Five markets charts that matter for investors
QE and the S&P, Italy’s debt load and US oil exports to hit Opec
Your “springboard” guide to current market concerns, presented in a logical and concise manner, with direct links to more details.
1 - QE and the S&P 500 (new)
2 - Italian debt load expected to fall
3 - Central banks and excess liquidity
4 - US oil exports to hit Opec
5 - The great Bund yield bounce — does it continue?
1. The importance of central banks for equity prices
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The bullish performance of stocks as central banks keep buying bonds
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The S&P 500’s lengthy bull run began in 2009 as the Federal Reserve fired up quantitative easing. Suppressing bond yields and financial market volatility via QE has certainly been a boon for equities. All told, the big central banks have bought some $14tn of assets, providing a very supportive tide of liquidity for global equities led by the S&P 500.
Now as the Fed looks to start reducing its $4.5tn balance sheet this year and the European Central Bank discusses tapering bond purchases in 2018, equities will soon need to reflect a reduction in the so-called ‘punchbowl’. Having outperformed other leading equity markets during the post-financial crisis era, some believe US stocks are vulnerable, once the liquidity tide slackens in the coming year.
“We think the swing in global liquidity will weigh on the performance of stocks,’’ say analysts at Bank of America Merrill Lynch. “With the Fed about to reduce its balance sheet and the ECB likely to end quantitative easing by the end of 2018, growth in central bank assets is likely to decelerate significantly next year and turn negative in 2019.’’
For now, there appears further room for equities to run higher as central banks are likely to take their time withdrawing stimulus. Soothing words on the interest rate outlook from Janet Yellen in her semi-annual testimony to Congress has bolstered equities ahead of the latest earnings season. Michael Mackenzie
2. Italy’s national debt predicted to fall
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Whether the nation at the heart of the European debt crisis is recovering
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Is Italian debt sustainable? The question matters because the country has the most sovereign debt outstanding of any member of the eurozone, both in absolute terms and when compared with the size of annual economic output. Fears about Italy’s ability to support the debt and so remain a member of the single currency were at the heart of the European debt crisis in 2011.
Borrowing costs have come down considerably since then, suppressed in particular by European Central Bank purchases of sovereign debt since 2015. As bond markets have begun to anticipate a reduction, or tapering in that programme, Italian bond yields have crept upwards this year, from 1.6 per cent to 2.1 per cent.
Elections due within the next year have also caused market nerves, with Japanese investors among the sellers wary of strong Eurosceptic sentiment. Yet analysis from UBS suggests the relative size of national debt should decline over the next decade.
Taking IMF growth forecasts as a starting point, the bank assumes an annual government surplus of 2.5 per cent from 2019 onwards and ongoing funding through the bond market. For its tapering shock scenario it assumes a jump in bond yields of 50 basis points for debt maturing in five years, and of 100bp for longer-dated debt.
The shock changes the debt dynamics only moderately, because only a small portion of debt is refinanced each year, and much of the stock was issued at much higher interest rates than today.
Lefteris Farmakis, strategist for the bank, says “it is highly improbable that ECB’s tightening pushes Italian debt off the cliff. Such an outcome would require the ECB allowing Italian rates to hover for several years at high levels (circa 5 per cent), while growth there hovers close to zero and inflation runs below 1.5% in the long run.” Dan McCrum
3. Central bank tightening put in perspective
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Central bank tightening
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Is the market getting central bank tightening out of perspective? Robert Bergqvist thinks so. SEB Group’s chief economist has looked at the amount of excess liquidity in the world economy and calculates it at $15tn — or one-fifth of global stock market capitalisation.
Even if the Federal Reserve starts to unwind its balance sheet as soon as September, the pace towards normalisation will be so slow that come the end of 2018 there will still be plenty of liquidity lubricating the financial system.
The Bank of Japan’s umbilical link to quantitative easing is responsible for a large slice of unconventional monetary policy over the next year.
Global monetary policy may be entering a new phase, but talk of a shift to a “tighter” policy is overblown, says Mr Bergqvist. “Monetary policy will continue to be very expansionary for many years,” he says.
“The overall liquidity situation, together with a very slow adjustment upwards for nominal policy rates, will continue to provide strong support to asset markets. Any correction in assets prices is likely to come from other factors, not the expected changes of monetary policy.”
His conclusion: bank reserves will continue to rise and the Fed’s monetary policy downsizing will have a limited impact on stock and debt markets. Roger Blitz
4. US oil exports set to lengthen Opec’s struggle
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Opec’s drive to raise oil prices by reducing supply
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The US crude oil export boom is set to kick into a much higher gear.
By 2020, exports of US crude would reach 2.25m barrels a day, according to PIRA Energy, an influential consultant. By comparison, last year Kuwait exported 2.1m b/d, Nigeria 1.7m b/d and the US itself 520,000 b/d.
The forecast suggests the Opec exporters’ cartel faces a drawn-out struggle as it tries to raise crude prices by curtailing output in the face of a prolific US shale oil industry.
Other analysts have more modest targets: IHS Markit sees US crude oil exports reaching 1.4m b/d by 2020, while the most bullish scenario from the US Energy Information Administration does not envisage exports surpassing 2m b/d for a quarter of a century.
The US still depends on imports of crude oil, having bought 7.9m b/d last year. But the type of high quality, “sweet” crude flowing from fields in Texas and North Dakota has a limited appetite from US refineries configured to run heavier grades of oil.
The mismatch favours exports of some domestic oil and continued imports from countries such as Canada and Saudi Arabia. Gregory Meyer
5. The great Bund yield bounce — Does it continue?
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The rise in German 10-year Bund yields
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The benchmark German 10-year yield has broken fresh ground in 2017, climbing to an 18-month high of 0.58 per cent.
With European Central Bank president Mario Draghi recently noting that stimulus is not forever, Bund investors have borne the brunt. German 10-year yields are up more than 24 basis points in the last two weeks.
“Complacent long positions have been shaken out of the Bund market following what appears to be a change in central bank focus,’’ says Steven Major at HSBC.
Mr Major calls recent developments a “wake-up call” for investors after the ECB highlighted fading deflation risks and noted a broadening recovery across the 19-country bloc.
Analysts at UBS think a “fair value” on Bunds is anywhere between 0.9 per cent and 1.2 per cent. But they warn that any moves close to 1 per cent “may be too fast, too soon”.
Reasons for caution abound. Eurozone inflation is still expected to fall below the ECB’s target of just under 2 per cent in 2019. Senior ECB officials have also damped any speculation of an earlier than expected normalisation in interest rates and QE following Mr Draghi’s comments last week.
Minutes from the central bank’s June meeting show policymakers are acutely aware of triggering an adverse market reaction that would make their job of raising inflation even harder by driving up the euro.
“The ECB is likely to lean against a spike in yields that leads to a sharp tightening in financial conditions”, notes Yianos Kontopoulos at UBS, who expects Bund yields to end the year around 0.7 per cent. Mehreen Khan