2nd Quarter 2017
Content: Switzerland, Eurozone, USA, Focus topic: Labour market in the eurozone
The global upturn was also partly reflected in Swiss growth. After a weak 4th quarter in the previous year, GDP grew by 0.3% in Q1 2017. This translates to an annualised rate of 1.1%, lower than the analysts' expectation of 1.5% for 2017. Growth was fuelled by significant increases in exports and investment in equipment, whereas private consumption stagnated. Similarly, there was little change in the labour market. The seasonally-adjusted SECO unemployment rate was 3.2% at the end of May, a slight fall from 3.3% in the first few months of the year. Inflation also remained stable. In May a price increase of 0.5% was recorded, which remains unchanged from the Q1 result. Leading indicators point to a continued expansion in Q2 and the coming months. The Swiss Manufacturing PMI for May fell almost two points month-on-month, but, at 55.6 points, remained above the growth threshold of 50 points. The KOF Economic Barometer also signalled that growth is slowing. The indicator showed a marked fall in May, but, at a value of 101.6, was still above its long-term average.
Economic growth increased once again in Q1 and rose 1.9% year-on-year. The main drivers were consumption and investment activity. After the French presidential elections in May, the political risks in the eurozone also abated, as reflected in various survey data. The Purchasing Managers' Index (PMI) stood at 56.8 points in May, thanks to strong, positive momentum from Germany and France. Initial estimates for June show a fall to 55.7 points, although this still indicates a robust expansion. The manufacturing component is still flying high, reaching a 74-month peak of 57.3 points according to estimates. Consumer sentiment is currently also particularly strong, thanks to the recovery in the labour market. In April, the unemployment rate fell to 9.3%, nearly 1 percentage point below the previous year's level. These developments will bolster domestic demand in the next quarter. However, wage growth remains subdued and therefore core inflation is only rising slowly.
GDP expanded by an annual rate of 1.4% in Q1 2017. Weaker private consumption weighed on growth while investment activity improved. Retail sales have also been rather disappointing in the last few months, but industrial output increased significantly, which should further boost economic growth in Q2 and the next few months. The labour market continued to strengthen as the unemployment rate reached 4.3% in May, a level 0.5 percentage points below the rate at the beginning of the year. This trend supported the decision of the Federal Reserve (Fed) to raise its benchmark interest rate to 1.00%-1.25% in June, despite a slight fall in the PCE inflation rate.
With a PMI reading of 54.9 points and historically high consumer confidence, especially if that translates into stronger spending, the economy should expand further. However, risks remain. In the last few weeks, most US macroeconomic data have not met the market's expectations and central aspects of US policy remains unclear.
Despite solid economic growth, core inflation has remained below 1% and wages only rose 1.4% in Q1. The European Central Bank (ECB) considers this to be too low. Monetary policy will only be tightened if there is sustained inflationary pressure. The question is how exactly wage pressure will come about. From an economic perspective, the mechanism is simple: if the economy grows, companies require more staff to meet the heightened demand. As the unemployment rate falls, employees gain bargaining power and wages rise. This, in turn, leads to higher consumption and pushes up consumer prices. Higher wages also mean an increase in costs for companies, which are then passed on to consumers through price increases. However, a look at the eurozone labour market shows that wage pressures are still weak in some regions. At 9.3%, the unemployment rate in the eurozone is still around 2 percentage points above the level before the financial crisis in 2007. Figure 5 shows significant regional discrepancies within the eurozone. While Germany is close to full employment, the unemployment rates in Spain and Italy are still far above the optimum level (the Non-Accelerating Inflation Rate of Unemployment, NAIRU).
Content: Switzerland, Europe, USA
After Swiss bond yields increased significantly at the time of the US elections, they drifted sideways in Q1 and Q2 2017. Yields on 10-year Swiss Confederation bonds moved within a band of between -0.21% and -0.02% and stood at -0.02% on 30 June 2017. The Swiss National Bank (SNB) also left the reference interest rate and the target range for the three-month Libor interest rate unchanged at -1.25% to -0.25% in Q2. According to the SNB, no sustainable acceleration in the inflation rate can be expected until 2019. The inflation forecast was hardly changed. The central bank expects an inflation rate of 0.3% for 2017 and 2018 and forecasts an increase to 1.0% in 2019.
At the ECB meeting at the start of June, the growth risks in the eurozone were no longer classified as "tilted to the downside" for the first time in a long time. Draghi's speech also left out the passage about even lower interest rates. However, the inflation forecast was lowered slightly. Yields on 10-year German government bonds had fallen to 0.16% by 18 April 2017 and then rose to 0.44% by 16 May 2017 before further falling to 0.25%. When Mario Draghi said on 27 June 2017 at a central bank conference that "all the signs now point to a strengthening and broadening recovery in the euro area", yields rose again and reached 0.47% by 30 June 2017.
As expected by the market, the Fed decided on a further hike in the key interest rate by 0.25 percentage points to a target range of 1.00%-1.25%. The median interest rate forecast by the members of the Open Market Committee for 2017 and 2018 remains unchanged at 1.375% and 2.125%. A slightly lower key interest rate of 2.938% is now being forecast for the end of 2019. The Fed also announced specific details on the planned balance sheet contraction. Towards the end of 2017, approximately USD 10 billion per month in expiring bonds will not be reinvested (this will then be increased by USD 10 billion every three months until it reaches USD 50 billion per month).
Yields for 10-year treasuries fluctuated between 2.4% and 2.1% in Q2 and stood at 2.3% on 30 June 2017. The drop in interest rates can be attributed to disappointing US economic data. Figure 7 shows the expected one year performance for an investment in US government bonds. Based on the current market expectations for the development of short- and long-term interest rates, it does not make sense to invest in 10-year government bonds with an expected performance of -3.4%.
