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August has been an uncharacteristically eventful month this year as fears surrounding imminent budgetary concerns in Italy and weakness in a handful of Italian banks, coupled with the crisis in Turkey, have resulted in a marked increase in risk aversion, shifting investor sentiment well into risk-off mode. As result, both US Treasuries and Bunds rallied, almost reaching yields last seen in May, with the Bund hovering around the 0.30% level. With market jitters seemingly abated from the high volatility period, the focus may soon shift back to economic fundamentals and steer away from the focus Emerging Markets (EM) has garnered in recent weeks. The economic backdrop in Europe and the US remains robust, which is, at least in the short-term encouraging for spreads and equities.
Trade wars and the concerns they brought to the market, coupled with EM weakness as well as persistent fears of a looming US recession have prevented yields from the uptick the markets were anticipating. However, risk appetite seems to be creeping upward, albeit timidly, as flows out of EM have abated, and this, could prove to be positive for the trajectory of performance in the months ahead.
The market’s focus over the weekend was undoubtedly on the US Federal Reserve Chairman’s speech at Jackson Hole, particularly linked to the current balance sheet as well as the projected rate path of interest rate rises. The Fed minutes last Wednesday did in fact indicate that the Chairman expected the balance sheet discussion to begin sometime in “the fall”. The minutes of the August FOMC meeting confirmed the likelihood of a September rate hike, but the tone was generally dovish. The minutes laid out the agenda for the remainder of the year. The committee is also likely to discuss the size and composition of the Fed’s balance sheet and excess reserves in the upcoming meetings.
Chair Powell’s speech at Jackson Hole was, as expected, focused around the uncertainty on the trajectory of the concoction of interest rates, unemployment and growth. With the discussions centred on the state of the current US economy and with regional Fed presidents offering their own estimates, Powell’s speech opined that the Committee will ultimately remain, at least in the interim, data dependent. We interpret this as a reiterated cautious stance by the Fed as the Committee continues its gradual rate hikes.
Meanwhile, in Europe, the second estimate of German 2Q GDP did in fact on Friday confirm the above-potential momentum in the euro area, with net exports having been a drag for way too long. In this vein, from its increasingly less dovish tone, the ECB remains cautiously optimistic on the euro area economy and remains more confident than ever that accelerating wage growth is expected to result in upward inflationary pressures. However, market sentiment continues to play a critical role in the ECB’s stance as Italian uncertainties have been a drag in 2018 and have kept market doves content in recent months.
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