Here are the big questions for markets and investors as a new trading week beckons.
Does a measured Fed risk being left behind by inflation?
After a barrage of central bank meetings, Brexit angst and the first major European election for the year, market volatility across bonds and equities remains quiescent. Having been primed for a more aggressive Federal Reserve and wary of polls being wrong ahead of the Dutch general election, an element of relief pervades markets, best expressed by emerging market stocks hitting a 20-month high.
However, there are disconcerting signals. These include the fact that just three weeks ago no one in the bond market expected a Fed rate tightening in March. Anticipating just two more for the rest of 2017 at this juncture is certainly a leap of faith. Last week’s surge in the price of gold reflects concern that a measured Fed runs the risk of being left behind by rising inflation. Also nagging in the background as Wall Street looks to take out recent record highs, the fall in US corporate profit expectations for 2017. Analyst estimates for S&P 500 earnings are $131.28, down from $133 a share before the election of Donald Trump.
Another way of gauging investor complacency towards US equities is illustrated when we look at the S&P 500’s 12-month forward price-to-earnings ratio, divided by the current low level of Vix — S&P implied volatility. Clearly, the market looks rich.
This comes as investors continue pulling money from US junk bonds — often a leading indicator for broader risk appetite — as a sliding oil price rattles sentiment. As doubts grow over Opec’s ability to drain the crude supply glut, another drop lower in oil prices looms as a major risk for investors. Then there’s the French election, set to pick up the pace and increasing dominate market attention ahead of the first round of voting in April.
For all the recent chatter about the Ides of March, perhaps T.S. Eliot’s line, ‘April is the cruellest month’ will resonate more for markets.
They think the dollar rally’s over — is it?
The market sprinted up to last week’s Fed meeting buoyed by the prospect of a rate rise and excited by the idea of a faster rate-setting pace. The Fed delivered the rise but not the pace, and the risk for dollar bulls is that the post-meeting disappointment that knocked 1.4 per cent off the dollar index may not only linger but turn into something more permanent. This was reinforced by hawkish chatter out of the European Central Bank and the Bank of England.
Derek Halpenny at MUFG thinks positioning was behind the sharp drop in Treasury yields, that the Fed message was far from dovish and so the market “looks detached from reality”. Conclusion: there is room for further dollar strength, but as other central banks start to follow the Fed’s tightening lead, the window for the dollar rally is closing.
With central banks having had their say, politics returns to the spotlight as the first debates in the French presidential election are held and the Trump budget plan is aired. The dollar looks fairly rangebound in the short term.
Are Kiwi and Aussie dollars approaching an inflexion point?
Hot housing markets yet recovering economies mean investors think both will start raising rates at about the same point in late 2017 or early next year. But will they? Both also want lower rates for longer to help weaken their currencies and lift inflation. Yet the Reserve Bank of New Zealand, meeting on Thursday, has the hotter housing market — and has a habit of using rates to control it. Expect no action this week but watch for comments. Watch too the Kiwi-Aussie cross: it makes up the largest part of the RBNZ’s trade-weighted basket, ahead of the US dollar and the kiwi is at an 11-month low, which in theory helps any RBNZ hawks.
How long before attention returns to Italy?
The European country with the largest absolute stock of government debt is not due to hold elections until May 2018, but an earlier vote is possible. A caretaker government is in charge after Matteo Renzi resigned in December, and the populist Five Star Movement leads in opinion polls.
Markets appear relatively unconcerned and UniCredit, the country’s largest bank by assets, recently completed a €13bn sale of stock to address fears about its financial health. Yet similar measures for other banks, including the country’s third largest, remain stalled. Questions about popular commitment to the euro, meanwhile, continue to percolate.
Remember, once inflation and population changes are adjusted for, the Italian economy has not grown since it joined the euro in 1999. Bond house Pimco also highlights an unemployment rate of 11.9 per cent, broadly unchanged from 1998, and high levels of youth unemployment and bad loans held by banks.
The point is not that a euro break-up is imminent, but the ECB will face much more than questions of inflation when it begins to reduce monthly asset purchases early next year, or sooner. The buying has kept bond yields in Italy, and perhaps other problems, firmly suppressed.
Reporting by Michael Mackenzie, Roger Blitz, Jennifer Hughes and Dan McCrum
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