4th Quarter 2016
Content: Switzerland, Eurozone, USA
The Swiss economy almost stagnated in the third quarter of 2016. Compared to the previous year, the growth rate was 1.3%. Positive impetus was provided here by investment activity. Consumer spending stagnated, however, and did not make any contribution to growth. Foreign trade had a negative impact, as import growth was higher than export growth. The unemployment rate has remained unchanged since September at 3.3%. Contrary to expectations, the core inflation rate has declined since August and currently stands at -0.3%. The Swiss industrial PMI rose in November for the fourth month in succession, reaching 56.6%, its highest level since the beginning of 2014. Here, all the sub-components experienced positive development. Production rose, order books grew and for the first time since the end of 2014, the surveyed companies indicated they were recruiting more staff again. Early indicators such as the KOF Barometer and the ZEW Index rose in the fourth quarter, suggesting that growth of over 1.5% can be expected up to the middle of 2017. This assessment is underpinned by the current forecast of the State Secretariat for Economic Affairs, which estimates a growth rate of 1.8% for 2017 and 1.9% for 2018.
In the third quarter, GDP growth accelerated slightly compared to the previous year to 1.7%. The driver for this positive trend was private consumer spending, while investment activity did not provide any contribution to growth. Foreign trade had a dampening effect on economic growth. The encouraging economic momentum can also be seen on the labour market. The unemployment rate fell to 9.8% in October and was thus below the 10.0% mark for the first time since May 2011. The purchasing managers' index rose in November to 53.9%, putting it firmly in the growth zone. While the index in Germany and France declined slightly, in Italy it rose to a nine-month high. The Spanish PMI also recorded a five-month high of 55.2%. A look at the sub-components reveals that both production and order books made strong gains. Moreover, employment increased for the 25th time in a row. The purchasing managers surveyed also indicated that wage costs and purchasing prices are starting to rise again. However, the core inflation rate remained unchanged in November at 0.8%. The European Central Bank has extended its quantitative easing programme by nine months, but from April 2017 will "only" buy EUR 60 billion of bonds a month, rather than the previous EUR 80 billion.
After a disappointing first half of the year, the US economy performed very well in the third quarter. The annualised growth rate was 3.5% and was the result of higher consumer spending, more investment activity and an increase in government spending. An average of 165'000 new jobs have been created every month in the US since September. As a result, the unemployment rate fell in November to 4.6%, reaching its lowest level since August 2007. The purchasing managers' index for the service sector rose more strongly than expected in November to 57.2%, and the industrial sector is also growing surprisingly strongly with a PMI of 53.2%. The good economic situation and especially shortages on the labour market are having an increasing impact on inflation. Wages rose by 2.5% on average compared the previous year, core inflation remained unchanged at 2.1%, while the inflation rate including energy and food prices accelerated to 1.7%.
One indicator that measures consumer confidence rose in December to a strong 113.7 points. The increase can be attributed to the expectation of a more pro-business policy in the US, which could lead to greater economic growth and higher corporate profits. The Federal Reserve took the good economic data as an opportunity to raise the key interest rate to a target range of 0.25%-0.75% and is predicting three more interest rate hikes for 2017. A growth rate of 2.2% is forecast for 2017 (see Figure 4). The very high level of uncertainty of the forecasts compared to other countries (with the exception of Great Britain) is striking here.
Figure 5 shows the development of US industrial production since 1980. This has risen by 93% in the period under consideration. In comparison, the number of people employed has declined by 37% to 12 million. The increase in productivity can be attributed in particular to the increasing use of robots. It has been discussed for some time whether automation might lead to mass unemployment in the future. Critics of this thesis point to economic history. There were also warnings about unemployment in earlier phases of technological transformation. In the final analysis, however, more jobs have always been created than have been destroyed as result of automation. This is because the automation of a work step produces savings in time and costs, which result in an increase in demand. In order to satisfy this demand, more staff are required to perform the tasks that have not been automated. Less optimistic academics argue that it will be different this time. Their main argument is the fact that in the next few years, automation will have an impact on all industries at the same time. It will therefore no longer be possible for the workers who are affected to retrain and switch to another industry. Who is right, the optimists or the pessimists? The truth probably lies somewhere in between. Artificial intelligence will probably not lead to mass unemployment, but the transition process will be more difficult than in the past.
