Uncertainty about US policy outlook & geopolitical risks affecting markets - NAB

After rising strongly since the latter part of 2016, advanced economy stock markets have recently given up some of their gains, despite the resumption of strong growth across many advanced economies in the June quarter, points out the analysis team at NAB.

Key Quotes

“In part this reflects concerns over the US political environment and geo-political risks, particularly relating to North Korea.”

“This is not to say that financial markets are panicking. For example, the VIX volatility index has spiked on occasion but quickly settled, and South Korean 10 year government bond yields only rose modestly following missile tests by North Korea.”

“Commodity prices, after falling through the first half of 2017, have broadly stabilised in recent months, supported by an improving demand outlook and USD weakness.”

“The USD weakness appears to reflect improved global economic conditions (particularly in the Euro-zone) and a move from the Trump ‘trade’ to ‘discount’, as doubts about what changes the new administration can deliver have grown.”

“These doubts can also be seen in interest rate markets. Expectations of Federal Reserve rate hikes rose following the US election in November last year, reaching a peak in mid-March. Since then expectations of future rate hikes have been unwound, despite the Fed actually delivering three rate hikes. This is more than just a Trump effect as inflation has also slowed noticeably in the US. As a result, while the Fed is likely to start winding back its balance sheet at its September meeting, a further rate hike this year will depend on inflation strengthening.”

“US financial conditions often affect other countries and recent times are no exception. The futures curve for Euro-zone interest rates moved higher following the US election but has now returned to where it was. However, the unchanged slope of the curve signals higher rates are expected in the future, reflecting the recovery in the Eurozone economy and expectations of ECB tapering its QE program next year.”

“The ECB is indicating that it will likely make a decision about its QE program in October. Some analysts had expected the details might be announced sooner, but the rise in the Euro has made the ECB cautious. This, as well as the uncertainty around the direction of US monetary policy, has contributed to the unwinding of the June spike in long-term bond rates for some countries. However, this is not the case for all countries – for example, Canadian yields have held onto  the June increase, supported by another Bank of Canada  monetary tightening this month.”