Political events have left their mark on the currency market in the last few months. After the election of Emmanuel Macron, the Euro strengthened against the Swiss franc and, at CHF 1,096 on 10 May 2017, was around 2.5% higher than at the start of the year. As a reaction to the UK elections on 8 June 2017, in which the Conservatives surprisingly lost their parliamentary majority, the British pound fell 1.4% against the Swiss franc. The Brexit negotiations, which started on 19 June, could have a further negative effect on the British pound or, if interim results are positive, could also strengthen it again. The US dollar weakened against the Swiss franc during the last few months and reached an annual low of CHF 0.966 at the start of June (around -6% YTD). The Fed's raising of the key interest rate in mid-June strengthened the US dollar, causing it to rise to CHF 0.975 on 15 June before the downward trend set in once again. The uncertainty and scandals surrounding the Trump administration are weighing on the US dollar. Disappointing economic data have also made investors doubt whether the Fed will still dare to hike interest rates again this year, as it has announced.
Equity markets in Switzerland, Europe and the USA saw further price rises in Q2. Since January 2017, stock markets have all seen a rise in the order of 10%, measured against the SMI, the EuroStoxx50 and the S&P500. From a quarterly perspective, they grew by 1.7%, 3.3% and 5.3%, respectively. Solid economic data, positive sentiment among consumers and companies, and strong company profits have bolstered equity markets. Fading political risks in Europe were also evident from the price movements in European stock markets. The EuroStoxx 50 gained 4% on 24 April, one day after the first round of the French presidential elections, while the SMI gained around 2%.
However, when Donald Trump came under pressure due to the sacking of FBI chief Comey in mid-May, the S&P500 fell by around 2% within two days. From 9 to 12 June, large technology stocks, such as Apple, unexpectedly lost up to 2.4% in one day and the S&P500 fell by 1%. The US technology sector recorded a rise of 22% between the start of the year and the start of June. The implied market volatility in the USA nevertheless remains at all-time lows. The VIX index, also referred to as "Wall Street's fear gauge", measures the expected volatility of the S&P 500 for the next 30 days. The VIX fell to below 10% several times in May and June. This has only happened 16 times since the index was launched 27 years ago.
Equities in Switzerland, the eurozone and the USA appear generally expensive as shown by Figure 15. While Swiss and European equities are still only moderately overvalued as measured by the price-earnings and price-book ratio, valuations of US equities are significantly above their long-term average. It is also the first time in the last 10 years that there has been such a large discrepancy between the regions. In addition to the overvaluation of US equities, it appears that the economic expansion is slowing down somewhat. The latest economic data are, at least, generally below market expectations, as shown by the Citigroup Economic Surprise Index, which compares the actual economic data with market expectations. The strong decline in the Economic Surprise Index has not, however, appeared to dampen the S&P500, as can be seen in Figure 14.
Precious and industrial metals have risen by 6% and 2%, respectively, since the start of the year. In contrast, agricultural commodities and energy prices have lost 5% and even 23%, respectively. The most striking price fluctuation could be seen in the oil market. Oil prices have trended downwards since the end of May and the price of Brent fell to an annual low of USD 44.82 per barrel on 21 June, a loss of 21% compared to the start of the year. This is the lowest the oil price has been since November 2016, when the oil-exporting organisation OPEC and its allies decided to cut production in order to reduce the supply glut and thereby reinforce prices. The reduction was extended in May this year, but it was also clear that some of the large oil producers, such as Russia and Iraq, had still not achieved the agreed cuts. Production also rose, mainly in the USA, but also in Libya and Nigeria, which offset the OPEC reduction and once again led to price pressures.
Content: Equities, Bonds, Currencies
Solid economic growth in the USA, the eurozone and Switzerland support corporate profits and equity markets going forward. The low interest rate environment will further bolster equities. There is a medium-term risk of a moderate correction, given high valuations and high expectations of furture economic growth, especially as the most recent data releases indicate a more moderate upturn. Political risks have subsided for now, but should not be disregarded. The Trump administration's fiscal and trade policies, Brexit negotiations or elections in Europe could unexpectedly cause renewed volatility
The theme for bonds is "gradual normalisation". After rapid and sharp rises in US interest rates at the end of 2016 and start of 2017 in the hope that Donald Trump would implement his expansive fiscal policy, pessimism spreads again across the market. While the Fed announced a further interest rate hike for this year, the market-implied probability for this is below 50%. Further, the 10-year yield on US government bonds in mid-June was below the level of December 2015, when the tightening of monetary policy began in the USA. Monetary policy remains expansive in Switzerland and the eurozone, as there are no signs of inflationary pressures. A reduction in the ECB's bond purchasing should, however, lead to a further slight rise in interest rates in the eurozone in the next year. In the short term sideways movements are to be expected, while, in the medium term, rates can be expected to rise in all key regions.
We could see an easing of the Swiss franc in the second half-year. The increasing monetary policy divergence to the USA should support the USD/CHF, if the Fed actually raises interest rates a third time this year, as announced. The majority of investors are currently of the view that there will be no further rate rise until 2018. Meanwhile, it is expected that the ECB will announce its plan of tapering its quantitative easing programme this autumn. The expected tapering of bond purchasing in 2018 should strengthen the Euro.
Bloomberg Finance L.P., BIS, FRED, Eurostat, OECD, IMF, SNB, EZB, FED, KOF, SECO, Markit, editorial deadline: 30.06.2017
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