A storming start for risk assets has defined the first two months of 2017, with heightened optimism on Wall Street pushing the FTSE All-World equity index into record territory. Whether the rally can be sustained in March depends on the outcome of several key events. Here is a rundown of what looms for investors during the month.
US jobs data and the Federal Reserve
The bullish sentiment in financial markets has mainly reflected high hopes for economic stimulus from Donald Trump’s administration, with investors expecting details in the president’s address to Congress on Tuesday evening.
The mood has been helped by improving US economic data, which only adds to investors’ interest in the US employment data for February due on March 10. Coming days before Federal Reserve policymakers decide whether to lift short-term interest rates, the report is arguably the most important global economic release of the month.
Economists surveyed by Reuters expect 180,000 jobs were created in February, slightly below the 227,000-strong expansion in January. The unemployment rate is projected to decline a tenth of a percentage point to 4.7 per cent, while hourly average earnings are forecast to rise 0.1 per cent from a month earlier.
The US stock market has so far appeared sanguine about the prospect of the Fed raising interest rates again, seeing tighter policy as a sign of a stronger economy that will buoy corporate profits. However, the recent pullback in Treasury yields suggests the debt market remains unconvinced that policymakers will tighten policy at their March 14-15 meeting.
Yields on the policy sensitive two-year Treasury note have eased from a high for the year of 1.27 per cent to 1.19 per cent. Interest rate futures place the probability of a March tightening at 50 per cent.
Importantly, investors will hear from Fed chair Janet Yellen this Friday about the US economic outlook.
If the Fed wants the option of raising rates in two weeks without surprising the market, the speech is Ms Yellen’s chance to prime investors for such a possibility. Her testimony to Congress in February emphasised the central bank’s intention to raise rates this year. For Lena Komileva of G+ economics, this was “long overdue for a data-dependent, inflation-lagging central bank that is set to see its effective policy stance drift into evermore accommodative territory”.
The March meeting will show investors whether they will have to get used to a more aggressive Fed in 2017.
The ECB and the stimulus question
Policymakers and investors in the eurozone will have to weigh the divergent forces of economic confidence and political concern this month, as the European Central Bank’s governing council prepares to meet on March 9.
With unemployment down, business confidence up and inflation approaching the ECB’s target for the first time in years, some officials are expected to argue that years of extraordinary economic stimulus should be nearing an end.
The ECB’s previous decision to cut monthly bond purchases from €80bn to €60bn from April is regarded by some as the first step in an eventual withdrawal of quantitative easing.
Yet ECB president Mario Draghi has been careful to note that the region’s recovery must be sustainable to warrant any change in policy. There remain concerns about peripheral countries with heavy debt burdens, such as Italy and Portugal.
Markets are displaying both perspectives — with stocks rising on the economic recovery and bonds reflecting anxiety about political instability. The latter is illustrated by ravenous demand for German two-year bonds pushing yields to a record low of minus 0.93 per cent as investors seek out debt issued by Europe’s largest economy.
Regardless of the eurozone’s recent economic resilience, it will be difficult for the central bank to remove itself from markets, says David Owen, chief European economist at Jefferies. After years of ultra-low rates and billions of euros of bond-buying, “the ECB effectively remains the only game in town”.
Article 50 and the pound
Not so long ago, the formal start of the UK’s official exit negotiations from the EU was viewed among traders as setting the stage for further post Brexit-vote lows in the pound.
However, UK prime minister Theresa May’s well-received Lancaster House speech and the untroubled passage through parliament of the government’s Article 50 bill have blunted expectation of the event’s significance. Sterling is charting a steady course, holding near $1.24, thanks to reasonable economic data, European political risk and concern over trade policies that may unfold under the Trump administration.
That said, investors are hardly feeling any more certain about Brexit even if the reality of divorce is sinking in. The start of the two-year process for Britain’s EU exit will generate plenty of coverage, and investors will have to pay closer heed to all the strands of the negotiation, including the cost of Brexit, the rights of citizens and trade prospects.
Sterling’s vulnerability was underlined this week with a report that Article 50 could coincide with Scotland calling a second independence referendum. Even so, says MUFG currency analyst Lee Hardman, “we still continue to expect the pound to strengthen in the coming months, benefiting from rising political risk in Europe”.
Jane Foley, a currency strategist at Rabobank, cautions that Brexit talks will be tough and lengthy. “Already the EU has indicated that trade negotiations may not commence until the end of the year meaning many UK businesses will have to cope with prolonged uncertainty,” she says.
Watch but don’t worry on Holland
On March 15, the Dutch voters will go to the polls and potentially deliver the latest evidence of growing anti-establishment sentiment in Europe.
Geert Wilders, leader of the country’s rightwing Party for Freedom, has been leading the polls in the build-up to the vote, despite recently cancelling public appearances over security concerns.
The Dutch political system is highly fragmented, with more than a dozen political parties vying for seats. The Freedom party is polling at 29 seats, according to data from Peil.nl released on Sunday, out of a total of 150.
The political structure inevitably results in coalition, for which 76 seats are required, and effectively rules out a government led by an anti-establishment figure.
As such, markets for Dutch assets have remained sanguine as the election date looms. Yields on Dutch two-year bonds hit record lows last week, alongside German debt.
Joost Beaumont, an analyst at ABN Amro, says there has not been a significant change in investor behaviour in markets for Dutch covered bonds, high-quality debt instruments that are backed by mortgages and issued by banks. Instead, the risks lie in signals to a broader European audience.
“The bottom line is they [the Freedom party] will not be in government — in that sense the political risk is non-existent,” says Mr Beaumont. “The only impact it might have is some spillover effects to France — if Wilders wins a lot of seats, that will, of course, be the headlines in Dutch newspapers but also the newspapers abroad, and that can, of course, influence public opinion.”
Europe’s profit engine
Profit growth has been one of the missing ingredients for European stocks — so often a hotly tipped asset class, and so frequently a stubborn underperformer.
The long, hard winter for earnings in the region stretches back to the financial crisis, and a proper recovery in sentiment in part depends on that changing. There are signs from the region’s drawn-out earnings season for the fourth quarter of 2016 of a recovery. According to analysis from Morgan Stanley, 39 per cent of companies that have so far reported have beaten consensus estimates by 5 per cent or more, with 31 per cent missing, giving a net beat of 8 per cent.
“We anticipate that 2017 will see the first year of positive earnings growth in Europe after five consecutive years of earnings declines, seeing European earnings growing by 12 per cent, driven by a rebound in commodity earnings, a trough in financial earnings, improving global growth and rising margins.”
If 2017 is to be the year that European equities start to close the gap with their record-breaking US peers, the remainder of earnings season in March will need to sustain the momentum. Earnings from a range of blue-chips over the coming weeks, including German exporters Merck and Adidas, Italian oil group ENI and Suez, the French utility, have the ability to break or make the thesis.
Reporting by Eric Platt, Joe Rennison, Roger Blitz, Thomas Hale, Michael Hunter and Elaine Moore
