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Weekly 21st July 2017

 

Highlights of the week

  • Markets: developed-country yields down slightly; the dollar declined against most currencies; European credit markets performed well during the week ; equity markets under the influence of forex.
  • US: mixed real estate figures
  • China: China’s Q2 2017 GDP surprised to the upside

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The week at a glance

Economic indicators

United States

Mixed real estate figures. The NAHB index (which tracks real estate developer confidence) fell back in July to 64 (vs. 67 expected and after 67 in June). In contrast, building permits exceeded expectations in June (1.254m vs. 1.2m expected and after 1.168m in May). It was the same story with housing starts (1.215m vs. 1.155m expected and after 1.122m in May).

Monthly figures were volatile but, overall, the rebound in the real estate sector is continuing to underpin growth.

China

China’s Q2 2017 GDP surprised to the upside, coming in better than expected at 6.9% (vs. consensus 6.8% and prior 6.9%). As for June’s real economic activity data, (1) Fixed asset investment growth came in slightly better than expected in June at 8.6% ytd yoy (vs. consensus 8.5% and prior 8.6%). (2) China’s Industrial Production growth came in slightly better than expected in June at 6.9% ytd yoy (vs. consensus at 6.7% and prior at 6.7%); (3) China’s Retail Sales growth also came in slightly better than expected in June at 10.4% ytd yoy (vs. consensus and prior at 10.3%).

Markets have been talking about “the Chinese economy peaking out in the first quarter of 2017” for around six months now. However, we believe that the Chinese economic stabilisation will continue until the end of 2017, and that the current correction/weakness is temporary. Higher than expected Q2 GDP confirmed our call. We even believe that Q3 GDP has a slight upside or will just simply stabilise around the same level. We continue to believe that emerging markets, commodities and cyclicals remain supported by China’s economic stabilisation.

 

Financial markets

Fixed -income

Developed-country yields down slightly. German and US 10-year yields closed out the week at 0.50% and 2.24%, respectively. We note that the German yield curve is now steeper than its US counterpart. In Europe, peripheral spreads narrowed slightly. The Spanish 10-year spread fell beneath the 100bp threshold for the first time since October 2016.

Our conviction is that long European bond yields will rise more than forwards in the second half of 2017, mainly because inflation expectations are excessively low.

Foreign exchange

The dollar declined against most currencies, with the dollar's effective exchange rate tracked by the Fed returning to its lowest level in a year. The extension of special counsel Robert Mueller’s investigation dragged down US long rates and the dollar. The EUR/USD exchange rate ended the week at 1.16, its highest level since January 2015. The pound lost ground, in particular due to the release of worse than expected inflation figures, which reduces the likelihood that the BoE will quickly increase its key interest rates.

The euro has probably risen too much in recent weeks, and some profit-taking is likely soon. However, we expect the trend in the coming months to indeed be a general strengthening in the euro.

Credit

Ahead of the much-anticipated ECB meeting, European credit markets performed well during the week, as total returns recovered ground and in some cases re-approached previous highs. In fact, IG bond spreads touched new lows, while HY bond spreads were back closer to levels recorded before the sudden and strong correction suffered by bond markets in recent weeks. Encouraging signals on the outlook for both corporates and financials came from the last survey conducted by the ECB on euro-area bank lending standards. The headline about a slight easing of standards playing a major role was probably not in itself the most relevant. Rather, it was the fact that capex and M&A were the major rationale behind the recovery in loan demand by companies and ongoing improvements in funding conditions for Eurozone banks. These signals appear consistent with the im-proving micro and macro picture which is supporting fundamentals. On the other side of the Atlantic, corporate bonds performed positively, too. HY spreads tightened further while IG spreads are now on average closer to the lows reached in 2014, also thanks to supportive equity performance.

Credit markets proved to be resilient to the spike in volatility suffered by other bond markets over recent weeks. Both monetary policy and fundamentals support credit markets in Europe, while the latest numbers published by rating agencies show that default rates of US high yield companies continue to trend down against a positive macro backdrop. The latest dovish signals from Janet Yellen helped keep on track the performance of US IG corporates, which are still also being supported by investment flows. In light of these considerations we confirm our previous views on both US and European corporate bonds.

Equity

Equity markets under the influence of forex. The return of the reflation theme on the back of interventions by central banks (the ECB and the Fed) was conducive to a rise in long rates over recent weeks, but it also brought about a weak dollar, which had an uneven impact on the equity markets. For example, the eurozone equity mar-ket was dragged down due to the strength of the euro, after having risen sharply this year, while Japan benefited thanks to the weak yen.

For now, the eurodollar is back around the same level as one year ago, and so is still not really hampering year-to-year earnings comparisons. However, if our 12-month forecast of $1.20 per euro proves to be correct, the exchange rate will start to impact these comparisons in Q4 2017. Forex is therefore back on centre stage when it comes to regional equity allocations, but it is still a little early to revise our strategy. Above all, we are interested in relative value for now. In other words, while the US market is holding up, we are still favouring the eurozone, Japan and the emerging markets.

 

Key upcoming events

Economic indicators

  • Eurozone: The Manufacturing PMI is expected to decrease in July. 
  • France: Consumer confidence index should remain stable in July.

Economic indicators

2017.07-ECONOMIC INDICATORS

Auctions

2017.07-auctions

Key events

2017.07 - KEY EVENTS

 

Market snapshot

2017.07-MARKET SNAPSHOT

Letter finalised at 3pm Paris time

ITHURBIDE Philippe , Global Head of Research, Strategy and Analysis at Amundi
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Weekly 21st July 2017
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