All eyes were on Greece this weekend, as voters there voiced their displeasure with budget cuts and tax increases and elected the leftist Syriza party, whose 40-year-old leader, Alexis Tsipras, said in his victory speech that the people have given him “a clear, indisputable mandate to leave behind austerity.” Although one focus of today’s Eurogroup meeting of finance ministers in Brussels will be on how to negotiate with the new government in Athens, the greater urgency will be placed on discussions of how to combat deflationary pressures. Meanwhile, in the U.S. investors will be waiting on the Federal Open Market Committee announcement on Wednesday, with a strong possibility that Federal Reserve policymakers will address the dramatic decline in oil prices and corresponding drop in inflation expectations with guidance that they can hold off on raising interest rates for an extended period. Cheap fuel, compressed yields and a strong dollar all bode well for U.S. equity markets, but, as recent earnings releases have underscored, major U.S. companies are not immune to the economic slowdown abroad. While some analysts have expressed concerns that U.S. stock market valuations may be overstretched, others note that market cycles frequently can remain irrational for extended periods. “Neither valuations nor old age has ever caused a bull market to end,” Gluskin Sheff + Associates chief economist and strategist David Rosenberg wrote in a note on Friday. “The end comes when money gets so tight that the Fed inverts the yield curve and recession follows.” Rosenberg explains that while valuations for large-cap U.S. equities may appear high on a historical basis, this may be the collateral impact for a bond market that is extremely expensive. “This bull will die at some stage,” he adds, “but as long as it is alive and kicking we should try and generate some returns out of it.”
Markets take Greek election results in stride. The sweeping victory of the anti-austerity Syriza party in Greece rekindled fears that the cradle of democracy might leave the European Union. Unlike the so-called “Grexit” crisis during the immediate post-crisis period, however, these concerns appear to be taken in stride so far by bond investors as the ambitious quantitative easing plan announced by European Central Bank president Mario Draghi last week more than offset market jitters.
Improving confidence in Germany. January German IFO sentiment data drawn from business leaders rose for the third consecutive month as the mood in the private sector is buoyed by the prospect of ECB easing. The headline index rose beyond consensus forecasts to reach 106.7, up from 105.5 the previous month, while the current assessment subindex also expanded significantly. Despite general optimism, the subindex tracking future expectations failed to reach levels anticipated by analysts as geopolitics continue to cast a shadow over regional prospects.
Japanese exports jump. December trade data released this morning by the Japanese Ministry of Finance registered a contraction in the nation’s trade deficit on strong exports. Shipments abroad rose by 12.9 percent over the same month in 2013, with a surge in products bound for the U.S. The pace of imports moderated for the month largely as a result of lower fuel costs.
President Obama makes landmark trip to India. As the first U.S. President to visit the annual Republic Day celebrations in Delhi, Barack Obama continued his high-profile state visit to India. Indian media sources report that trade discussions between President Obama and Prime Minister Narendra Modi have included defense contracts.
Oil market rout continues. Front-month futures contracts for West Texas Intermediate crude oil reached $44.35 per barrel, the lowest level in six years, during overnight trading in New York. This week’s Energy Information Administration crude stockpile report will be closely watched after last week’s announcement of the highest monthly level for December since World War II.
Portfolio Perspective: The ECB has Taken the Plunge — Andrew Milligan, Standard Life Investments
Full-blown quantitative easing in the euro zone is overdue. The policy change last week has finally implemented a more appropriate monetary policy setting for the struggling currency union. This should support inflation expectations and demand in the region. News that credit conditions have eased in the euro zone should also provide encouragement that the transmission mechanism for this stimulus is slowly improving.
With monetary policy stimulus ratcheting up, the onus now turns to other policymakers. Indeed QE does not provide a panacea for the euro zone’s problems. Governments should accelerate structural reforms and loosen fiscal policy to take full advantage of this monetary boost. At present there are few signs of these proactive steps. With the ECB’s ammunition now running low, policymakers can no longer rely on the central bank to drive further improvements in economic conditions.
We think the impact on debt instruments should be clearly positive, but we are skeptical of the ECB’s ability to stave off the disinflation threat. In the absence of coordinated structural reform and support on the fiscal side from policymakers, the market will struggle to price in higher yields in the longer-end government bonds. The more likely long-term mover will be a continued mechanistic weakening of the euro as the ECB embarks on a series of QE tranches over the coming year.
All in all, we expect the ECB’s program to help stabilize the outlook for the euro zone, but we are not convinced that it will lead to a noticeable upturn in growth and inflation forecasts in 2016–’17.
Andrew Milligan is head of global strategy at Standard Life Investment (SLI) in London. SLI oversees $422 billion in assets under management globally.
