The past week’s market highlights:
Quote of the week:
“Don’t bargain yourself down before you get to the table.” — Carol Frohlinger, co-author, “Her Place at the Table”
Each week, we present our featured topics in the context of the major themes listed below from the Nuveen Q2 Outlook:
- U.S. economy: Late cycle has arrived.
- Global economy: There’s still good news out there.
- Policy watch: In an unusual twist, U.S. fiscal and monetary policies are diverging.
- Fixed income: Bond markets offer few places to run, even fewer places to hide.
- Equities: The bull market’s not over, but expect plenty more volatility.
- Asset allocation: Valuations are no longer at extremes.
Global economy: Eurozone a worry zone—and other uncertainties
Recent economic data from the Eurozone has been disappointing, raising questions about the durability of the recovery in this region. As of May 25, the Citi Eurozone Economic Surprise Index was at its lowest level since August 2011. This index measures the extent to which economic data releases have diverged from consensus forecasts. (Lower index readings indicate there have been more negative than positive data surprises relative to estimates.)
Despite the lackluster data, the Eurozone is likely still expanding above trend, meaning economic conditions continue to improve there—just not at the pace seen throughout most of 2017, or that was expected this year. The eventual end of quantitative easing and eventual start of rate hikes by the European Central Bank (ECB) are looming over the economy. On the plus side, Europe’s most important customers (China, the U.S., and itself) are all in decent economic shape, and its first-quarter earnings season was quite good. Additionally, business and manufacturing sentiment, as measured by Purchasing Managers’ Index (PMI) data, remain at a healthy level.
This week, we saw that investors’ confidence in the region may be vulnerable to political uncertainty in Italy and the impact of protectionist policies on global trade. Newly appointed Italian Prime Minister Giuseppe Conte of the populist coalition government is decidedly anti-establishment, with policy positions focused on universal base income and low tax rates—objectives at odds with European Union goals that highly indebted member nations reduce their debt burdens. With a debt-to-GDP ratio of 130% and growing external debt, Italy’s fiscal problems could complicate the ECB’s efforts to rein in accommodative monetary policy as the year progresses.
Against this backdrop, European equity markets fell last week. The STOXX 600 Index snapped eight consecutive weeks of gains, returning -0.91% in local currency terms and -1.90% when translated into U.S. dollars. Year to date, the index is up modestly (+0.49%) in local terms but down (-2.49%) in dollars. In contrast, U.S. equities were resilient: the S&P 500 Index eked out a 0.30% gain for the week, bringing its year-to-date return to 2.6%.
Beyond economic data and other more typical drivers of equity market performance, stocks have been subjected to a range of geopolitical tensions, protectionist trade policies, and other exogenous factors. These include:
- U.S./China trade relations. Our trade deficit with China ($375 billion in 2017) has been a source of contention for the Trump administration. China’s expressed willingness to increase its purchases of U.S. agricultural and energy goods (by up to $200 billion) was seen as a sign of good faith, and equity markets breathed a sigh of relief midweek.
- North Korea: Markets were relatively unfazed by President Trump’s cancellation of the scheduled nuclear summit with North Korea. Nonetheless, the dismantling of these talks could hamper the already fraught U.S./China trade negotiations.
- Turkey: Concerns that the country’s increasingly autocratic president will take greater control over the central bank have deepened. Rapid economic growth, rising inflation, and a high current account deficit have led to a perfect storm for the Turkish lira. Despite the central bank’s raising a key policy rate by 300 basis points (+3.00%) on May 24, the currency’s slide continued.
Lastly, President Trump’s proposal to add up to a 25% tariff on automobiles imported to the U.S. amplified growing concerns over global trade disputes.
Policy watch: The Fed gets symmetrical
Minutes of the Federal Reserve’s May 2 meeting, released on May 23, contained language satisfactory to both hawks and doves. The former were assured by the Fed’s belief that further tightening would “likely soon be appropriate” if the economy stayed on track. Indeed, with recent economic data broadly positive, a June rate hike is all but certain.
Meanwhile, doves latched on to the minutes’ frequent mention of “symmetrical” inflation. This relatively new buzzword reflected officials’ willingness to tolerate inflation levels above the Fed’s 2% target, as measured by the core PCE Price Index. We believe this more flexible stance suggests the Fed won’t necessarily raise rates more rapidly amid brief periods of above-target inflation. While the PCE index could touch 2.2% or so this year, slightly above March’s 1.9% reading, it’s unlikely to move much higher. The labor market still contains enough slack to avoid a wage-price spiral, and the economy is beginning to feel the disinflationary impact of Fed rate action.
With the Fed poised to raise rates for the seventh time during the current tightening cycle, officials discussed the possibility of reaching a neutral interest rate—one that neither accelerates nor restrains the economy—“before too long.” This could lead to removing the long-standing reference to “accommodative” monetary policy from the Fed’s post-meeting statement.
Treasury markets welcomed the dovish aspects of the Fed meeting minutes. The yield on the 2-year note, which is highly responsive to changes in Fed policy, fell from a near-decade high of 2.59% on May 22 to 2.48% on May 25. (Bond yields and prices move in opposite directions.) Geopolitical uncertainty in the wake of President Trump’s decision to pull out of talks with North Korea, along with ongoing concerns around U.S./China trade policy, benefited safe-haven assets such as longer-dated Treasuries. The bellwether 10-year note rallied as a result, with its yield slipping by 13 basis points (0.13%) during the week, to 2.93%.