US
The market movers in the week just past us in the US were certainly the news on the labor market; non-farm payrolls soared past estimates at 295,000 and unemployment tumbled at 5.5 per cent. The latter figure is the upper limit of what has been previously defined by the Fed as the rate consistent with US full employment. This strongly points in the direction of the Fed dropping its “patient” qualifier when describing the timing of an interest rate rise already at its next meeting. However, Fed officials can point to still limited wage gains, which are the main determinant of core inflation, that are up 2 per cent on last year’s level, a figure that policymakers would like to see closer to 3 per cent. Other possible signs of slack in the labor market that do not show up in the unemployment rate figure are the participation rate, ticking up by ten bps again at 62.8%, and the proportion of long-term unemployed, still very high by historical standards at 31%. Still, even discounting the dovish bias of the Board, our base case is a first rate hike by September, in order for the Fed not to be behind the curve when inflation does show up.
The effect of Friday’s development on stocks was negative, with the S&P 500 falling by nearly one and a half per cent as agents priced higher borrowing costs in the near future. The index fell from above 2,100 to close the week at 2,071. The DJIA and the Nasdaq suffered similar losses, both falling in value by more than one per cent.
The effect on bond yields was more dramatic in proportion, as can be seen in the yield curve below. Yields on the rate-sensitive 2-year note rose by 8 bps intraday while those on the 10-year maturity rose by nearly 15 bps. Indeed, the strong showing of the US labor market is not only putting pressure on the timing of rate hikes, but also raising inflation expectations for the future.
The US dollar was also affected by the news; the dollar index rose by more than one per cent to 97.61, with a clear spike at the time when the payrolls figures were released. That the jobs figure was so remarkable despite the continued appreciation of the dollar, which puts a drag on profits of US companies abroad, is a sign of optimism; however, policymakers and businesspeople alike will need to tolerate a stronger dollar still, especially as the monetary policy divergence between advanced economies enters its acute phase.
Eurozone
The week began with encouraging data concerning Italian economy. Italy’s unemployment rate unexpectedly fell in January, dropping to 12.6%. However, the market did not react euphorically to this news as approaching a record high level not breached in years. The FTSE MIB stood flat at 20485. On the other hand, Eurozone’s Markit Manufacturing PMI has been revealed to be slightly lower than expected (51.0 vs 51.1 exp.) with mixed interpretations regarding each single country. Italy is showing a good momentum with PMI at 51.9 vs 50.3 exp, Germany is on a good track too at 51.1 vs 20.9, while France’s struggle to recovery has again been revealed to be worse than expected 47.6 vs 47.7 exp. Later on the day, February’s Consumer Price Index surprised positively the market at -0.3% vs -0.5% exp. relieving investors’ concerns about a worsening deflation report.
On Tuesday, German retail sales recorded the biggest monthly increase in seven years, on the back of rising wage and cheaper oil. In particular, seasonally-adjusted sales in real terms rose 2.9% from the previous month. However, as it happened in the Italian market, the DAX posted a negligible positive performance.
Nevertheless, the main event of the week was Draghi’s speech set on Thursday. ECB’s upbeat comments on the outlook for Eurozone growth and inflation, plus confirmation of the imminent start of the QE programme, provided a positive backdrop for stocks and Govies rates across the region. Draghi confirmed that the €60bn a month bond-buying plan will continue until at least September 2016 and especially until the European economy reaches a “sustained adjustment” of inflation towards medium-term price stability. He then defined -0.20% as the maximum negative yield of the bonds he is willing to buy. Euro Stoxx 50 edged up almost 1% to a renewed 6-year record high, while 10y sovereign yields in Italy, Spain and Portugal fell 8-10 bps to finish the session near to record lows.
On the FX side, since the beginning of the week, the EUR/USD exchange rate continued to show a downward trend. The movement was driven by the divergent monetary policies that US and Eurozone’s central banks are going to implement. Furthermore, on Friday, a remarkable US NFP figure strengthened even more this performance, given a higher possibility of an early hike of interest rates in US. The exchange rate touched 1.0842, trading at its lower level in more than 11 years.
Source: Bloomberg
UK
The week began with stronger than expected reports of Manufacturing PMI (54.1 vs 53.4 exp.) and PMI Construction (60.1 vs 59.0 exp.). These confirmed that UK’s economy is still on track of good momentum of growth. However, the FTSE 100 lost about 1%, after hitting a new record intraday, during the first 2 days of trading because of some profit takes at the 7-year record high level, along with the rest of Europe.
On Thursday, FTSE 100 edged up along with rest of the European equities thanks to Draghi’s confirmation of QE and his confidence in European growth and inflation recovery.
While on Friday, the equity index closed at -0.71% following New York’s fall after American Non-Farm Payrolls and Unemployment rate outstripped expectations.
On the other hand, the UK Gilt 10Y rate edged up remarkably (+10bps) on Friday US NFP release given the similar situation on unemployment, which could show a good momentum as US job market is doing. On the FX side, GBP/USD depreciated to a level of 1.5057 following the possibility of an early interest rate hike in US.
Emerging Markets
It has been a though week for emerging markets as a whole. Emerging Markets are sensitive to monetary policy in the US because most of them have dollar denominated liabilities, while assets and revenues denominated in their own currencies. A rise in US short term interest rate, as the markets are increasingly pricing after another strong NFP, would not only increase liabilities of countries borrowing in US Dollars, but also decrease the relative attractiveness of investments in EM. Economic theory forecasted selloffs in equity, bonds and currencies of Emerging Markets that occurred this week, exacerbated by a strong NFP on Friday.
In particular, the following chart shows the JPMorgan Emerging Market Currency Index over the past five years. It shows that since the Fed announced it would taper in mid-2013 a basket of Emerging Markets Currencies lost about 20%, most of which in the past few months. Losses were particularly strong on those currencies who were already under pressure, such as the Turkish Lyra and the Peso, which hit new low. Brazilian Real was instead more resilient, partially helped by Wednesday 50 Bp rate hike, which brought the Selic rate to 12.75%.
Source: FT, Bloomberg
Equities responded negatively as well, with widespread selloffs including that on SHCOMP (Shangai Composite Index) losing about 2% from Monday. This was partly due to the Chinese Premier Li Keqiang reduction in the country’s growth outlook to around 7%, acknowledging that Chinese growth will necessarily have to slow down in the future.
Russia, the Emerging Market that suffered the most the Oil slide, was the best performer in this category. Its equity index, the MICEX, trades near 4 year high and was flat on a 5 days basis. The Ruble, sharply sold off in the past few months, even managed to make some gains on the Dollar.
Overall, we expect further losses on equity indexes and currencies of emerging markets. Those most likely to suffer the most are those of countries with a negative economic situation (Argentina, Turkey and partly Russia and Mexico), as well as an unfavourable balance of payments. Finally, we expect high volatility on indexes and currencies of those countries with significant foreign holdings in assets.
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