ destination as it is removed from European or US market troubles when they appear. With the world in a ‘risk on’ mode (favouring equity investment) investors are shying away from the Japanese currency.
Commodities – OIL
OPEC finally reached an agreement on a solid 1.2 million barrels per day reduction in oil production. As part of the deal, non-OPEC countries, Russia and Iraq, also agreed to reduce production. Brent crude rose 9% on the news. OPEC, led by Saudi Arabia, had forced down the price of oil over the last 18 months to try and eliminate the US shale gas industry which has much higher costs. This has only been partially successful as the shale gas industry matures and the cost of production decreases through efficiency gains. The significant fall in OPEC oil revenues over the last 18 months, and the economic pain of OPEC members, has led to the need to reverse the oil price decline.
S&P 500: 2250
FTSE 100: 6900
Bonds – 10 Year Government Yields
EUR/USD 1.0600 (1 euro buys 1.0600 dollars)
GBP/USD 1.2600 (1 pound buys 1.2600 dollars)
OIL: Brent: 56.00 (dollars per barrel)
GOLD: 1155 (dollars per ounce)
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