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Weekly 28th July 2017

 

Highlights of the week

  • Markets: bond yields move higher on both sides of the Atlantic; FOMC statement supported a further upside move of EUR/USD; high beta credit segments outperforming again within corporate bond markets; Equity markets in the black.
  • Growth: as expected GDP growth accelerated in the United States in Q2, it surprised on the upside in Spain, and remained stable, as expected, in France. Surveys point to stronger growth in Germany in Q3.

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The week at a glance

Economic indicators

United States

Growth picked up in Q2, as expected. GDP growth was revised down in Q1 (from 1.4% to 1.2% at annual rate). GDP growth accelerated in Q2 to 2.6% (+2.1% yoy). Primarily driven by household consumption (which contri-buted 1.9pp to growth), economic activity has also benefited from the unexpected acceleration of investment in capital goods (+8.2% after +4.4% in Q1, revised down).

Durable goods: orders are easing off, deliveries are increasing. Deliveries increased for the 5th consecutive month in June.

The drop in orders seems to indicate a loss of momentum in Q3. But consumption is solid and the job market quite strong. We keep our growth forecast for 2017 unchanged at 2%. Overall, the economic data released corroborates our monetary policy scenario: the Fed will probably begin normalising its balance sheet in September and will raise interest rates by 25bp in December. This expectation is clearly supported by the Fed’s press release following the FOMC meeting on 26 September..

France

GDP growth stabilised in Q2 at 0.5%. On a year-on year basis, growth accelerates from 1.1% in Q1 to 1.8% in Q2, its highest level since 2011. In Q2, growth was driven both by domestic demand and exports. Consumption accelerated (+0.3% after +0.1% in Q1). Investment slowed (+0.5% after +1.4% in Q1). Exports surged by +3.1%. However, corporate destocking weighed on the performance.

The PMI fell slightly in July. The PMI Composite fell slightly from 56.6 to 55.7. However, this decline hides the improvement posted by the manufacturing sector, where the index rose more than expected (from 54.8 to 55.4).

Inflation remains low, at +0.8% yoy in July (preliminary estimate).

GDP growth came in line with expectations. The rebound in French exports confirms the solidity of the recovery in the Eurozone and the renewed strength of global trade. The carry-over for 2017 (i.e. annual growth in 2017 assuming zero growth in H2) now stands at 1.4%. Surveys continue to indicate a solid recovery in H2. But PMI indexes would seem to indicate that the growth peak was in Q2. We may slightly revise up our forecast for 2017 (1.6%). One thing is sure: the consensus (1.5%) is too low.

Germany

The IFO hit a new record high in July. The German flagship index reached its highest level since reunification. The short-term business outlook improved but still lags behind the current business situation. The index is driven by the manufacturing and construction sectors.

Inflation remains stable. Inflation came out at +1.5%yoy in July (preliminary estimate), at the same level as in June.

Growth appears to be continuing to pick up in Q3, following a probable strong reading in Q2. If this trend is confirmed, we may increase our 2017 growth forecast again (currently at 1.8% vs. 1.7% for the consensus).

Spain

GDP growth accelerated in Q2! Growth came out at +0.9% in Q2 (after +0.8% in Q1). The breakdown will only be available at the end of August.

Consumption probably accelerated, boosted by job creations. Private investment was probably also dynamic. As in France, exports certainly also contributed to the good performance in Q2. Business surveys remain solid. Against this backdrop, we may revise up again our growth forecast for 2017 (2.8% currently).

 

Financial markets

Fixed -income

Ahead of the Fed meeting, the very start of the week saw bond yields moving higher on both sides of the Atlantic. Then, the US curve reacted to the FOMC statement with a limited bull-shift, as long-term treasuries generally outperformed short maturities. This reactions seems to show that market players were more impressed by the prudent wording referred to inflation rather than by a clearer indication that the balance sheet normalization is likely to start sooner than later. The focus of the Fed on inflation is likely to keep next data monitoring prices’ trends on markets’ radar screen in the following weeks. Overall, however, yields just returned closer to weekly opening levels: the same is true also for 10-year bunds. Periphery government spreads stabilized after previous weeks’ recovery, while Greece returned to the bond market almost exactly five years after the ECB president made the famous “Whatever it takes” pledge to defend euro in July 2012.

