Topic Tags: International Economy

Taking the PEPP Out of the Eurozone’s Recovery?

Amid concerns over the Delta variant and signs of a sharp slowdown in the global economic rebound, many central banks have signaled that they will keep monetary policy loose over the near-to-medium term. U.S. Federal Reserve Chairman Jerome Powell, at the annual Jackson Hole summit on August 25th, maintained that rate hikes were not imminent. Though, on the spending front, Powell did indicate tapering bond purchases may be on the horizon, as long as economic progress continues. We expect to hear a similar narrative at this Thursday’s European Central Bank meeting, with a subtle caveat. Given how well the European economy has rebounded, the ECB is expected to slow the pace of their €1.85 trillion asset-buying program — the Pandemic Emergency Purchase Programme (PEPP) — in the fourth quarter.

The chart above shows monthly net bond purchases made under the PEPP since its inception in March 2020. There was a substantial injection in the first four months of the pandemic, which then decreased as the first wave waned and lockdown measures relaxed. Bond purchases remained at or below €70 billion for the next seven months. However, in response to rising bond yields, the ECB increased PEPP purchases in March 2021 and has kept them at a higher pace since. At the coming meeting, ECB officials are likely to agree to trim PEPP bond purchases to roughly €60 billion per month for the remainder of 2021, a 25% drop from the current pace of €80 billion per month.

What impact will this modest tightening have on the European Union’s economic recovery? The pan-European market benchmark, the STOXX 600 Index, posted its seventh straight month of gains in August, the longest winning streak since 2013, on the back of strong corporate earnings, lower unemployment, an adult population that is 70% fully vaccinated, and continued accommodative fiscal measures. We expect ECB hawks to argue for the need to curtail the current inflation trajectory, citing its potential to outpace expectations given supply chain bottlenecks and resurgent household demand. Inflation, as measured by the Eurozone HCIP, was 3% at August month-end, above the ECB’s 2% target. On the contrary, more dovish members will likely be more concerned with ramping up the existing ongoing asset purchase program once PEPP ends. As COVID-19 variants test the need for further abatement measures and restrictions in Europe and around the world, central banks are under increased scrutiny. Monetary policy decisions, particularly the pace of tapering and rate increases, will have lasting effects on global markets for the remainder of 2021 and the next several years.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

China: From Leader to Laggard

In 2020, China was a top performer in the global equity market, returning 29.5%. In 2021, however, Chinese equities have struggled thus far compared to many of their peers. While several of the world’s major equity markets have generated double-digit returns year-to-date, China has lost 12.3% with the majority of those losses occurring in the last several weeks.

In this newsletter, we review reasons why China has transitioned from leader to laggard — with a focus on recent regulatory actions by the Chinese government — and discuss future prospects from here.

Read > China: From Leader to Laggard

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Where is Inflation Headed?

Despite a number of commodity prices, including lumber, corn, and pork, retreating from recent highs, inflation remains a key focus for investors, especially as the Delta variant rages on and vaccination rates slow. Our chart this week looks at what the data can tell us about where inflation is headed.

Actual inflation, as measured by year-over-year growth in the headline Consumer Price Index (CPI), is shown in green in the chart above. CPI ran hot in 2008 just before the Global Financial Crisis (GFC), fell into negative territory in 2009, and then peaked twice before turning a corner, declining in 2011 and normalizing from 2012 to 2014.

The market’s expectations for average annual inflation are shown above in purple and teal, over the next two and five years, respectively. The breakeven inflation rate measures the difference in yield between U.S. Treasury bonds and Treasury Inflation-Protected Securities (TIPS) of the same maturity. This difference is the return that the TIPS provide to protect from inflation, or the inflation rate where an investor would be indifferent between owning the two instruments.

What do these three lines tell us? First, actual CPI does loosely follow, on a lag, the two-year and five-year breakeven rates. Both breakeven rates fell and recovered ahead of CPI in 2008 and 2009. The difference between the two-year breakeven and five-year breakeven also provides critical information. In the post-2008 GFC recovery, the five-year breakeven remained higher than the two-year breakeven from 2009 to 2011, with the market expecting inflation to rise and be higher on average over the next five years than over the next two years as the global economy continued to recover. In 2011, the five-year breakeven fell below the two-year breakeven, showing that the market began to forecast that average inflation over the next five years would be lower than average inflation over the next two years. Actual CPI peaked not long after that, declining and normalizing from 2011 to 2014.

