The weak U.S. non-farm payroll report on October 2 ultimately led to a relief rally in riskier assets, as the probability (over 50%) of a move in interest rates was pushed off until March of 2016. In addition, oil prices rallied. Prices may have been bolstered by a September IEA (International Energy Agency) report that the supply/demand imbalance would resolve, with global demand at a five-year high in 2015 and dramatic production cuts in store, especially in the U.S.
1. Can Central Banks and their QE programmes really influence inflation?
The announcement last week that inflation in the Euro-area had again fallen into negative territory wasn’t a huge surprise, given the recent fall in the oil price. And the core rate (inflation with the volatile food and energy components stripped out) was reported at 0.9%. Most forecasters expect the headline rate to increase towards 1% by early 2016, as the negative effects of the significant fall in oil prices in late 2014 fall out of the index. It must be disappointing to the ECB that eight months after announcing its QE programme, inflation remains so low. Not only that, but the ECB’s preferred measure (the expected 5-year inflation rate in 5 years’ time) hasn’t really moved much higher over those eight months. Neither is it just a European phenomenon – in all the major economies that have undertaken QE programmes (U.S., UK, Japan), headline inflation remains far from targeted levels. The European Investment-Grade Fixed Income Team have long been sceptical about the ability of QE programmes to directly influence inflation and economic activity.
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.
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.