Content: Switzerland, Europe, USA
After falling for the most part in the first three quarters of this year, the yields on Swiss bonds marked the fourth quarter with a rise. While 10-year Confederation bonds were still giving a return of -0.55% at the end of September, yields rose again in November and finished the year at a value of -0.19%. 30-year Confederation bonds recorded a return to positive territory in the fourth quarter, yielding 0.39% at the year's end. The Swiss National Bank 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 the fourth quarter. The negative interest rates on sight deposits also remained at -0.75%. The players on the financial markets do not expect any hikes in the key interest rate in Switzerland in the foreseeable future (see Figure 9).
The yields on 10-year German Federal bonds rose again in the fourth quarter, ranging from -0.09% to 0.40%. The difference in interest rates compared to US Treasuries has not been this large since 1989 (Figure 7). After the yields on government bonds from Europe's periphery increased in the run-up to the Italian constitutional referendum, the clear rejection of the reforms proposed in the referendum caused minor fluctuations on the bond market. However, the yields on 10-year Italian bonds rose in the run-up by almost 100 basis points. They reached their annual high of 2.13% at the end of November, before closing back down at 1.82% at the end of December.
At its December meeting, the European Central Bank decided to extend its bond-buying programme at least until December 2017, but to reduce it to EUR 60 billion a month from April 2017 onwards. This decision was based on the events in Italy as well as the persistently weak inflation and economic outlook in the eurozone. A key interest rate hike is not expected in the EU before 2019 (See Figure 9).
The surprising outcome of the presidential election in the US affected US government bond yields in particular. While 10-year US Treasuries reached an all-time low of 1.36% in July this year, they made considerable gains following the US presidential election. Investors are expecting inflation to rise as a result of the fiscal policy measures and infrastructure spending announced by Donald Trump. As expected by the market, at its December meeting, the Federal Reserve finally decided on a second hike in the key interest rate by 0.25 percentage points to a target range of 0.50%-0.75%. This was due to the fact that the previously published data on the US labour market was positive and inflation expectations continued to near the target level of 2%. As of the end of 2016, 10-year US Treasuries yielded 2.44%.
The EUR/CHF exchange rate fell from 1.095 to 1.070 from the beginning of October to mid-November. A counter-swing was triggered after the US election, which saw the Swiss franc depreciate against the euro to 1.083 up to 7 December. When the ECB announced at its meeting on 8 December that it was extending its bond-buying programme by nine months, the euro again lost value. The EUR/CHF exchange rate ended 2016 at 1.072. At the beginning of the fourth quarter, one US dollar cost 0.971 Swiss francs. After a volatile sideways movement up to the beginning of November, the US dollar appreciated strongly after the US election, costing 1.019 Swiss francs as of 31 December 2016. The background to the dollar rally is the expectation of more pro-business policies in the US, which could boost economic growth. Another driver of the dollar strength is US monetary policy. The Federal Reserve increased the key interest rate by 0.25 percentage points as expected in mid-December and is predicting three further key interest rate hikes for the coming year. The depreciation of the British pound after the Brexit referendum continued up to the beginning of November. The GBP/CHF exchange rate fell by just under 6% to under 1.19 up to 1 November, before a trend reversal took hold and the pound increased in value to CHF 1.29. The exchange rate fell to CHF 1.258 up to the end of the year.
In October, the EuroStoxx50 increased by 1.8%, while the S&P500 and SMI fell by 1.9% and 3.8% respectively. The poorer performance on the Swiss stock market can be attributed in particular to pharmaceutical stocks, which were affected by the expectation that Hillary Clinton would be elected as the new US president. She had repeatedly implied during the election campaign that she intended to act against high drug prices. After the surprising result of the US election, the stock markets dropped for a few hours at the beginning of November and then began a year-end rally, especially in the US, which also established itself on the European stock markets from December onwards. When the Federal Reserve raised the key interest rate in mid-December, this also failed to shock the markets, as the hike had already been completely priced in a few days before: the probability of an interest rate hike based on futures contracts was 100% for a while. In November and Dezember, the EuroStoxx50, the S&P500 and the SMI rose by 7.1%, 5.8% and 5.5% respectively.
