The first consequence of the prospect of an increase in interest rates was a generalized rise in US interest rates in the bond and money markets. With this increase becomes more attractive hold dollars because they are remunerated at a higher interest rate than the Euro and the Yen (two currencies with a perception of risk almost identical to the US dollar). But the appreciation of the dollar makes the purchase of commodities (whose price is expressed in US dollars) more expensive for European and Asian buyers. On the other hand, with the appreciation of the dollar (depreciation of the Euro) becomes more competitive European exports, which could mitigate the negative effects mentioned. However, the appreciation of the US dollar increases the debt (expressed in euro) of many emerging countries as well as their inflation (because imported goods are more expensive). Some of these countries (such as South Africa and Brazil are in a phase of economic contraction, which can not be tackled by the respective central banks to the extent that they can not reduce interest rates because of rising inflation. The rise in interest rates and US yields increases the attractiveness of bonds of this country when compared to the stocks of utilities and other more defensive securities with a high dividend yield. The increase in interest rates in the US decreases the present value of profits companies will generate in the future. This current value is calculated by the division of the value of estimated future profits for an interest rate. By increasing the denominator decreases the value of future profits and as such the fundamental value of companies. In this context, the banking sector is an exception. The rise in interest rates increases the differential between interest rates on loans and interest rates on deposits, which has a positive impact on the margin of the banks. This effect does not guarantee a valuation of US bank shares (or European banks present in the US) but may lead to an over-performance compared to other sectors.
Today begins one week quite intense in terms of interventions of members of the Fed. After the publication of the minutes of the last meeting of the Fed, investors will find out whether the position of the various members of the Fed remain. In fact, the meeting was held on 26 and 27 April, before they were published a series of economic data which pointed to a slowdown in the US economy. For today are scheduled interventions of Governors of the Federal Reserve of St. Louis, San Francisco and Philadelphia.
What an expressive rising effect on European Shares as Euro Falls!
The rise in European markets during yesterday’s session was due in part to the recent decline of the euro. Despite the depreciation of the European currency has started two weeks ago, only recently (when finally broke the 12.01 against the dollar) is that stock markets began to react to this movement. The depreciation of the Euro does not always translate into a recovery of European markets; often translates into a mere over-performance compared to their American counterparts. Despite the devaluation of the past few weeks (which was due to a higher probability of a rise in US interest rates), the Euro in 2016 has appreciated against the dollar contrary to most forecasts. To this has contributed, in relative terms, that the economy of the Eurozone have had a very resilient performance compared to the downturn suffered by the US and some emerging economies. Favoring this trend has mainly been domestic demand that has benefited from the reduction in fuel prices, the low interest rates and expansionary fiscal policies in some countries.
The stock market is extending the gains made in the previous sessions, supported by the statements of a member of the Fed, the positive indications of the real estate market, and the buying that have flocked to the technology sector.
The Chairman of the Fed has been, within the executive committee, the more conciliatory with the financial markets, and the one whom have shown more prudent in relation to a change in monetary policy.
Today, US markets will be closed, celebrating the Memorial Day. On this day are reminded Americans who have died in all military conflicts since the Civil War. This date marks the beginning of the period in which Americans begin to enjoy the summer holidays.
After a few weeks of under-performance, Chinese stocks were boosted by a Goldman Sachs study that assigns a probability between 50% and 70% of some types of Chinese shares to be included in the MSCI indices. These indices serve as a benchmark for many global managers. So, after being included in these indexes, global managers necessarily have to buy them for their portfolios. In Japan industrial production rose 0.30%, while household spending has retreated to 0.40%.
After trading above 50 USD / barrel on both sides of the Atlantic, crude has in recent hours a sharp devaluation. This downward movement is explained by the approach of the OPEC meeting tomorrow (which led some investors to profit taking), the statements of the Minister of the UAE oil (which reports that it is satisfied with the current market conditions, away so the scene of a freeze on production) and the disappointing data of the Chinese economy.
During the press conference, Mario Draghi should reiterate that monetary policy remains accommodative. It will be interesting to see if Mario Draghi will mention some risks approaching on the horizon, as the referendum in England (June 23) and the legislative elections in Spain (26 June).
On one hand, rising wages increases consumption and reflexively boosts GDP. On the other hand, the increase in wages generates inflation (increasing production costs and intensifying the demand for goods and services), helping the Fed to achieve the desired 2%. Thus, the two main employment report variables will be job creation and change in wages. Most likely, it is sufficient that only one of the two variables increase to reinforce the likelihood of an increase in US interest rates. Even if there a significant reduction in employment but accompanied by a rise in wages, the Fed may consider that the conditions for a rate hike are met. This position is explained by the fact that the lack of job creation is due not to a decline in economic activity but the lack of people available for hire without a prior increase in wages. In other words, such a scenario could mean that companies would be forced to pay higher wages to hire new employees, thus triggering the positive effect desired by the Central Bank. The employment report also deserves a note of warning. The reaction to its publication may be volatile to the extent that their numbers may be adulterated due to the strike by 36,000 employees of Verizon. Many of these workers (who are paid weekly) may not have received their salary and as such may be statistically treated as unemployed.
