Which feels more likely: A Brexit resolution or reaching an intergalactic black hole 55 million light years away?
The past week saw little volatility in global risk assets despite an avalanche of data, central bank rhetoric and political events all in the spotlight. A further stabilisation in economic data continued to allay fears over global growth.
In the US, the recent headline payrolls and jobless claims numbers portrayed a robust labour market and helped to ease concerns that February’s disappointing jobs report was likely an anomaly.
Moderate wage growth data and a benign CPI inflation print also provided a favourable backdrop for risk markets to perform.
Mixed bag on the trade front
Treasury secretary Steven Mnuchin signalled that the US and China had reached a tentative agreement on the enforcement mechanism – one of the last remaining roadblocks to a deal. However, the focus could now turn to Europe.
Earlier in the week, news of potential US tariffs on European goods hit the wires and a possible trade escalation between the US and Europe looks increasingly likely.
In our mind, upon completion of the US-China trade deal, president Trump could shift his target to Europe ahead of the European parliamentary election in May.
Meanwhile, central bankers brought few surprises this week. The ECB’s latest meeting had a slight dovish tilt and confirmed our view that the bank is moving towards deposit rate tiering as the next step to mitigate the negative impact on banks of its policy actions.
We are also of the view that the ECB is not out of policy tools and we remain hopeful that an accommodative stance, coupled with stabilisation in eurozone economic data, could potentially outweigh any potential negative impact from auto tariffs.
Overall, we still expect euro core rates to remain anchored at current levels.
A split Fed
In the US, the March FOMC minutes showed Federal Reserve (Fed) members were split between optimism and caution. While the Fed is keeping its options open, we maintain our upbeat assessment on US growth and expect US economic activity to bounce back from a soft Q1.
In the latest spring budget document, the Italian government raised the deficit target this year while cutting GDP forecasts. While the headline deficit is set to grow, the structural deficit would be 1.50% of GDP this year – in line with the commitment with Brussels.
For now, we think the tug-of-war between Rome and Brussels is largely on the back-burner and the upcoming European elections could potentially see Five Star in retreat and open the door for a right-wing coalition government later this year.
With 10-year Italian sovereign debt trading 250bps over zero-yielding German Bunds, we see notable value in Italy, as the search for yield continues in a world of USD10 trillion negative-yielding bonds.
Brexit: A flexible extension
Closer to home, it was another crunch week for Brexit. As expected, talks between May and Corbyn stalled and yielded little common ground.
Forced to request another extension to Article 50 from the EU, May originally sought a 30 June deadline – the day before the start of the newly-elected European parliament.
What she ended up returning with was a longer ‘flextension’ (a flexible extension) until 31 October this year.
Furthermore, the UK is expected to participate in the upcoming European election, something that will not go down well with Leave voters.
Should the UK fail to participate, they could still leave without a deal on 1 June unless a withdrawal agreement is ratified before then. But for now, investors can breathe a sigh of relief with the can being kicked further down the road (again).
Notwithstanding this, failure to reach a lasting solution would increase the odds of a general election and continue to provoke political turmoil going forward.
From macro to micro
With fears of a corporate earnings recession still on the tips of many investors’ tongues, the upcoming earnings season will shed better light on the state of affairs at a micro level.
While we acknowledge that earnings growth has passed its peak, with analysts' earnings estimates revisions bottoming and scope for a recovery in forward guidance, any beats versus depressed expectations could, in our view, provide a strong catalyst for equity markets to continue their bull run.
Low volatility and positive seasonal effects during April have both helped to support corporate credit spreads over the past week.
The first quarter of 2019 was notable for the bullish decompression that we witnessed, whereby higher-rated, defensive issuers outperformed more high-spread, higher-risk names on a beta-adjusted basis.
The past week has seen a catch up from higher-beta assets, as the grab for yield led to a compression in spreads.
Coinciding with peak Brexit hysteria, an actual black hole with a swirling ring of fire was captured for the first time this week and it only reminds us of the impossibility of escape with the endless Brexit talks.
It would take a whopping 55 million light years to get to that black hole in space and, while we do not expect Brexit negotiations to take quite that long, the political horror show is likely to drag into Halloween.
No scary supernova explosion is expected just yet, but political paralysis and voter fatigue await.