The Chairman of the Federal Reserve (Fed) believes that the US central bank is approaching the end of its rate hikes, which are now “just below” a neutral level that neither stimulates nor hinders growth. As a reminder, the Fed has raised its rates eight times by 25 basis points since December 2015 and should decide on a new increase at the end of its next meeting on 19 December. Jerome Powell’s statements, which were considered accommodating, were mainly a shift from previous speeches. Until then, he had considered that rates were “a long way” from the neutral level and that the Fed could go even further in view of the extremely positive evolution of the American economy.
Bonds are useful in terms of portfolio construction because of their diversification power. They are also advantageous when the economic cycle, after reaching a peak, is reversing. In the coming months and quarters, as global growth slows, as equity markets seek new lows, investors are progressively shifting to fixed income assets. However, not all bonds are equal and the strategies to be implemented do not offer the same risk/reward.
Between June 2017 and October 2018, oil prices had risen sharply (see chart 2), from $43 to $76 per barrel for WTI on the Mercantile Exchange (Nymex) in New York and from $45 to $86 per barrel for North Sea on the Intercontinental Exchange (ICE) in London. As the implementation of US sanctions against Iran approached on 4 November, they had reached their highest level of the last four years. Since then, oil prices have entered a bear market, contracting by more than 25% from peak to trough. A barrel is currently trading at $57 on WTI and $67 on Brent in the North Sea.
Getting a divorce settlement through a bitterly divided Parliament was to be Theresa May’s biggest challenge for the fall of 2018 (see chart 2). Promises are made to be kept. The situation is very delicate. The British Prime Minister had to abandon the idea of convening her government today to approve a text on Brexit. Although Britain and the European Union have moved closer to an agreement that could be signed at the November summit, the momentum seems to be waning as opposition hardens in the country. Pressure is mounting for Theresa May to abandon her plan or face a catastrophic defeat in Parliament. Without any surprise, the pound dropped versus all its Group-of-10 peers (see chart 3).
October ended with a record drop in stock markets. Fortunately, over the past week, investors were able to take a break, benefiting from a welcome technical rebound. The MSCI Emerging Markets rebounded by 6.1%, the Swiss Market Index by 3.8%, the EuroStoxx by 3.0% and the S&P500 by 2.4%. Despite these excellent performances, their year to date performances remain clearly in negative territory, with the exception of the US markets.
The week begins as the previous one ended, with important political, economic and financial publications. Brazilians and Germans were called to the polls this weekend. Not surprisingly, the far-right candidate, Jair Bolsonaro, was elected President of Latin America’s leading economy with 55.1% of the vote (see WIF of 8 October 2018). During his televised speech, this former army captain promised to “defend the constitution, democracy and freedom”.
Once again, China’s economic growth slowed more than expected in the third quarter. The Gross Domestic Product (GDP) grew by +6.5% year-on-year, compared to +6.7% in the previous quarter. This is the slowest growth rate since the 2008 global financial crisis. As leading indicators are on a downward trend, the slowdown is expected to continue. The different confidence indices of purchasing managers are close to the 50 point-mark, which separates expansion from contraction in activity. Echoing this analysis, the International Monetary Fund (IMF) lowered its economic growth forecast for China next year. GDP growth is expected to increase from +6.9% in 2017, to +6.6% this year and +6.2% in 2019.
Today, Monday 15 October, Italy is due to submit its provisional budget for 2019 to the European Commission. With a budget deficit of 2.4% of Gross Domestic Product (GDP), well above the European recommendations for Italy, the institution could reject it, exacerbating the political crisis and putting pressure on the Italian bond market. As a first step, Tuesday 16 or Wednesday 17, Brussels could send a letter to “ask for explanations” to the government of Giuseppe Conte. This could then be followed by a one-week period of “dialogue and consultation” to try to get the Italian authorities to reconsider their decisions.
Since 2014, Brazil has been caught up in one of the most important crises in its history from which it is struggling to emerge. The Gross Domestic Product (GDP) of the eighth largest economy in the World (see chart 2), and the most important in Latin America, fell by 8% between 2014 and 2016, in complete decorrelation with the good dynamics of other major emerging countries, such as Mexico (see chart 3). As a result, inequalities are widening. After affecting 13.7% of the working population, the unemployment rate has stagnated at 12% for several years (see chart 4). Brazilians are seeing their purchasing power eroded, with wages rising at a slower rate than the cost of living, particularly in industry.
On Thursday evening, the Italian government set its deficit for the next three years at -2.4% of GDP, despite the risk of increasing its debt to one of the highest in the world. The Italian anti-system parties, Salvini’s League (far right) and Di Maio’s 5-star Movement (far left), won the deficit battle against the Minister of Finance, Giovanni Tria. To be clear: this is bad news.