By continuing on this site you have agreed to cookies being placed and accessed by this website. More information and adjusting cookie settings.
It is possibly the calm after the storm, following the strong market reaction to the Fed’s communications in May, says Robeco’s Chief Strategist, Ronald Doeswijk. Since then, the central bank has made some efforts to improve the quality of its forward guidance, discerning between unwinding unconventional policy measures and maintaining its accommodative stance on interest rate policy to promote US growth.
But at the same time, the Fed has not revealed much. “Although we expect the Fed will not give away the progress it has made in preparing the market for tapering, we believe it will use the underlying weakness in the labor market and inflation running below its target to scale down the tapering expectations if necessary,” says Doeswijk.
The US economy remains on track to start scaling down quantitative easing before the end of this year after a 1.7% rise in second-quarter GDP on an annualized basis showed the sequestration effect from budget cuts on activity to be modest. The rise in non-farm payrolls of 162,000 was below the average of 200,000 new jobs seen in previous months. US consumer confidence rose to its highest level since the onset of the financial crisis, despite still-moderate wage growth of 2.2% in June. And Inflation is less of a worry, as the PCE price index remains low, although core CPI inflation rose to 1.8% in June.
The US economy in numbers
‘Abenomics’ remains on track; China less so …
In the world’s next two largest economies, Japanese Prime Minister Shinzō Abe secured his mandate for ‘Abenomics’ when his LDP party won the Senate elections, thereby eliminating the previous standoff between the Upper and Lower house. However, prioritizing his nationalistic agenda could become a threat to economic progress, says Doeswijk.
Worries mounted last month about a slowing Chinese economy. The HSBC flash PMI came in at an 11-month low of 47.7 in July, indicating that the contraction is deepening. We hold the view that the Chinese economy will struggle to achieve its 7.5% growth target, despite efforts by the authorities to mitigate the slowdown using measures including investment in railroads and an audit of local government debt.
Euro zone tensions wane
The euro zone economy is improving, as manufacturing and export activity increased, and political tensions in the periphery have waned. The euro zone composite PMI strengthened further from 48.7 to 50.4 in July. Although not a dead-cat bounce, we think this development confirms the stabilization of the euro zone economy rather than pointing towards a nascent recovery.
On the periphery, Greece was granted another EUR 5.7 billion by the Troika after making “commendable progress” and Portugal avoided early elections. We also believe German Chancellor Angela Merkel won’t risk another stand-off in the periphery before the German elections on 22 September. However, political danger lurks in Italy where it is becoming more obvious that the legacy of former Prime Minister Mario Monti has hurt domestic growth.
The UK was a pleasant surprise, reporting Q2 GDP growth at an annualized rate of 1.4% and a manufacturing PMI reading of 54.6 for July. With the BoE committee voting 9-0 against further easing of monetary policy, more QE is now highly unlikely given the strengthening economy.
“Merkel won’t risk another stand-off in the periphery before the German elections on 22 September”
Emerging markets deteriorate
Economic news from the BRIC countries point towards a deceleration and we remain negative on emerging markets generally, as we do not anticipate an improvement in economic data. Brazil in particular faces headwinds, hiking rates again to bring down inflation and defend its currency. As a large commodity exporter, Brazil is negatively affected by the slowdown in China. Earnings revisions across emerging markets are also bad, though we believe the downward potential relative to other regions to be limited from here.
Equities and high yield our top choices
We maintain our positive view on equities. Moderate economic growth results in an attractive macroeconomic environment and interest rates will be artificially depressed for the foreseeable future. The flipside is that we believe global economic growth will be lower than trend due to structural problems, and we see a weakening in momentum. Within equities, we still favor North America, whose superior economic performance relative to other regions has been underlined by earnings revisions and momentum.
We are also still positive on high yield. ’Covenant lite’ issuance has reached an all-time high, which is a negative, though we expect low default rates as we should move from below-trend growth to trend or above trend in the years ahead. In the meantime, spreads remain attractive and, contrary to investment grade credits, still offer the potential for a reasonable absolute total return. We remain negative though on government bonds as we expect riskier assets to outperform them as rates stay low.