BNP Paribas: Swinging from fundamental to liquidity drivers

On the first, FOMC policymakers kept US interest rates unchanged at their meeting on 31 January, released a dovish meeting statement and, importantly, dropped any references to further rate rises.

With respect to trade war fears, reports that the talks between the US and China were progressing fuelled new hopes of an agreement between the two leading economies, with a meeting between President Trump and President Xi tentatively announced at the time of writing.

These two drivers combined buoyed equity markets, but compared to January’s strong rebound, February’s returns were less stellar. Regionally, the US market rose further, with the S&P 500 index flirting with 2 800 points (a roughly 4% gain MoM). In Europe, EMU and UK equities rose in line with other developed markets. European markets were bid up especially after comments on a new round of TLTRO emerged from an interview with ECB board member Benoit Coeur. These were later confirmed by chief economist and board member Peter Praet (even though a decision still has to be taken). European banks outperformed on the back of this news in the second half of February.

Given the risk-on mood in stocks, major government bond markets traded broadly sideways to slightly higher in February, with the dovish central bank stances providing important support. EMU ‘peripheral’ bonds underperformed (posting a negative MoM return, but still up YTD) amid uncertainty over the outcome of Spanish elections and the impact of Italian populism. German Bunds did well, on the other hand.

The Brexit saga continued, even as the UK is getting closer to the end-March deadline for departure from the EU. PM May suffered another defeat. Further votes are on the calendar as we write, and the situation remains fluid, although Brussels seems reluctant to discuss new conditions for Britain’s exit.

On the currency side, the USD was seemingly not affected by the Fed’s decision to pause. The greenback gained marginally over the month. With FX being a relative price, weakness out of Europe was the main driver. The JPY, typically a risk-off asset, fell, but its historically positive correlation with gold turned negative. Indeed, since the start of the year, gold has been boosted mainly by lower real rates rather than risk sentiment.
Elsewhere, in commodities, energy outperformed in February. This boosted most other complexes too. Oil rallied in the second half of February amid political and social tensions in Venezuela, strong Chinese demand and OPEC output cuts led by Saudi Arabia.

Otherwise, on the macroeconomic front, some data pointed to a robust US economy. Weaker signals came from Europe, mainly the UK and Germany. The UK economy is clearly at risk of a no-deal Brexit (UK GDP Q4 0.2% vs. 0.3% consensus, industrial production -0.5% vs. 0.1% consensus). The slowdown in Germany (GDP Q4 0.1% vs. 0.0% consensus and industrial orders -1.6% vs. 0.3%) is a source of concern for the entire European economy given that Germany has been its growth engine for many years.

In the current corporate earnings season, results were mixed: US companies posted generally positive surprises, whereas Europe disappointed. With positive surprises overall, Japan falls somewhere in between the US and Europe.

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