The second half of May has been a lot calmer than the first which saw a number of equity markets posting sharp losses (Germany and France down almost 5 %) and bond yields moving significantly higher. Higher bond yields means lower bond prices and therefore losses for investors! The yield on the benchmark 10 year German government bond moving from 0.10 at the end of April to 0.75 by the middle of May. Both bond and equity markets had been ‘spooked’ by the surprise rise in oil prices (which gives the potential for higher inflation down the road) and a feeling that markets had got ahead of themselves.
Since then markets and prices have stabilised and indeed recovered somewhat. Bond prices are higher with 10 year German government bonds now back to a yield of 0.55%. Major equity markets are again not far from all time highs.
Markets are calmer partly due to continued weak economic data coming out of the US reinforcing the belief that the Federal Open Markets Committee (FOMC**) will not now raise interest rates in June with September looking more likely. Will the interest rate rise when it comes be bad news for markets?* Part of the FOMC’s job is to manage market expectations and to ensure that any rate rise is no shock. Janet Yellen, the Chairman of the FOMC, stated after last week’s meeting “I think it will be appropriate at some point this year to take the initial step to raise the federal funds target and begin the process of normalising monetary policy***”. So it is likely, when we do get this first Fed Funds rise in perhaps September, markets are unlikely to fall at all as the move has been so well telegraphed.
*Financial markets tend not to like higher rates as it suppresses economic activity/company profits and also makes current bond yields look unattractive in a new higher interest rate environment.
**The FOMC is the US Federal reserve system which makes key decisions about interest rates and the growth of the United States money supply. It meets every six weeks and issues a policy statement after each meeting. This statement, and the exact wording, is poured over by analysts around the world for guidance and clues as to the direction of US monetary policy which impact both the US and the global economy.
*** What is normalised monetary policy? The current ‘Fed Funds Rate’ is targeted between 0.00 and 0.25%.Pre financial crisis Fed Funds was around 5% in the same way that UK interest rates / Base Rate was 5.50 % in 2007. It is widely believed that it will take several years before interest rates return to anything like these levels. However a good point to understand is that the current extreme low global interest rates (and negative short term bond yields in Europe) is not the norm!
Miscellaneous
- The ECB announced that it would make changes to its EUR 60 Billion a month bond buying programme by varying the monthly amount purchased to suit market conditions. Particularly relevant given often heavy European holiday schedules!
- Greece debt repayments remain on a knife-edge although the markets are well used to this by now and a huge market shock is unlikely whatever the outcome.
- The Japanese economy showed strong growth in the first quarter as Japan continues it’s ultra lose monetary policy. The Nikkei 225 index has responded well trading above the 20,000 level.
- The Chinese market continues, what seems to be, its speculative ‘bubble’ rise with the Shanghai index reaching a seven year high not backed up by improving economic fundamentals (GDP growth remains around 7% which is low by Chinese standards!)
EQUITIES
S&P 500: 2125
Nasdaq: 5080
BONDS – 10 Year Government Yields
US 2.20%
EU 0.55%
GB 1.92%
FOREIGN EXCHANGE
USD/EUR 1.1000 (1 euro buys 1.1000 dollars)
GBP/USD 1.5500 (1 pound buys 1.5500 dollars)
COMMODITIES
OIL: Brent: 65.00 (dollars per barrel)
GOLD: 1200 (dollars per ounce)
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Regards
Paul McCormick
