Q1 2020

FischView commentary

Beat Thoma, Chief Investment Officer, explains the FischView model results and his views on financial markets.

Key takeaways

• Following a temporary slump, the global economy is turning the corner again. A stabilisation is especially visible in Europe and China.
• Both fundamental and monetary indicators are improving.
• Inflation still poses no problem for central banks.
• Equity and credit market trends remain positive, but investor sentiment is at euphoric levels.
• Downtrend in interest rates is clearly weakening – neutral assessment.
• Valuations of equity and credit markets appear fair to expensive – government bonds are expensive.

• Equity markets: The scores for equity markets have risen slightly compared to the previous month, and thus remain clearly in positive territory, especially for China and various other emerging markets. After some temporary weakness in recent months, the situation here has stabilised significantly. Accelerating global money supply dynamics and higher readings for various economic indicators have driven this improvement. Inflation remains low and thus does not pose a threat to the very loose monetary policy of central banks. This means that there is still a combination of positive monetary and fundamental factors that is favourable for financial markets, additionally supported by an easing in the trade war. However, short-term sentiment indicators signal a very high risk of a temporary correction.
• Credit markets: Credit markets are also supported by the current monetary and fundamental environment. However, much has already been priced in at current levels. Total return expectations are still positive by virtue of coupon income, but the market should remain within a neutral range in terms of pure price movements.
• Interest rates: The marked acceleration of money supply dynamics, together with better economic figures, should lead to a reflation of the financial system in the medium term, as desired by central banks. The gold price, which has been robust for some time, already confirms this development. Although the interest rate trend in Europe and Japan is currently still pointing downwards (and the USA is neutral), there could be a turnaround to the upside at any time, so we are positioning ourselves neutrally here.
• Currencies: The momentum of the US dollar has weakened somewhat. On the one hand, the euro and the yuan are benefiting from the easing of the trade dispute. On the other, the US central bank is pumping up to USD 60 billion into the money market every month to prevent liquidity bottlenecks. This means that the overall environment for the greenback is negative.
• Convertible bonds: Every performance driver for convertible bonds is either neutral or positive

In Focus

US Federal Reserve's course attracts attention

At its last meeting, the US Federal Reserve made far-reaching statements, the importance of which may have been underestimated by many investors and market participants. For example, the clear announcement that an interest rate hike was unlikely throughout the next year was noteworthy. And this despite the fact that the labour market is close to overheating and private consumption is at record levels, developing extremely robustly.

Another astonishing announcement was the exclusive link between interest rate hikes and a "significant and persistent rise in inflation". In summary, the Fed has thus severely restricted its own future room for manoeuvre: Interest rates can only be raised as a function of inflation, and not before the end of 2020 at the earliest. This means an accelerating economy would have no influence on monetary policy for the time being. In addition, overshooting inflation must be tolerated so that we can speak of "significant" inflation at all.

Overall, this communication by the Fed contains a certain potential for conflict. Inflation is only developing very moderately, which is probably the main reason for the current monetary policy path. However, the increase in the price of gold and the rise of the money multiplier (money supply M2 in relation to central bank money) show that inflationary disruption potential has been building up in the banking system for some time. The current policy of monthly liquidity injections of USD 60 billion to support the repo market further complicates the situation. Market participants are now assuming that the Fed will not become more restrictive even if inflation signals pick up slightly. This could lead to a dangerous and difficultto-assess change in market expectations regarding long-term interest rates.

The impact and extent of such new expectations are underestimated. This could at any time lead to new assessments not only of interest rates, but also of the stock and currency markets. The danger of a central bank acting too late would then at some point be interpreted as a serious problem.

Chart: Inflation expectations remain low, but first signs of trouble need to be watched closely

Market-based inflation expectations, as measured by the five-year forward inflation-linked swap five years ahead, are still low. But there are initial signs of a trend reversal and a level above 2.6% would constitute a warning signal.

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