European Equity Strategy - Fed Up? Impact on European Equities…
* Market implied probabilities of US rate hikes are rising…
The market implied probabilities of an upcoming Fed hike have risen sharply in recent weeks (Figure 1). In part, this has coincided with better macro momentum in our UBS Economic surprise indices. This adds to the heightened level of "event risk" for European equities in June (such as the UK referendum, Spanish general election, ECB meeting and BoJ meeting).
* What does it mean for European Equities?
Looking back over the last 6 US rate cycles, European Equities have tended to perform reasonably well in the 12 months following the first hike: up 7% on average and outperforming the US. But our Macro Strategy team have highlighted how this US rate cycle is likely to be far shallower than previous cycles – meaning each hike may have a bigger impact. The gap between policy rates in the US and Europe has been an indicator of the relative performance of European and US equities. This time around may be different given the disconnect between the two cycles and negative rates in Europe: nonetheless European relative performance is now at an extreme.
* Sectors: Winners & Losers
Cyclicals stand to gain the most from higher yields – all but 2 sectors are positively correlated to rising US yields. In particular, Insurance, Autos and Tech are the best performers in rising yields. European Banks' relative performance has also tracked the level of US yields in the last few years. Defensives are all negatively correlated.
* Stock Screen
We screen for European stocks that are most correlated to rising US yields. Banks make up the bulk of the names of the companies but there are also Autos, Cap Goods and Construction Materials