The broad-based stock market rally that characterised much of the first quarter of 2015 ran out of steam in March. During the month, investors focused on weaker US economic data, renewed geopolitical tensions in the Middle East and a corresponding bounce in the oil price. In bond markets, benchmark 10-year government yields remained extremely low, with German Bund yields finishing the month at just 0.18%. In the US and UK, 10-year yields also moved lower, reflecting the softer tone of US data and the ‘gravitational pull’ of the ECB’s QE programme. In credit markets, there were some signs of indigestion following heavy new issuance, but these concerns have eased somewhat following the seasonal lull in activity over Easter.
Looking to the second quarter, there are three important issues which investors will have to consider – the trajectories of interest rates, currencies and economic growth. On the interest rate front, much was made of the Fed’s decision to drop the word ‘patient’ from its March policy statement but the bottom line is that, seven years on from the financial crisis, we are still living in extraordinary times. Consumers and governments in the developed world remain overlevered and overindebted and companies across a number of sectors are struggling to maintain pricing power. In my opinion, it is not obvious that there is a need for any aggressive rise in interest rates, particularly given the deflationary impact of lower energy prices. At the time of writing, barely one US rate rise is priced in by markets for this year, and in the UK markets have pushed the timing of the first rise all the way out to August 2016. The eurozone and Japan, meanwhile, are expected to keep policy extremely accommodative.
Interest rates provide a neat segue to currencies. The combination of European and Japanese QE and the expectation that the US should raise rates this year has driven a very strong rally in the dollar index over the past six months. We do not expect the dollar to maintain its very robust rate of appreciation but the greenback remains the global reserve currency by default. Moreover, further short-term volatility in the euro/dollar exchange rate cannot be ruled out as Greece appears to be heading towards a ‘day of reckoning’. In the long run, a Greek exit from the euro could be a positive for the country but the period of adjustment in the short term would be extremely painful. But, by itself, a ‘Grexit’ would not be a disaster; the real issue is what happens elsewhere in the eurozone, particularly if Greece does succeed, over time, in going it alone.
The global economic growth outlook appears to be deteriorating at the margin. The recent weaker US data is almost certainly linked to weather-related disruptions and other one-offs such as the West Coast ports strike, but it was probably unreasonable to expect the US to keep outpacing the rest of the developed world by such a wide margin. At the corporate level, US companies are undoubtedly feeling the pinch of the reduction of capex in the energy sector and the stronger dollar. Our own view is that the US economy is in a soft patch, and this is likely to be reflected in Q1 US GDP and probably Q1 reported earnings. Nonetheless, for risk assets, and indeed the global economy in general, it is important that the recent ‘blip’ in US data is nothing more than that.