European bond yields look more stable at current levels after the last wording and the communication of the ECB and in sight of a more limited trading activity in August. US bond markets seem to be confident that the Fed approach will remain gradual, as the inflation outlook doesn’t look worrying. The next hike (+25bp) is expected in December, but the focus should gradually move from rates to balance-sheet normalization.

Foreign exchange

FOMC statement supported a further upside move of EUR/USD, which in fact reached, as we are writing, the 1.17 area. The lack of progress on the fiscal stimulus front adds pressure on the US currency vs Euro, as well, together with relative trends on the macro side and in terms of financial flows. Previous week’s ECB statement and wording contributed to stabilize European bond yields, after the sharp rise starting from the end of June, but failed to refrain the European currency from reaching new highs. On this side, the role of US monetary and fiscal policies’ perspectives continue to look dominant, despite the more dovish recent signals from the ECB. Among emerging currencies, we underline the positive performance delivered by commodity currencies, supported by quite a recovery in oil and other commodity prices.

As we underlined in the focus of the previous week, however, the EUR/ USD is still largely below the levels where it traded when ECB introduced negative rates and at current levels it doesn’t seem yet to represent a risk for the improving macro picture or a factor leading the ECB to revise its plans. Emerging markets, on the other side, still look in a bright spot thanks also to the last recovery in commodity prices.

Credit

The week saw the “usual suspects”, namely the high beta credit segments (HY and subordinated financial debt) outperforming again within corporate bond markets. Both US and European speculative grade, in particular delivered further spread tightening and therefore year to date total returns touched new highs: when we are writing, major broad credit benchmarks respectively register a total return in the 6% area for US HY and close to 5% for European speculative grade bonds. The outcome of the FOMC was in line with expectations and therefore substantially neutral for European credits: however, the confirmation that the prudent approach followed by the Fed in its gradual policy normalization remains in place mildly supported risky assets and the following reaction of forex market looks slightly more supportive for US credits. The further depreciation of the USD looks in fact more friendly for US rather than for European companies’ perspectives, but at the same time, given the tight valuations of credit markets on both sides of the Atlantic EUR appreciation vs USD should produce a muted impact on corporate bonds on a relative, regional basis.

As the earning season is proceeding, first numbers seem to confirm a picture of healthy fundamentals for European companies which, combined with very supportive technicals, keeps a rosy scenario in place for corporate bonds, despite valuations getting tighter. Recent price action confirms that the appetite for risk is alive and kicking and that within fixed-income markets, corporate bonds proved to be quite resilient to the recent, rapid rise of government bonds’ yields. We therefore keep our positive stance on spread products despite recognizing that future returns will more and more come from yield carry rather than from further spread tightening.

Equity

Equity markets in the black. The US market hit another all-time high. Eurozone markets held up well against the continued rise in the euro, thanks to positive earnings releases. However, it is still too early to analyse the entire earnings season.

For now, the basis of comparison for earnings remains favourable and is only expected to deteriorate in the fourth quarter. There could be some more surprises in store in the autumn: beyond the outlook for less accommodative monetary policy from the Fed and the ECB, questions may also arise about China’s choice of economic policy in the wake of the Communist Party Congress. The upside potential on the equity markets is not yet completely exhausted, but we are keeping a close eye on the potential risks for the second half of the year.

 

Key upcoming events

Economic indicators

  • Eurozone: Unemployment rate is expected to decrease in June. 
  • USA: Manufacturing PMI should remain stable in August.

Economic indicators

2017-07-28-indicators

Auctions

2017-07-28-auctions

Key events

2017-07-28-events

 

Market snapshot

2017-07-28-snapshot

Letter finalised at 3pm Paris time

ITHURBIDE Philippe , Global Head of Research
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Weekly 28th July 2017
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