What could these indicators mean for inflation going forward? Actual CPI is again running hot at 5.4% in both June and July. However, the two-year breakeven, despite characteristically falling faster than the five-year breakeven at the height of the COVID panic in 1Q20, is already higher than the five-year breakeven, a leading indicator of CPI peaking and something that didn’t happen after the GFC until 2011. Additionally, both the two-year and five-year breakeven appear to be plateauing. Both breakeven rates have been fluctuating around 2.5%, meaning the market believes annual inflation will settle around an average 2.5% over both the next two and five years, supporting the idea that heightened near-term inflation is more transitory. While this market-based data does have its limitations, it is a helpful input as we look to help our clients prepare for the future.

Print PDF > Where is Inflation Headed?

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Chinese Equities Sold Off in July

In 2020, China was a top performer in the global equity market, returning 29.5%. In 2021, however, Chinese equities have struggled relative to peers. In July, the MSCI China Index lost 13.8%, dragging the broader MSCI Emerging Markets Index to a 6.7% loss for the month.

On July 23rd, the Chinese government, as part of its efforts aimed at boosting a declining birth rate, announced that private for-profit education companies were no longer allowed to make a profit. Among other restrictions, these companies are now required to transform into non-profit entities. As a result, two of the largest education companies — New Oriental Education and TAL Education — were down 73.5% and 75.9%, respectively, in July. This dramatic change is a recent event in a series of regulatory actions that have been taken by the Chinese government over the last nine months. Previous changes predominately impacted internet-based businesses.

Chinese equities have sold off as investors assess the risks of the new regulatory climate and the potential impact to future profitability of several key industries. From here, the market will likely remain jittery on Chinese stocks, especially within regulated industries. However, this is not a new phenomenon. We have seen the Chinese government increase regulations in the past after periods of unchecked growth. The online gaming industry, for example, came under pressure in 2018 when the Chinese government imposed a curfew for minors as a means of limiting gaming consumption. In those past instances, the market recalibrated to the new regulatory environment and the resulting winners and losers were identified. We anticipate a similar outcome in this case.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Have Things Been Too Quiet?

Although this is only the second iteration of my quarterly letter series, Marquette has always produced quarterly market narratives in one shape or another. And in almost all cases, it has been relatively straightforward to formulate a narrative that stitches together the primary headlines from the prior three months. But as I sit here today, things seem quiet…too quiet, almost. Of course, it is the first summer after a crippling global pandemic that shuttered the economy and constrained us almost exclusively to our homes for the better part of the year. Summer is in full swing and the images of crowded beaches overlaid with higher prices for airline tickets and hotel stays illustrate that people are getting back to their pre-pandemic lifestyles, both socially and economically. Anecdotally, my email volume slowed over the last quarter as well; whether this is pure coincidence or a function of markets generally behaving in conjunction with economic re-openings and summer vacations remains to be seen.

Nonetheless, the purpose of this letter series is to track the pulse of the financial markets and let our readers know what we’re thinking about (worrying about?) when looking at the overall financial market landscape. Given that objective, the following outlines several market factors that we believe bear monitoring as the remainder of the year plays out.

Highlights from this edition:

  • Market volatility and reversion to the mean
  • COVID-19: new uncertainty with the Delta variant, vaccination progress
  • Interest rate expectations
  • Inflation following a crisis
  • Valuations: signals from the credit and equity markets

Read > Have Things Been Too Quiet?

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

 

2021 Halftime Market Insights Video

This video features an in-depth analysis of the first half of 2021, reviewing general themes from the second quarter and risks and opportunities to monitor in the coming months.

Our Market Insights video series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real estate, infrastructure, private equity, and private credit, with presentations by our research analysts and directors.

