Week End Blog – Starring Mr. Draghi and many others

Draghi did it again. His words already proved very convincing, but now that the time for action has come, Draghi delivered as well. In what was quite a surprise, the ECB lowered all official rates with another 0.10%. The main financing rate is now only 0.05%, while parking your money at the ECB will cost you 0.20% per year. The measures taken by the ECB sent the euro/dollar exchange rate to below 1.30 for the first time since July of last year.

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Draghi also announced that the ECB will start purchasing non-financial assets by October. ‘The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme (ABSPP).’ What’s interesting is that mortgage-backed securities could also be included, something that was not anticipated before. We have to wait for the next ECB meeting on October 2nd to get all the details, but the main goal seems clear, expanding the balance sheet US/Japan style.

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What will this program, and perhaps even more ‘QE-like’ measures, mean for other assets? After zigzagging for quite some time, yields on German and US governments bonds went up modestly. Remember that US yields rose aggressively after the Fed announced its QE programs. Concerning equities; there has been a strong relationship between stock market returns and the amount of QE that is deployed. So, could European markets play catch up? Read more on the relationship between returns and QE here.

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Let’s move back to the start of the week. With the exception of Japan, global PMI numbers were weak. Especially in Asia and Europe the Markit PMI data came in below expectations, signaling slower growth.

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China’s PMI number was also disappointing. After a modest increase in growth momentum, China, always a black box, seems to be falling back again. First we had the totally unexpected fall in new loans, and this latest PMI number also raises questions.

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China is not the only emerging country showing this pattern. The graph below reveals that the manufacturing activity in emerging markets lies below that in developed markets. This has been the case since May last year.

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When it comes to manufacturing activity, the United States are top-notch. The ISM managed to beat expectations once again and reached the highest level in three years. And while this signals stronger GDP growth, the graph below suggests equity investors may also be pretty satisfied with the latest outcome.

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The publication of the ISM index for August triggered a new update of my fair value bond yield model. Based on the most recent numbers for ISM new orders, inflation and short-term rates, the fair value 10-year bond yield in the US should be … 4.22%. You do the math.

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Too bad I have to squeeze in the nonfarm payrolls. They came in well below expectations. But, perhaps this will please Janet Yellen, who was running out of stories to keep the Fed rate low.

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Fortunately, as the week progressed, Europe also experienced some ‘happy’ moments. After a series of disappointing macro data, Germany stood up and reported better than expected factory orders and industrial production. Even the French managed to reveal a small positive surprise this week. Consumer confidence did not fall any further. Vive!

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Currencies have been on the move lately. With the Fed heading for the exit, investors are piling into the greenback. The trade-weighted US dollar has moved up aggressively, which could cause some problems for other assets. The graph below shows the relationship between the relative performance of emerging markets and the value of the dollar. Historically, the two didn’t get along that well…

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With the dollar appreciating, the yen reached new lows. One interesting, and perhaps disturbing point, Japanese equities did not outperform all that much. Has the correlation between the relative performance of the Nikkei and the yen been broken?

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Don’t forget, September is here again. Traditionally, THE month that keeps investors up at night. But should they really? An analysis of September month returns through time reveals that its damaging power has abated. For more on the shifting September returns read here.

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Last but not least! Excited about the upcoming Apple event? If so, then watch this IKEA video to get you warmed up.


Enjoy your weekend!

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