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Weekly investment update – Markets consolidate ahead of policy news

Markets have been consolidating in recent days after the strong rally in global stocks last month (the MSCI World index rose almost 13% in November) and the first days of December. Two major themes continue to drive markets: The coronavirus vaccines and..



This article was originally published by BNP Paribas Asset Managment Blog ( Investor's Corner)

Markets have been
consolidating in recent days after the strong rally in global stocks last month
(the MSCI World index rose almost 13% in November)
and the first days of December. Two major themes continue to drive
markets: The coronavirus vaccines and the possibility of US economic stimulus.

The risk is that markets get too far ahead of the
macroeconomic situation, particularly as infection and hospitalisation rates
are still rising in the US and much of Europe. Chancellor Merkel today said
Germany must go into a hard lockdown before Christmas to curb the spread of

The yield on 10-year US Treasuries has fallen back to
0.94%. It touched 0.98% last Friday, its highest level since the market
ructions in March, as investors moved out of safe haven debt. The S&P 500
and NASQAQ indices meanwhile remain close to all-time highs.

Policy makers at

Brexit talks have so far failed to break the current
impasse. The market is now waiting to see if the latest meeting between Boris
Johnson and Ursula Von Der Leyen will lead to a compromise and hence a deal. A
no-deal remains a distinct possibility, but the consensus view is that the
economic and political cost of a no-deal will bring both sides to a last minute

Besides Brexit, the European Union (EU) 2021-27 Budget and
the EU Recovery Fund will be under discussion at the EU Summit this week. Given
Poland’s and Hungary’s current veto of the Recovery fund, if a deal is not
found, it is likely the EU will take the fund off-budget using voluntary
guaranties, thus circumventing the veto.

US labour market
raises concerns

In the US, private sector job growth was slower than
expected in November at 345 000 (vs 540 000 in Bloomberg consensus, which in
normal circumstances would be a sizeable miss). Although the US unemployment
rate fell from 6.9% to 6.7%, it did so for the wrong reason, some unemployed
people gave up looking for work and thus exited the labour market.

This leaves the US economy down almost 10 million jobs
since February. At the current rate of job creation it would take until
mid-2023 to recover all the lost ground in the labour market.

Next spring/summer is likely see a burst of, potentially
very rapid, hiring in those sectors poised to benefit from widespread
deployment of the vaccine (restaurants, leisure). Nonetheless, the state of the
US labour market has again led Federal Reserve Chair Powell to urge Congress to
err on the side of over-stimulating the economy with fiscal policy, rather than
risk under-stimulating it.

Perhaps spurred on by Chair Powell’s comments, perhaps in
response to the worsening Covid situation, policymakers in the US Congress have
edged a bit closer to striking a deal over a new round of fiscal stimulus. They
hope to complete their work before Congress breaks for Christmas.

Both the size and content of the package are still being
negotiated. Yesterday the Trump administration made a new fiscal stimulus offer
worth USD 916 billion to congressional Democrats.

Observers have generally expected the US Congress to
eventually pass another stimulus package, although opinions have differed about
when and how large it would be. If something does pass before Christmas, it
would be earlier than most commentators have expected, but if the cost comes in
significantly closer to USD 500 billion rather than USD 1 trillion it would
also be smaller than most would have projected.

Democrats view this latest negotiation as a stepping stone
to the possibility of more stimulus after President Elect Biden is inaugurated
on 20 January 2021. But unless Democrats win both the Georgia runoff elections
in early January, they might well find the US Senate refusing to pass anything
other than an incremental package (if even that) once there is a steady stream
of Americans getting vaccinated in the new year.

Waiting for the ECB

Tomorrow the governing council of the European Central
Bank (ECB) holds the final monetary policy meeting of 2020. As coronavirus
vaccines are close to being approved and delivered across Europe, the ECB might
be expected to adopt a more upbeat outlook in the economic forecasts. However,
the prospect of a downturn in the fourth quarter means the ECB will probably
lower its growth outlook for 2021. Investors will also focus on whether the ECB
cuts its inflation forecasts.

ECB President Christine Lagarde and other ECB policymakers
have already signalled that they are highly likely to increase the central
bank’s stimulus measures in an attempt to ease the continuing economic damage
caused by the coronavirus pandemic and lockdown restrictions.

We expect clarification on the following areas of ECB
policy tomorrow:

  • Expansion
    of the Pandemic Emergency Purchase Programme (PEPP)

Launched this spring as the virus took hold across Europe
this quantitative easing programme aims to buy up to EUR 1.35 trillion of
bonds. It is scheduled to run until June 2021. However, in view of the new wave
of coronavirus infections and restrictions, the ECB is likely to expand the
size and timeframe. Currently there remains EUR 600 billions left to spend. It
is possible the ECB expands the programme by up to EUR 500 billions and extends
PEPP to the end of 2021 or even to June 2022. This would potentially enable the
ECB to buy around 70% of all bonds issued by eurozone governments next year,
equivalent to and 150% of net issuance after redemptions.

  • Extending
    lending to banks

The second element of the ECB’s response to the crisis is
lending money to banks at ultra-low rates to facilitate provision of credit to
the economy. Through its targeted longer-term refinancing operations (TLTRO)
the ECB has lent almost EUR 1.5 trillion to banks at rates as low as minus 1%
on the condition that banks maintain lending levels. This programme is due to
expire in March 2021. The ECB has indicated it is likely to be extended but
clarification is expected tomorrow on a possible lowering of the interest rate.
We see little prospect of the ECB cutting its headline deposit rate tomorrow
below minus 0.5%.

Our view is that the ECB is already implementing yield and
spread control. The ECB is basically running short on ammunition and relying on
good fortune and accommodative fiscal policy to reflate demand, even if this
keeps pumping up asset prices.

Exhibit 1: An inconvenient rally – In recent weeks the euro has climbed above USD 1.21, its highest level since 2018 (graph shows change in exchange rate EUR/USD for the period from January 2018 to 08/12/2020).

Source: BNP Paribas Asset Management as of 09/12/2020

The rally in the euro mostly reflects a weaker US dollar but remains a concern for the ECB as the stronger euro puts downward pressure on inflation by lowering import prices. The stronger euro potentially negates reflationary benefits from fiscal measures in response to the pandemic.

Any views expressed
here are those of the author as of the date of publication, are based on
available information, and are subject to change without notice. Individual
portfolio management teams may hold different views and may take different
investment decisions for different clients. This document does not constitute
investment advice.

The value of
investments and the income they generate may go down as well as up and it is
possible that investors will not recover their initial outlay. Past performance
is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Writen by Andrew Craig. The post Weekly investment update – Markets consolidate ahead of policy news appeared first on Investors’ Corner – The official blog of BNP Paribas Asset Management.

us dollar
monetary policy

Author: Andrew Craig


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