Market movements
August was an excellent month for investors in both bonds and equities. We saw government bonds in Europe rise sharply with the best monthly performance since the beginning of 2012. This also helped US Treasuries produce strong returns. In Europe, returns were variously 1.9–2.0% for the month as a whole. US Treasuries were up 1.2% and gilts rose 3.5%. This hauled credit up with it.
Of particular note was the recovery in US high yield, which posted a positive return of 1.8% for the month after outflows in July. For equities generally, markets were led by the S&P 500 index, which breached 2000 for the first time.
This represented a 4% rise, with financials outperforming. European stockmarkets were variously up between 0.5–2%. The UK market was up 2.1%. In emerging markets, Brazil was the star performer, up nearly 10% as people scented a political change coming. Indian and Chinese assets also rose. Only commodities were weak: copper was down 3%; sugar fell 5%; corn was flat after a weak July; and Brent crude oil was down 3.1%. The most important event was in currencies – the dollar strengthened, particularly against the euro, which declined nearly 2% against the US currency.
Quantitative easing for Europe?
Policy (or expectation of policy) linked all these developments together, as has been the case for the last two to three years. In August, we heard the admission by European Central Bank (ECB) Governor Mario Draghi – speaking at the Jackson Hole retreat – that the ECB was beginning to be concerned about the decline in European inflation expectations, which indicated a move towards some form of quantitative easing (QE). This was key to the stronger performance of European bonds, with 10-year German bond yields dropping by 27 basis points in August. French yields dropped by 28 basis points, from very low levels. People now hope the ECB will move towards implementing sovereign QE. However, real policy action remains some way off.
The first step along the way will be approval - possibly as early as Thursday of this week - of the beginnings of a programme to purchase asset-backed securities. This is a relatively small market in Europe, some 500 billion euro, so the injection that the ECB could make in terms of existing stock would be stretched over a period of time. The expectation is that the ECB would buy new asset-backed securities, and help companies reduce their cost of funding as a consequence.
Sovereign QE is some way off and we saw, as expected, a rather cutting response from Germany’s finance minister Schaeuble, who suggested monetary policy had reached its fullest extent in Europe. This is consistent with everything we’ve seen in the dance of ECB policymaking over the last two or three years: an initial proposition from Mr Draghi, followed by a period in which the hawks object, followed by a re- examination of still-softening data and a grudging acceptance. Nevertheless, I think we’re several months away at least – it may be the middle of next year – from full-on quantitative easing in the sense of buying sovereign debt. However, the markets anticipate, and that’s what we saw in relatively thin volumes in August.
Policy highlights in the coming week
In the coming week, the ECB has its meeting on Thursday this week. On Friday, payroll figures are announced in the US. Regarding the ECB, the market will be focused on whether or not the bank actually announces the beginning of QE, and Draghi’s remarks at the following press conference.
In the US, there is some expectation, given the softening trends in retail data and personal consumption, that the payrolls number will be sufficiently low – around 200,000 or below – to mean that the Federal Reserve’s meeting on 16 and 17 September will produce no significant change in the outlook.
One other central-bank policy point to note in August was the Bank of England’s (BoE) Monetary Policy Committee voting by seven to two in favour of retaining interest rates as they are. This was the first time under Governor Carney that the vote was not unanimous.
We believe that the BoE is slowly moving towards some form of tightening, but that this is several months away from materialising. Monetary policy is still wholly supportive and will remain so. This means holding cash is a rather painful experience, with bonds likely to continue to perform strongly, and equities even more so, particularly if good funding markets continue to allow buybacks of shares and cash-funded M&A activity. The only major fly in the ointment is geopolitics, especially developments in Ukraine. Here, the line in the sand that would lead to risk expanding well beyond Russian equities would be Europe and the US agreeing sanctions that would exclude Russia from the Swiss settlement system. If that happens, then I think we will see further escalation of geopolitical risk, but at the moment it’s more talk than walk as far as the markets are concerned. We continue to watch Ukraine and the build-up of Russian soldiers there, as it is the key threat to a pro-bonds, pro-equities, anti-cash environment.
