Following the turmoil in mid-October financial markets have calmed down and settled in muddling along mode. US assets have performed sharply, while the rebound has been weaker in European and emerging markets. Four mainly factors have supported risk assets over the past month.
1. New central bank stimulus: Most significant, was the considerable boost to asset purchases signalling a ‘whatever it takes’ attitude from Bank of Japan. On Thursday, the ECB was also more dovish than expected, now setting an official target for the balance sheet at the level of early 2012, which is EUR3trn. The ECB also signalled unanimous support for this policy and that it is ready to take measures if either (a) current measures are not enough to reach the EUR3trn target or (b) the inflation outlook deteriorates further.
2. Sharp decline in oil prices: Oil prices have fallen more than USD30/bl over the past three to four months, with oil now trading close to USD80/bl (Brent). While weighing on energy companies, this is positive for the overall economy in the developed world and has supported the case that growth will reaccelerate in 2015.
3. US optimism still intact: The markets took a big hit following the publication of weak US retail sales for September (see Strategy: The straw that broke the camel’s back, 17 October) but since then US data have been decent. In particular, the ISM manufacturing index stayed very robust in October and the markets still focus a lot on this index to gauge the strength of the US, even though its correlation with the real economy over the past three years has been quite weak (for more on the US see below).
4. Stock markets were strongly oversold technically: Finally risk markets were strongly oversold technically in mid-October, supporting a technical rebound in the market as well.
The key question is what comes next? In the short run, it is hard to see more fuel coming from central banks. The market has probably also priced in the sharp decline in oil prices now and unless it falls further, the support from this factor will also fade. When it comes to the US, we believe there is still a risk that ISM manufacturing will take a hit at some point from the high levels. In Europe, it still seems too early to expect a rebound in data, at least judging from our short-term models. In China, we still see downside risk to the PMIs following weakness in production and a sharp decline in credit formation over the autumn. Thus, we could see a fading momentum in risk assets soon, or even another correction. However, this should be temporary, as we continue to expect the euro area to recover next year and US growth to accelerate again in 2015. Together with sharply rising global liquidity, this will support risk markets. Our medium-term view is thus still positive on risk assets.
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