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From what can be evidenced in bond markets over recent weeks, the search for yield phase in the eurozone is back as the lower for longer tone by the ECB is extended further. The ECB’s problems seem to be structural in nature yet it still opted to tackle a number of cyclical solutions, with little effect so far. It could be argued that low rates and especially negative rates may actually have the opposite effect of that intended. The ECB’s decision to halt the bond sterilisation SMP programme is evidence of the fact that rates are on hold until December 2016. However, a new set of targeted LTROs also provides implicit signals that rates will be on hold until September 2018- which has not been fully priced in. Apart from sending yields further southbound, it is clear that the ECB has not delivered with respect to increasing inflation expectations.
On the data front, preliminary PMIs as published by Markit yesterday add further impetus to the case that the US economy has bounced back strongly from its weather-led contraction in the first quarter of 2014, as the flash manufacturing PMI rose from 56.4 in May to 57.5 in June, its highest level since May 2010. The revised estimate of Q1 GDP, to be published on Wednesday, on the other hand is likely to show a contraction of around 2.0% annualised.
Elsewhere, fears of a pronounced slowdown in China appear to have been toned down as initial indication here also suggests that activity held up well in April and May. The preliminary manufacturing PMI for June, released by Markit yesterday, rose to a seven-month high, mainly on the back of stronger domestic demand, which was brought about by government-backed infrastructure spending.
However, the euro-zone appears to be missing out on the recover as preliminary composite and manufacturing PMIs for the region both fell to six-month lows. More importantly, these surveys have tended to overestimate the strength of the euro-zone economy in recent quarters. Looking ahead, the most likely scenario is that the world economy gradually gains momentum in by 2016, led by the US as policy-makers are likely to continue to support growth.
Being more country specific in the Eurozone, the French economy has probably fared better than June’s dreadful PMIs suggest. However, additional austerity and weak competitiveness mean that it will continue to weigh on the euro-zone’s recovery. The fall in France’s composite PMI from 49.3 to a four-month low of 48.0 in June suggests that the weak recovery there failed to gain any momentum in the second quarter of this year.
Meanwhile, last week we saw the world’s leading equity indices trading higher, with all major U.S indices up by 1% w-o-w. This performance was brought about despite a marked element of complacency evident in the market, bearing in mind the low levels of volatility (as evidenced by the VIX index) and the lack of a meaningful correction over the past few years. One could argue that markets have entered the so-called denial stage from a sentiment perspective. Nevertheless, markets keep trending higher and this week is no short of economic data releases as focus will be placed on the final US GDP reading on Wednesday. Much of the first quarter weakness has been blamed on the severe weather across the U.S this winter. However, complacency in the markets have made a large number of investors more aware that the market the market is overdone and is due for some type of correction. Corrections are usually brought about by market triggers or event risk, something which the market is clearly not catering for right now.
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