The Council of the European Central Bank pulled an impressive stunt at the monetary policy meeting on 26 October. ECB President Mario Draghi announced to reduce the extremely supportive monetary policy in the near future while sounding very cautious (dovish) with regard to the process at the same time.
Economic growth in the Eurozone has embarked on a clear upward trend. At the same time, the fear of falling wages and prices has disappeared for now. The worries over a possible break-up of the European Union have also eased. Against this backdrop, the ECB President Draghi issued a slightly more optimistic growth forecast yet again on 27 April at the press conference of the European Central Bank. This is another tiny step indicating a possible reduction of the monetary support in the medium term.
The first weeks of the new year have already picked up from where the trends that started in 2016 and the hypotheses for 2017 left off: higher growth, normalisation of inflation, increased uncertainty with regard to the effects of Trumponomics, and a gradual end of the loose monetary policy.
Economic growth in the emerging markets has picked up substantially, while that in the industrialised economies has been rather stable. This has led to an increase in the growth differential in the emerging markets’ favour. Investor demand for emerging markets bonds has been on the rise in search of higher yields and interest rates.
Author: Martina Groll, Senior Fund Manager
The bond purchase programme of the European Central Bank has caused a drought on the bond markets. As a result, investors now have to take into account the liquidity risk on top of the interest rate risk and the default risk.
The Council of the European Central Bank (ECB) further loosened its monetary policy on 10 March 2016. In view of the decline of the leading economic indicators and the excessively low inflation in the Eurozone, the bundle of measures introduced by the ECB is necessary. But, to paraphrase Mohamed El-Erian, the expansive central bank policy is “ the only game in town”. Effective fiscal policies and structural reforms have been a long time coming. At least the effectiveness of the central bank policies, while it has declined, does still exist.
The arguments supporting a further rise in share prices have become stronger. The important central banks have been sending expansive signals in recent weeks, i.e. signals that support the economy and the markets. The latest measure was the statement made by the president of the European Central Bank (ECB), Mario Draghi, at the ECB press conference on 22 October.
Earlier this year the president of the ECB said we would have to get used to elevated levels of volatility. And it is true, the market environment has changed. The years 2009 to 2014 were subject to an asset price reflation regime. High rates of return were coupled with low volatility. This relationship has now reversed. The asset classes are now pricing in the moderate recovery in the industrialised economies, with low expected return amid elevated fluctuation as a rule.
In searching for a perfect example of a sideways market one does not need to look further than at Central and Eastern European (CEE) equity markets. The CECE Composite, a Euro-based index of 23 Polish, Czech and Hungarian blue-chips (Bloomberg: CECEEUR), has been range bound for nearly four years, rarely trading outside a narrow range of ±8% from its mean over the period. A recent spike by 23% that started in January and lifted the index beyond this trading range was halted by the escalation of Greece-related risks. The only market in the region that has participated in the broader equity rally in Europe and the US in recent years has been the Romanian market.
The big trends of the past weeks such as the appreciation of the US dollar, the weakening oil price, falling yields, and the outperformance of Eurozone equities have reversed in the past days and weeks, in some cases drastically so.
What is behind all of this?
When both demand (i.e. economic growth) and supply (i.e. production growth) are weak and the central bank policies are very loose, we have a textbook example of an environment causing yields to fall and/or remain low. Indeed, yields were high after the Great Depression in 2008/2009. Having transitioned to a slow, weak, and fragile recovery, yields have started to fall and bond prices have started to rise (i.e. asset price inflation). Even if the economic regime remains unchanged, the market environment may change; the higher the asset price, the lower the expected return or yield.