NN IP: Politics still creating short-term volatility

Markets continue to respond daily to the political news flow. This week started with some positive news from Germany, where the CSU and CDU parties reached on an immigration deal involving refugee centres at the German border. However, the deal still needs approval from the SPD party, Merkel’s other coalition partner, which will no doubt ask a price. 

For markets, the fear of an escalating trade war is a more prominent theme. The market is anxiously waiting for Friday, when the US is scheduled to impose tariffs on USD 34 billion of Chinese goods. In addition, fears that the US will impose a tariff on European cars and that the EU will have to retaliate are still very much alive. Over the weekend, President Donald Trump added to the tension, suggesting the US might leave the WTO, although this was downplayed later by Commerce Secretary Wilbur Ross. Statements from China that it will not use the yuan exchange rate as a tool to cope with trade conflicts provided some relief for markets, especially in Asia. At least it helped to stop further depreciation of the Chinese currency.

Some reasons for optimism

There are some reasons for optimism, though, both from a fundamental and a behavioural angle. The US June ISM manufacturing printed at a stronger-than-expected level (60.2), with the reading up 1.5 points from May. Surprise indicators have bottomed, both in developed and emerging markets, providing more evidence that global economic growth is stabilising at a high level and that a period of weaker data behind is behind us. However, we don’t see this improvement in our own cyclical indicator yet, which could even deteriorate when we get a full update of this signal later this week.  

Investor sentiment also provides some reasons to become more constructive on markets. Bull/bear and put/call ratios show that investors have become quite pessimistic already, and dynamic positioning indicators show that on average investors hold a low beta positioning.

Stay on hold

Balancing out the political uncertainty with hopeful fundamental data, we decided to maintain our allocation stance. in fixed income we hold on to an underweight duration. Better economic data, higher commodity prices, fading political risk in Europe and our short-term dashboard all support higher Bund yields, currently at the bottom of their trading range. On spreads we see the technical trends as main reason to stay underweight. We are more concerned about emerging markets, where the fundamentals (dollar, oil prices, more rate hikes) provide reason for caution, whereas developed markets provide some more comfort on economic fundamentals.