Market commentary: Subdued inflation, weak German numbers characterize EU economy

It has been a rough second half of the year for risky assets, both within the equity and credit space, despite the relative strong start to the year.

The marked increase in volatility in H22014 has not only resulted in the erosion of performance of risky assets but also the snowballing effect on performance on the so-called safe-have assets such as Investment Grade bonds and sovereign (government bonds), primarily in the Eurozone.

Heading into the New Year, asset managers are this time more than ever being faced with a mighty dilemma, that of preserving portfolio performance to date (and increase their cash holdings), maintain their allocations in the hope of an end-of-year rally, or else beginning to take strategic asset allocation decisions now to better position themselves and get a head-start in 2015. Tough call, difficult to say, but all 3 scenarios could be well justified.

Event Risk in the short-to-medium term could turn all 3 strategies belly up, but with the unpredictability of the evolvement of market direction in the second half of this year, erring on the cautious and not taking on unnecessary might be the right way to play the markets.

There has been lots of talk recently on the ECB’s next move and which markets are going to benefit most from the next round of asset purchases. The inclusion of sovereign bond purchases seems to be a formality whilst a number of market participants also expect corporate bond to fit the bill.

Any possible inclusion of corporate bonds could result in corporate bond purchases could drag corporate yields to yet again historical lows and could also result in a shift into the higher yielding US corporate bond market as well as into the higher spectrum of the European high yield bond market.

It’s difficult to say at this stage which scenario will materialise, what is sure, however, is that markets will continue to be driven by fundamentals. And any incoming economic data will without a doubt dictate market direction.

The theme right now in Europe is subdued inflation and weak German economic numbers, which hand-in-hand, remain a drag on investor economic sentiment and growth. In Japan, the story is somewhat similar, with Prime Minister Shinzo Abe officially announcing his decision to postpone the VAT hike scheduled for October 2015 to April 2017 and concurrently dissolving parliament.

On the flipside, we’ve got the US, whose central bank’s tone continues to point towards a rate hike in mid-2015.  And then, on a global macro scale, we have also had the oil crisis to contend with. With the marked decline in the price of oil negatively affecting the net oil exporting countries and energy companies, which make up a large chunk of the high yield market, the price of oil is going to be key over the coming weeks.

This week’s OPEC meeting and the decision on whether (or not) to trim the supply (in an attempt for demand to support the price of oil) will have oil exporting countries such as Venezuela and Libya in favour of such a move.

Meanwhile, there are several economic data releases next week, including the eurozone unemployment rate as well as the second round of Q3 GDP figures in the US. Over recent months, subdued inflation has been one of they key themes – any surprise to the downside on this front could propel credit yields lower as this would place mounting pressure on the ECB to shore up its efforts in achieving its 2.0% target level, a far cry away from current levels.

This article was issued by Calamatta Cuschieri, visit www.cc.com.mt for more information.

The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website. 

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