The third quarter was a rough one for global financial markets. Concerns about global growth – particularly with respect to China, tightening global financial conditions, slumping commodity prices and the prospects of U.S. rate normalization:
- Triggered a broad based sell-off in global equities and emerging markets (EM) sovereign/credit debt
- Pushed investment grade/high yield spreads higher
- Supported G10 global bond yields
- Led to a broadly stronger U.S. Dollar (USD)
The results of the regional elections in Catalonia are now in and have given a resounding victory to the two pro-independence parties. It now looks like these two parties may form a coalition with the stated aim of declaring unilateral independence within 18 months. Such a gesture is unlikely to be met with acclaim by Spain’s central government in Madrid. A famous old phrase notes “a week is a long time in politics”, so much could change in the near-term. Our best guess right now is that some form of compromise will be reached between Catalonia and Madrid, which will involve a significant devolution of power to the Catalan region, but no independence. What might help concentrate minds is the threat from the Spanish Football Association that, in the event of independence, Barcelona would not be eligible to play in La Liga. Either way, Spanish government bonds have underperformed their Italian and German counterparts in recent weeks, and we suspect that this trend could continue in the short-term.
2. Euro Money Supply
The ECB has long understood that one of the keys to getting the European economy growing again was to stimulate money supply. After all, without access to credit most companies will struggle to survive. This was behind the ECB’s attempt to narrow the gap between the funding costs of Southern European companies and those enjoyed by French and German companies. In addition, that gap has been closing, with a parallel pick-up in European money supply (commonly known as M3). That progress hit a speed bump in August with M3 growth slowing from an annualised rate of 5.3% in July to 4.8% in August. However, the slowdown was apparently caused by a reduction in deposit flows, which may mean that money is being utilised elsewhere instead of being put on deposit. We believe this is a case of the ECB not being too concerned about one month’s numbers, but still being alert to the overall trend.
3. Euro PMI’s
The release of the European Purchasing Managers Indices (PMI’s) earlier last week was greeted with quiet satisfaction by the more hard-core and orthodox members of the ECB. Despite concerns about the potential impact of the recent slowdown in the Chinese economy on Europe, and Germany in particular, activity appears to have held up well. There was a minor drop in the Euro-area Composite PMI (the aggregate of the Manufacturing and Services PMI readings), but nothing too damaging. Indeed the levels of the Composite PMI would still suggest that Europe is on track to achieve annualised growth of about 1.5% in 2015, with Germany being slightly stronger. That is likely to ease pressure on Mario Draghi and the ECB to announce an immediate extension of the European QE programme, something that the Bundesbank and Northern European grouping within the ECB will surely appreciate.
The fallout from the surprisingly dovish Federal Open Market Committee (FOMC) and Yellen press conference were the main drivers behind slumping equity prices, falling commodity prices, supportive G10 global bond yields and a broadly stronger U.S. dollar (USD). Adding fuel to the fire was a growing Volkswagen scandal and weaker than expected PMI Manufacturing survey from China.
1. Over to you, Mario
Here in Dublin, the European investment-grade fixed income team must confess to being a bit confused. Some time ago, Stanley Fischer (Vice-Chairman of the U.S. Federal Reserve) indicated that the Fed would set U.S. interest rates based on what was happening in the domestic U.S. economy, and basically told developing markets to get used to it. But this week Janet Yellen (Chairperson of the Fed) told us that U.S. interest rates had been left unchanged due to, amongst other things, “recent global economic and financial developments that may restrain economic activity” – a clear reference to China. And while markets tried to digest this new focus, the Euro continued to strengthen. Continue reading
The Federal Reserve Board did what most observers expected today, holding any rate increase until at least October or December 2015.
While the Federal Open Market Committee professes to be “data-dependent” and focused primarily on U.S. economic data in making policy decisions, in the end, it was lack of progress on “core inflation”, and uncertainty regarding the global market outlook and market turmoil, that carried the day and led to their decision to defer a rate increase.
We believe three key factors entered into their decision.