From a quarterly perspective, increases of 9.9%, 3.8% and 1.0% resulted on the EuroStoxx50, S&P500 and SMI respectively. Only the stock markets of the emerging markets recorded a negative quarterly performance of -4.2%. The reason for this was the key interest rate hike and the appreciation of the US dollar. Looking at the year as a whole, the differences in performance between the regions considered here are striking. The winner is the US stock market which was up 12.0%. The stock markets of the emerging markets also delighted investors with a performance of 11.2%. On the other hand, returns in Switzerland and Europe were disappointing at -3.4% and 3.7% including dividends.
Figure 14 shows the performance of European bank shares since the start of the year. What is interesting is the high correlation (85%) with the steepness of the yield curve, measured by the difference in the yields of German government bonds with terms of 10 years and three months. The ECB bond-buying programme pushed the long-term interest rates to a new record low in the middle of the year. As a result, it became increasingly difficult for the banks to generate profits from the traditional interest margin business, where short-term deposits are used to grant loans with a longer term. Thanks to the rise in interest rates following the US election, the yield curve is currently significantly steeper, as a result of which bank stocks have gained 42.9% in value from their lowest point. Higher long-term interest rates would thus not only relieve the strain on European savers and pension systems, but would also make a significant contribution to stabilising the banking sector.
Having dropped to 43 US dollars a barrel up to the beginning of November, the oil price made a significant recovery after the US election. Here too, the expectation of increasing demand for oil, caused by higher economic growth and statements by Donald Trump that he intends to focus more on fossil fuels, played a major role. After OPEC agreed on 10 December to reduce oil production by 1.3 million barrels a day, the oil price rose to 54 US dollars a barrel up to 31 December 2016. The price of gold fell in the fourth quarter from 1,316 to 1,148 US dollars. The reasons for this include higher interest rates, which increase the opportunity costs of holding gold, as well as the stronger US dollar. In addition to this is the prospect of higher global economic growth, which makes investing in gold as a safe haven appear unnecessary.
Content: Stock Markets, Bonds, Currencies
The year-end rally is based on the expectation of a more pro-business policy in the US, which could lead to greater economic growth and higher corporate profits. The announcement of deregulation in the banking sector, lower corporate taxes and the much-cited infrastructure programme had a particularly positive effect. The players on the financial markets currently seem to be largely ignoring certain critical points from the election campaign, such as greater protectionism, restrictions on immigration and general uncertainty.
It can be assumed that the momentum on the stock markets will remain positive for the time being. Risks currently lie primarily in exposure to emerging market shares, the performance of which relies heavily on capital flows from abroad. The stronger US dollar and higher interest rates could continue to have a negative impact here. Especially in the US, the valuation level of shares is now considered to be very high (see Figure 15). A risk also lies in the danger that the optimistic economic forecasts for 2017 will not materialise, something which could lead to a price correction in the medium term on account of the high valuation levels.
The assessment of the medium-term potential return on bonds hardly changed compared to the preceding quarter. Although a slight counter-swing could materialise in the short-term following the swift and intense rise in interest rates, overall the current yield level, especially in Switzerland and in Europe, remains unattractive. The rise in interest rates since the middle of the year is probably not the long-awaited long-term interest rate reversal. This may only be seen once the ECB ends its QE programme, which is not due until the end of 2017 at the earliest.
The financial markets have already priced in the current expectations concerning key interest rates. For the US dollar to continue to appreciate in 2017, the key interest rates would have to be raised by the Federal Reserve more quickly than is currently expected. The EUR/CHF exchange rate will probably also not be able to move very far from this year's average level in the forthcoming quarter. The euro will be kept artificially low by the ECB for the foreseeable future. At the same time, the SNB will in all probability not tolerate an exchange rate of less than 1.05. The British pound may well remain weak for the time being on account of the continuing uncertainty surrounding Brexit, especially assuming that more specific details emerge on the Brexit negotiations in the coming year.
Bloomberg Finance L.P., BIS, FRED, Eurostat, OECD, IMF, SNB, ECB, FED, KOF, SECO, editorial deadline: 31.12.2016
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