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- The policy meeting of the European Central Bank (ECB) was the main focus for markets last week. There was a split in expectations about whether the bank would raise rates or not. In the end, it did raise the policy rate by 25bps. However, it gave sufficient indication that the hiking cycle could be over: “rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target”. Due to this strong language, the rate hike caused no negative reaction in markets. Instead, markets focussed on the prospect of no more hikes with equities moving ahead and bonds holding steady.
- We regard this as a positive development for the fixed income markets in the euro area and we have increased our allocation to fixed income in the region. There was always uncertainty about what the terminal policy rate would be in the euro area. The latest statement reduces that uncertainty significantly. Of course, if inflation turns out higher than currently thought we may see rates rise further. However, given the weakness of the economy and the fact that it was not a unanimous vote to raise rates at last week's meeting means the ECB is likely to be patient going forward.
- We still maintain a preference for short-dated bonds but increased our exposure to sovereign debt given the healthy yields that are available there. The yield curve is still heavily inverted (longer dated yields are lower than short-dated yields) so buying longer dated debt means you are giving up potential yield. Since interest rates are likely to ‘stay higher for longer’ this does not make sense at the moment.
- The inflation data from the US was disappointing and contains a warning sign. The core Consumer Price Index was slightly higher than expected, although the annual rate did drop to 4.3% from 4.7% last month. The downward journey in inflation is continuing but the rate is slower than forecast. The pick-up in headline inflation was a bit concerning as the recent spike in the oil price feeds through. Central banks do not normally react to energy price inflation, viewing it as temporary, but it does depress real incomes.
- An update on consumption in the US shows a potential slowing in momentum. Core Retail Sales were up just 0.1% month-on-month and that is after a downward revision to last month’s growth from 1.0% to 0.7%. Taking the two months together, core Retail Sales are running 0.2% below forecast. We felt that the momentum in US consumption could not be maintained, perhaps we are seeing the turning point now.
- Better news from China this week. Both Retail Sales and Industrial Production growth improved on a year-on-year basis and beat forecasts. It is unlikely that recent policy measures have impacted yet, and it is probably a natural stabilisation in the economy. The property market remains weak with the level of investment weakening further. To counter this the authorities have been announcing policy measures. Last week the People’s Bank of China reduced the reserve requirement for the banking system. At some stage these measures should bring some stability, the questions of when and for how long remain.
Chart of the week: A bit of a worry?
The oil price is on the move up again spiking up 20% over the last couple of months. The driver has been agreed supply cuts by OPEC and Russia. It spiked up this time last year and subsided as we travelled through the winter period so perhaps we are seeing the worst of it now. But while it stays here, it does act like a tax on consumers, particularly the US consumer. In last week’s Retail Sales report while core sales were close to flat month-on-month, sales at petrol stations were up over 5%. With global growth increasingly dependent on the US consumer, this trend in the oil price is a worry.
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