The month of December was characterised by several important monetary events in which market participants had clear indications from central banks on their course of action. That said, in my view the Federal Reserve (Fed) had a more clear path, which in fact the market was entirely pricing. This was the much-awaited rate hike for the second time since the 2008 crisis. To a lesser extent, rumours that the European Central Bank (ECB) was planning a reduction in its quantitative easing (QE) program had increased over the past months, but the change in the ECB’s stance was still unclear to the market.
What is interesting, apart from the change in policies, are the comments and moreover the market reaction. However, let’s chronologically look at the sequence of events.
ECB meeting
On the 8th of December the ECB announced that it would reduce its monthly purchasing program from €80 billion to €60 billion, but extending the program by nine months to December 2017. The initial market shock was a spike in the EUR/USD which gained momentum, while yields on mainly long-dated issues rose.
However, in the after press conference Draghi on several occasions has strongly voiced the fact that the ECB will react by increasing its QE program if market conditions deteriorate, in addition to the once again sustained comment that tapering was not discussed. For the avoidance of doubt, quoting Draghi’s comments, ‘the word has several meanings depending on who is using it, but the natural way to look at a word like that is to have a policy whereby purchases would gradually go to zero’.
Following the ECB’s dovish stance the EUR/USD reversed all its gains and touched lows of circa 1.057.
The aftermath market reaction till yesterday was a continued sustained equity rally, with the Euro Stoxx 50 gained just over six per cent, while the sovereign long-dated yield curve continued its steepening momentum, whereas European High debt continued to tighten.
Despite the ECB guaranteed a change in stance in its policies if market conditions deteriorate, the key indirect message is that QE will continue to decrease in line with improving data. And yes, to-date we have continued to see positive data. Going forward if sustainability prevails, we will experience a tightening monetary policy and the prime losers would be undoubtedly long-dated government bonds.
Thus I once again sustain my previous rationale of re-aligning portfolios by reducing long-dated government exposures, including Malta government stocks. Over the past years the latter have created strong comfort for Maltese investors, but now are also at the mercy of a re-pricing steepening European sovereign yield curve. Act fast, don’t lose the plot.
Fed meeting
Priced 100 per cent by the market was a rate hike from a range of 0.25 percent to 0.5 percent to 0.5 percent to 0.75 percent. What was not priced-in were the new projections by the Fed of three quarter point rate increased in 2017, the market was solely pricing two quarter rate hikes. The projections were mainly based of some further strengthening in the labour market and closer desired inflation figures.
The initial market reaction was a surge in the US dollar and a spike in US Treasury sovereign curve which breached levels last seen way back in September 2014. The reaction is a natural move, what was surreal was the U.S. market rally following Trump’s victory. However, regarding the latter, by now investors should be aware of the new so-called ‘unpredictable market’. Yesterday the Dollar continued to strengthen pushing the Euro to a new 14-year low.
In my view the market seems to be pricing a sustained U.S. economic growth following the new projections with U.S. equity markets touching all time record highs. What is surely interesting to see going forward are Trump’s fiscal expansion promises. If well implemented we should experience more positive economic data, such as the recent strong producers price index, in addition to yesterday’s homebuilder sentiment index which spiked by seven points. The main beneficiaries would be equities and risky bonds.
To conclude, the now experienced monetary divergence is creating market shocks, with a very interesting fact. The hawkish stance in the U.S., is making it much easier for the ECB from a currency perspective. A stronger dollar due to the hawkish stance by the Fed, is pushing European equity markets towards strong gains, case in point yesterday’s market positive momentum.
A roller-coaster 2016 which offered both opportunities and threats. Next year will be another challenging event year. Identify the niche opportunities and you’ll be rewarded.
This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.