Broadgate: Weekly Briefing 28/11
28 November 2014It was a strong week for equities, particularly in the eurozone. Amid further hints of quantitative easing (QE) and a modest improvement in economic data, European equities rose by around 3% during the week. Elsewhere, the US and UK also performed reasonably well – up around 1.5% – while Asia was flat on the week. A key driver for this has been the fall in the price of crude oil and expectations that this will lead to improvement in terms of economic data. Crude oil is now trading below $80 per barrel, down 30% over the last few months. An OPEC meeting will take place this Thursday in Vienna, but there is an expectation that we are unlikely to see a significant cut in crude production. It is worth thinking about the transition mechanism regarding how that feeds into the underlying economy. Take, for example, the US: petrol prices at around $3 per gallon, which is down from over $4 per gallon earlier in the year. This is having a significant impact – effectively a tax cut – for the US consumer. Presumably, over the following months, that will start feeding through into US economic data. But it is not all good news: concerns are beginning to creep in at the corporate level, particularly amongst shale producers, where the cost of production is now probably higher than the current levels of crude oil. Those companies are effectively operating at a loss, which is unsustainable over the long term. We are also keeping one eye on the weather. We’ve seen significant snowfall over the last week in the north-eastern region of the US, which has been driving natural gas prices up by about 10% compared with their levels in mid-October. But as mentioned, crude oil prices remain weak, and the expectation remains for positive growth, particularly in the US.
Emerging markets rally on China’s rate cut
In terms of that strong equity-market performance, central banks, as always, played a key role. In the eurozone, we saw further hints of QE. European Central Bank president Mario Draghi commented on the likelihood of more asset purchases through and into early next year. In the US and the UK, markets continue to push rate hikes out into the latter part of 2015 and the early months of 2016 based on expectations that inflation will continue to fall. In China, we saw an interest-rate cut late on Friday, the first in two years. It seemed a sign of desperation that something more needed to be done to prop-up the economy. We saw a 25 basis-point (bps) cut in the deposit rate and a 40bps rate cut in the lending rate. This was enough to spur quite a substantial rally across emerging markets, particularly in Brazil (where it looks likely that President Dilma Rousseff, the victor in the recent presidential election, will appoint a market-friendly finance minister). Asia also recorded rises overnight on the back of that rate cut.
Elsewhere across asset markets, gold traded above $1,200 an ounce for the first time in over a month; the central bank impact is being felt there as well. Turning to bond markets, you would think that that strong rally across equities would be enough to push government bond yields higher, but that wasn’t the case. US Treasuries were flat on the week, and gilts and German bund yields were down around 10bps on the week, with 10-year gilt yields now hovering just above 2%. The driver here is probably inflation expectations, or the prospect of interest rates, particularly in the US and the UK, being pushed out well into 2015.
In currency markets, the ongoing theme of a stronger dollar continued to be the case, with the dollar rising by about 1% over the week. Most notable was the push in the yen toward 119, which reflected a weakening of over 15% since the summer. It was driven to these lows by a snap election called by Prime Minister Shinzo Abe and a delay of further tax hikes, again, giving the idea that the yen will continue to weaken further in a bid to not only drive up domestic Japanese equity markets but stimulate some level of economic growth and inflation.
We have a busy week forthcoming. A lot of economic data will be released, including third-quarter GDP growth for the US, the eurozone, and the UK. We have consumer confidence and house prices in the US, along with consumer confidence, unemployment, and inflation data in Europe. In Japan, we have retail sales, industrial production, and inflation data and, in China, we have leading economic indicators. It’s also worth noting that Thursday is Thanksgiving in the US, so markets will be closed that day and very quiet on Friday. On the political front, there are ongoing talks around Iranian nuclear power; it looks likely we won’t see a successful outcome of those by the deadline of today, 24 November. There is continued conflict in Russia and Ukraine. There is the Swiss referendum coming up next weekend: the topic of discussion will be the requirement of the central bank to hold a minimum of 20% in gold, which could create some volatility around both gold prices and the Swiss franc.
So there’s plenty going on. Activity has yet to quieten down as we head towards year-end, but at some point, that will happen.
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