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The Lasting Effects of a Temporary Trade Stoppage

In late March, one of the busiest waterways in the world came to a standstill after the Ever Given, a 1,300-foot container ship, became lodged in the Suez Canal. Nearly 30% of the world’s daily shipping container freight passes through the Suez Canal, and with supply chains already disrupted amid the COVID pandemic, the timing could not have been worse. While only a one-week stoppage, with approximately 7% of the world’s oil and 12% of global goods trade flowing through the canal, it is estimated that each day lost delayed more than $9 billion worth of goods.¹

In this Chart of the Week, we analyze the impact that the Suez Canal closure had on maritime shipping costs and the contribution to inflation. The chart above shows the daily price movement of the Shanghai Containerized Freight Index (SCFI). As one of many proxies for global trade and ocean freight health, the SCFI reflects the weekly shipping spot rates of Shanghai container exports along 15 major trade routes, including Shanghai to the United States (east and west coasts), Europe, South Africa, and South America. In contrast to the highly-cited China Containerized Freight Index (CCFI), the SCFI focuses solely on exports in these 15 individual trade routes, rather than nationwide import and export container transport, which would include more contractual and futures rates. Rates surged throughout 2020 amid increasing demand for goods over services and tighter supply. The blockage, which may take months to fully recover from, combined with pent-up demand and economic re-openings has exacerbated the imbalance and sent SCFI spot shipping costs up another 20% over the last month. Rising inflation has been an increasing concern for investors this year and, given current dynamics, we do not expect the contribution from higher global shipping rates to abate anytime soon.

Print PDF > The Lasting Effects of a Temporary Trade Stoppage

¹Lloyd’s List Intelligence

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

One Year Later, What’s Next?

Welcome to our inaugural quarterly client newsletter! As a way of introduction, I am Greg Leonberger, Director of Research here at Marquette. I have had the privilege of meeting many of you over the years, and for those that I have not worked with previously, please accept this virtual introduction; my hope is to meet many more of you in person once in-person meetings resume. As I embark on this newsletter series, the goal each quarter is relatively simple: provide you with our views on capital markets, the economy, emerging risks as well as opportunities, and hopefully stitch in a few anecdotes to make for a more engaging connection with our readers.

Highlights from this edition:

  • One year anniversary of the equity market trough in 2020
  • COVID-19: lingering uncertainty, vaccine progress, economic recovery
  • Equities update: value and small-cap outperformance, valuations, TINA
  • Fixed income: reflation trade and interest rates, spreads
  • Alternatives: opportunities in real estate, hedge funds, and private markets
  • Inflation worries: money supply and commodity prices

Read > One Year Later, What’s Next?

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Q1 2021 Market Insights Video

This video features an in-depth analysis of the first quarter’s performance by Marquette’s research analysts and directors, reviewing general themes from the quarter and risks and opportunities to monitor in the coming months.

Our Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real estate, infrastructure, private equity, and private credit, with presentations by our research analysts and directors.

Sign up for research alerts to be notified when we publish new videos here.
For more information, questions, or feedback, please send us an email.

Weak Dollar, Strong EM

For U.S.-based investors, the movement of the dollar has a direct and indirect impact on emerging market equity returns. The direct impact is straightforward. Purchasing foreign-listed equities requires conversion to the local currency. On top of the change in the price and any dividends of the underlying stock, a weakening U.S. dollar creates a positive currency return, while a strengthening U.S. dollar generates a negative currency return.

The movement of the dollar also has an indirect impact on emerging market returns. This week’s chart looks at the performance of the MSCI EM Local Currency Index and the U.S. Dollar Index (DXY). The local currency index removes any direct currency impact, isolating price performance of the underlying stocks. The DXY measures the U.S. dollar versus a basket of trade partner currencies. Since 2000, the correlation of monthly returns between the local currency index and the dollar index is -0.40, meaning historically they have moved in opposite directions.

There are several reasons why a weak dollar is supportive of emerging market equities. A weaker U.S. dollar is generally positive for overall economic growth and emerging economies typically benefit from strong global growth. Many developing economies are also reliant on dollar-issued debt. A weaker dollar lowers the cost of borrowing, a positive for emerging markets companies and equity markets. The U.S. dollar weakened throughout most of 2020, with the DXY down 10% between February and December. Over that same time frame, emerging markets equities returned 19%. So far in 2021, the dollar is up modestly, with emerging markets pulling back more recently. Looking forward, we expect the historical relationship between the two to persist, positioning emerging market equity investors to benefit should the dollar weaken further.

Print PDF > Weak Dollar, Strong EM

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.