March interest rate increase an option for the Fed

No major changes occurred last month with respect to valuation. Expected returns on bonds decreased slightly as a result of a decline in yields. Expected returns on equities also fell due to higher margins, especially in emerging markets. In absolute terms, expected returns remain low.


Will the Fed raise rates early?
Last month, Trump presented his ‘America first’ agenda to US Congress. He listed his hobbyhorses but failed to announce any further details. Yet his speech was well received by Wall Street. This was largely thanks to his more moderate tone. In early March, a significant shift in the rhetoric of the US central bank (the Fed) boosted equities further. Although February’s policy meeting minutes contained no sense of urgency regarding the next increase to interest rates, over the past few weeks several Fed governors have hinted that an interest rate increase in mid-March is an option. Not only do Fed officials have greater confidence in economic momentum, fears are growing that the Fed will overshoot its target. The market now has much higher expectations of interest rates being raised in March. We  also expect this to be the case and forecast three interest rate increases across 2017 as a whole.


Fears of a Frexit continue to occupy European markets
In Europe, country spreads against Germany continue to move in line with the risk of Marine Le Pen being elected. Although Le Pen’s chances of winning were higher in February, they have declined again slightly over the past few weeks. This is partly due to the rise of Emmanuel Macron. He now has the support of François Bayrou, who has withdrawn his candidacy. François Fillon has got into increasing difficulties over the past month, adversely affecting his popularity. On balance, Le Pen still looks set to win the first round, but our scenario remains that she will lose from Macron in the second round. In Italy, Renzi announced his resignation as party leader. As a party conference first has to take place to choose a new leader, there is now a smaller risk of snap elections. All in all, the political events of the past month have not prompted us to adjust our basic scenarios. We stand by our belief that this year of elections will fizzle out without a bang.

“Nevertheless, the political uncertainty is squeezing German bond yields. ”

German 2-year government bond yields drop to all-time low

Nevertheless, the political uncertainty is squeezing German bond yields. German 2-year government bond yields have dropped to an all-time low. Incidentally, this was not just caused by a flight to the safe German haven. Now that the ECB has decided it may buy government bonds with yields below the deposit rate of -0.4%, it is chiefly buying up short-term German government bonds. Moreover, European central banks outside the monetary union, such as the Swiss central bank, may be buying short-term German Bund in order to prevent their currency from appreciating excessively against the euro. Finally, demand for this type of bond for collateral purposes remains as strong as ever. The elimination of political uncertainty will therefore not make the short side of the German interest rate curve rise sharply. However, the elimination of political risk could push up European equity markets. The improved economic momentum combined with the advantage of the lower euro has currently only been partly priced in.

China focusing on greater stability

Prime Minister Li Keqiang has indicated that China’s economic growth target has been adjusted downwards. Instead of 6.5 - 7 percent, the Chinese economy should now grow by 6.5 percent. Given that most members of the seven-strong Politburo Standing Committee are to be replaced this year, the focus is shifting to preserving stability (both macro-economic and financial). A policy of prudent, targeted tightening is appropriate here. Interest rates on the interbank money market are likely to be slowly raised further and credit growth will be curbed further. Although sentiment remains intact for the time being, house prices have risen less quickly over the past few months and the volume of lending is rising less rapidly. Growth is picking up in emerging markets and sentiment is improving. Yet risks, such as Trump’s protectionist policy, rate hikes by the Fed and a slowdown in growth in China, continue to lurk in the wings. We therefore think it too early to advise buying emerging market equities.

Disclaimer
Kempen Capital Management N.V. (KCM) is licensed as a manager of various investment funds and to provide investment services and is subject to supervision by the Netherlands Authority for the Financial Markets. This information may not be construed as an offer and provides insufficient basis for an investment decision.

The Asset Allocation  Desk

Marius Bakker
Ivo Kuiper
Joost van Leenders

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