Markets - 06.08.2019

Monthly Pulse #08 19: FED cuts interest rates for the first time since December 2008 by 25 basis points

Markets expected more of a dovish stance in terms of the Forward Guidance though and took Powell’s statement as somewhat hawkish. The question will however remain: was this an insurance cut or rather a beginning of an easing cycle?


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Looking at the big picture, we stick to our view that trade disputes and geopolitical tensions remain the key drivers.for the global economy and markets. Trade tension have already caused global growth to slow and we expect further fallout that may weaken domestic spending. These days central banks have been quick to pivot to more dovish stances. This indicates they are ready to provide more stimulus to reduce downside risks, even though it is not clear that monetary policy stimulus can effectively offset the US protectionism.

Meanwhile the US economy is still resilient, and it does not look that a US recession is around the corner. However, market sentiments could change quickly which would weigh on global growth. Even if monetary policy and fiscal policy support helps extend the life of the cycle, we could still face the prospect of slower growth and higher inflation. Increasing macro uncertainty could also herald a shift to a new regime of more frequent risk asset sell-offs and higher market volatility. Therefore, we believe that that building portfolio resilience is critical as this cycle continues to age.

In Europe, the economy is still struggling with lacking inflation.Hence, the ECB will provide additional stimulus in form of a shift in forward guidance, lower rates or restarting of QE – all these ahead of the end of President Draghi’s term. Our main scenario is a deposit rate cut by 10 bp in September and a resumption of some sort of asset purchases. However, it is still doubtful if such measures are enough to spur the inflation, credit lending and ultimately growth in the Eurozone. Unfortunately, we have seen several times in the past that the ECB is not making any headway here.

Fixed income yields have lately fallen, driven by the decline in government bond yields and tightening yield spreads. However, if you look at easing measures by the central banks, the further downside potential for yields seems limited at mid to long end maturities – capping the return potential as well. We remain neutral and prefer short duration credit risk and exposure to capital structure with a tilt to EM debt.

Equity markets are attractive from the momentum point of view. European stocks look modestly overpriced versus the macro backdrop. However, the dovish shift by the ECB should provide an offset to a certain extent. However, we are still cautious and remain slightly underweight on global equities even despite of the prospect of an extended cycle. The geopolitical risks and trade tensions can shift quickly with increasing volatility and eventually stronger market slumps.

With the ECB becoming dovish again and the EZ economy continuing to be sluggish, the EUR/USD tends to stay under pressure. Additionally, the carry trade is still in favour of the USD with stronger labour data in the US. Gold has broken major resistances on the back of lower USD yields and softer USD. We continue to keep gold as a good portfolio diversifier but would dissuade from chasing the rally tactically as the trade looks crowed and particularly sensitive to FED policies. Oil bounced back lately as supply risks increased amid rising tensions in the Middle East. Analysts however consider a fair price of mid-60s for coming months.



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