August was an excellent month for investors in both bonds and equities. We saw government bonds in Europe rise sharply with the best monthly performance since the beginning of 2012. This also helped US Treasuries produce strong returns. In Europe, returns were variously 1.9–2.0% for the month as a whole. US Treasuries were up 1.2% and gilts rose 3.5%. This hauled credit up with it.
Of particular note was the recovery in US high yield, which posted a positive return of 1.8% for the month after outflows in July. For equities generally, markets were led by the S&P 500 index, which breached 2000 for the first time.
This represented a 4% rise, with financials outperforming. European stockmarkets were variously up between 0.5–2%. The UK market was up 2.1%. In emerging markets, Brazil was the star performer, up nearly 10% as people scented a political change coming. Indian and Chinese assets also rose. Only commodities were weak: copper was down 3%; sugar fell 5%; corn was flat after a weak July; and Brent crude oil was down 3.1%. The most important event was in currencies – the dollar strengthened, particularly against the euro, which declined nearly 2% against the US currency.
Quantitative easing for Europe?
Policy (or expectation of policy) linked all these developments together, as has been the case for the last two to three years. In August, we heard the admission by European Central Bank (ECB) Governor Mario Draghi – speaking at the Jackson Hole retreat – that the ECB was beginning to be concerned about the decline in European inflation expectations, which indicated a move towards some form of quantitative easing (QE). This was key to the stronger performance of European bonds, with 10-year German bond yields dropping by 27 basis points in August. French yields dropped by 28 basis points, from very low levels. People now hope the ECB will move towards implementing sovereign QE. However, real policy action remains some way off.
The first step along the way will be approval - possibly as early as Thursday of this week - of the beginnings of a programme to purchase asset-backed securities. This is a relatively small market in Europe, some 500 billion euro, so the injection that the ECB could make in terms of existing stock would be stretched over a period of time. The expectation is that the ECB would buy new asset-backed securities, and help companies reduce their cost of funding as a consequence.
Sovereign QE is some way off and we saw, as expected, a rather cutting response from Germany’s finance minister Schaeuble, who suggested monetary policy had reached its fullest extent in Europe. This is consistent with everything we’ve seen in the dance of ECB policymaking over the last two or three years: an initial proposition from Mr Draghi, followed by a period in which the hawks object, followed by a re- examination of still-softening data and a grudging acceptance. Nevertheless, I think we’re several months away at least – it may be the middle of next year – from full-on quantitative easing in the sense of buying sovereign debt. However, the markets anticipate, and that’s what we saw in relatively thin volumes in August.
Policy highlights in the coming week
In the coming week, the ECB has its meeting on Thursday this week. On Friday, payroll figures are announced in the US. Regarding the ECB, the market will be focused on whether or not the bank actually announces the beginning of QE, and Draghi’s remarks at the following press conference.
In the US, there is some expectation, given the softening trends in retail data and personal consumption, that the payrolls number will be sufficiently low – around 200,000 or below – to mean that the Federal Reserve’s meeting on 16 and 17 September will produce no significant change in the outlook.
One other central-bank policy point to note in August was the Bank of England’s (BoE) Monetary Policy Committee voting by seven to two in favour of retaining interest rates as they are. This was the first time under Governor Carney that the vote was not unanimous.
We believe that the BoE is slowly moving towards some form of tightening, but that this is several months away from materialising. Monetary policy is still wholly supportive and will remain so. This means holding cash is a rather painful experience, with bonds likely to continue to perform strongly, and equities even more so, particularly if good funding markets continue to allow buybacks of shares and cash-funded M&A activity. The only major fly in the ointment is geopolitics, especially developments in Ukraine. Here, the line in the sand that would lead to risk expanding well beyond Russian equities would be Europe and the US agreeing sanctions that would exclude Russia from the Swiss settlement system. If that happens, then I think we will see further escalation of geopolitical risk, but at the moment it’s more talk than walk as far as the markets are concerned. We continue to watch Ukraine and the build-up of Russian soldiers there, as it is the key threat to a pro-bonds, pro-equities, anti-cash environment.
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