What’s Pushing Markets Higher? It’s not the Reflation Trade
Bond yields reflected the weaker overall tone by retreating to their lowest level of the past three weeks. The U.S. ten-year note ended the week down ten basis points at 2.23 percent. The two-year note fell just one basis point, however, to 1.34 percent, resulting in a narrowing of the spread between the two to just 89 basis points, also the flattest in three weeks. The spread of high yield bond yields to governments also fell, ending the week at 364 basis points, its tightest since early March, before investors began to sour on the reflation theme.
The European Central Bank Helps Push Markets Higher
Aside from another week of inaction in Washington and a light domestic economic calendar, a big influence on last week’s market activity was the meeting of the European Central Bank, which left policy unchanged. President Draghi’s comments were initially interpreted as dovish, in contrast to his late June inference of tighter policy at year-end. However, by the end of the week, the euro had extended its recent surge to close at 1.166 versus the dollar, its strongest level since January, 2015. Since April of this year, the dollar has climbed 10 percent (against the euro). German bond yields extended their recent decline following the bank’s Thursday decision, shedding 10 basis points on the week to close at a yield of 0.49 percent.
It was Eurozone stocks that suffered the brunt of the currency’s rise, as the EuroStoxx 50 index fell 2.4 percent (in euro terms). Since peaking in early May, the index has dropped 5.6 percent as the euro has climbed, creating a headwind for an export dependent Eurozone economy. On Monday, the preliminary Purchasing Managers Index (PMI) reports from data provider Markit indicate some slowing of the Eurozone economy in July. The corresponding strength in the dollar has insulated U.S. investors however, and delivered a fractionally positive return during the same interim.
The softer dollar continued to provide a boost to emerging market equities, helped along by strong economic data from China at the start of the week. The MSCI Emerging Markets dollar index rose 1.3 percent, bringing its year-to-date rise to 23 percent. The same index in local currency terms rose 0.8 percent last week and 18 percent for the year.
Will the Fed Address the Lack of Inflationary Pressure?
This week it is the Fed’s turn to weigh in on policy. No significant policy announcements are expected, but investors will be watching for any hint regarding the timing of the commencement of its balance sheet unwind. Also watched carefully will be anything said regarding the lack of inflationary pressure and its impact on the Fed’s anticipated path of future rate hikes.
At the end of the week, we will learn the first estimate of how the U.S. economy performed in the second quarter. The Bloomberg consensus anticipates an annualized pace of 2.4 percent, a meaningful improvement from the 1.4 percent pace of the first quarter. That is close to the Atlanta Fed model that forecasts a rise of 2.5 percent, but well above the 2.0 percent pace forecast by the New York Fed. This week’s economic calendar also includes reports on new and existing home sales, flash PMIs, durable goods and consumer confidence and sentiment.
There is also a long way to go in second quarter earnings season. One fifth of S&P 500 companies have reported so far, and anticipated aggregate results have now climbed to 7.2 percent, according to Factset, up from 6.6 percent at the end of the quarter, led by better than expected results from financials. Among companies reporting this week are Alphabet, Caterpillar, McDonald’s, Ford, Intel, Chevron and Exxon Mobil.
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The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The EURO STOXX 50 is a market capitalization-weighted stock index of 50 large, blue-chip European companies operating within eurozone nations. The universe for selection is found within the 18 Dow Jones EURO STOXX Supersector indexes, from which members are ranked by size and placed on a selection list.
The Eurozone Manufacturing Purchasing Managers’ Index (PMI) is a weighted indicator calculated from indices of output, new orders, employment, suppliers’ delivery times and stocks of purchases.
The MSCI Emerging Markets (EM) Currency Index tracks the performance of twenty-five emerging-market currencies relative to the US Dollar.
Indexes are unmanaged and are not available for direct investment.
Third party companies mentioned are not affiliated with Ameriprise Financial, Inc.
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