Although the unemployment rate is very sensitive to statistical adjustments, a decline as steep unemployment in weak job creation scenario is a rather contradictory combination. The only certainty that stemmed from this report is that wages continue to grow (0.20% monthly; 2.50% in annual terms), confirming the trend of recent months. The main reading from this report is that increases uncertainty about the future of monetary policy in the US. This indicator raises the question whether after this data (which should probably be revised upwards next month) is sufficiently striking for the Fed to postpone a possible rise in interest rates at the July meeting. Although these figures decrease the likelihood of an increase in interest rates, increase the uncertainty in the current environment and the uncertainty is the worst threat to the financial markets. Investors fear over an uncertain and unknown factor than a negative factor already know. In this context the intervention of Janet Yellen in Philadelphia (17h30) will be closely followed.
Beyond the issue associated with the future of interest rates in the US (and its impact on the Euro), European investors will begin to give increasing weight to the referendum on the United Kingdom staying in the European Union, to be held on 23 this month. After a great advantage in favor of permanence, recent surveys point to a minimum differential between the two camps. In addition to surveys, investors have monitored the odds that the bookmakers have assigned to each scenario. Another barometer is the evolution of the British Pound. An appreciation of the British currency may indicate a greater likelihood of victory to the “Remain in EU”. The reverse case provide an opposite conclusion.
Chinese economic indicators support the decision of the IMF, the OECD and more recently the World Bank to reduce estimates for global growth. Yesterday, the World Bank said it expects the world economy to grow only 2.40% in 2016 compared to the previous 2.90%.
In the pre-opening, European indexes traded with slight losses. Despite the rise of Wall Street, European equities should be conditioned by the weakness of the Asian session and the fact that the Euro is being traded near 14.01 against the dollar. The recent weakness of the dollar, the result of uncertainty about the future of interest rates in the US, had a positive impact on oil, gold and other commodities, which could ensure an early stage over-performance in oil and mining sectors. The referendum in the UK will have an increasing role in investors’ decisions especially if the result is still uncertain. Today at 8:00 am Mario Draghi will inaugurate the Brussels Economic Forum, an event where diverse personalities of the political, economic and financial world will be present. These events are always an opportunity to sound out the feelings and perspectives of some of the key players in the current environment.
The US stock market yesterday made a pause after the recent valuations. The selling pressure was mainly driven by the drop in oil prices. An indicator of the labor market was published, but it did not have a very significant effect on the stock markets. The number of weekly claims for unemployment benefits fell by 4,000 to 264,000 in the week ended June 4, compared to 270 000 estimated. The data from the previous week were revised up registered another 1,000 weekly claims for unemployment benefits than previously indicated. The dollar depreciated, reaching the minimum in over a month against the Yen. The main exporting companies were favored by this movement of the US currency. Prices of Treasury bonds to 10 years were up, putting their yields to the minimum levels since 11 February (1.673%).
Since Thursday there has been a devaluation of the Euro, which possibly indicates that non-European investors (mostly American) are selling European assets. For its part, the European managers take refuge in assets with a lower risk associated as German bonds. In commodity markets, gold and silver in smaller scale have attracted the purchases of several global managers.
The uncertainty that characterizes the outlook of the stock markets will continue to generate a risk aversion among global investors. While there is almost a consensus view that the Fed will not change interest rates in its decision tomorrow, the unknown in relation to the statement of the meeting, is from the perspective of investors, an additional risk factor in the current environment. But the factor that seems to be most conditioning the investor sentiment is the UK’s EU referendum. Yesterday, two new polls were released. The first commissioned by Telegraph states that 48% of Britons are in favor of permanence and 49% support the output of the EU. In turn, the Times of London published a poll in which 46% of respondents said they would vote to leave and 36% would vote to remain. But perhaps the most striking news is the position of the newspaper The Sun, the most widely read in England, defending the “Leave”. The Sun is a tabloid that according to many sociologists has a high ability to influence the vote of a portion of readers. Given the recent risk aversion, the technical situation of European markets deteriorated significantly. DAX broke several support lines, being the area of 9480/9500 an important support. From a purely technical point of view and given the speed of recent declines can not be excluded that the German index can at an early stage, halting the falls if that zone is tested.
Today the “Brexit” (the possibility of the UK leave the EU) may be overshadowed by the meeting of the Fed. In this context, it is expected that many investors to position their portfolios for this event. Some of these investors are hedge funds which in recent days constituted selling positions on equity markets and also in the British Pound. Thus, it is possible that these investors close some of these positions which will represent a buying impulse in such assets.
After the reaction of financial markets to the meetings of central banks, European investors will focus again on the referendum on the permanence of the UK in the EU. Regarding this subject there is a slight discrepancy between the polls and the odds offered by the bookmakers. The latest polls point to a growing advantage of the favorable field outside the EU. However, the bookmakers continue to assign a higher probability to the “Remain”. The reason for this difference is that the bookmakers, based on similar events that occurred in the past, presuppose that the undecided will vote for continuity. Thus, according to this assumption of bookmakers, the undecided tend to vote for the stay. Today will meet the Bank of England and the referendum is undoubtedly the main theme of the press conference.