The first quarter of 2019 came to a close last week with an episode that typified the financial market confusion of the past three months.
On Wednesday, following a number of reports that it was on the European Central Bank’s agenda, Mario Draghi hinted that it might offer euro zone banks a “tiered” deposit rate, a measure used by other central banks running negative interest rates to mitigate their impact on the banking sector. The EuroSTOXX Banks Index jumped by almost 2%.
What is good for banks is good for lending and the flow of capital. And what is good for the flow of capital is generally good for business and the economy.
But tell that to the bond markets. The front end of the Euribor curve flattened out as far as two years. The German 10-year Bund yield collapsed further below zero, to -0.08%, for a while trading lower even than Japan’s 10-year yield, itself as low as it has been since the fall of 2016.
The week before, we went through a similar thing with the Federal Reserve. It confirmed that another rate hike is unlikely this year and that its balance sheet run-off would finish earlier than expected, while lowering its growth and inflation expectations.
Financial conditions would be looser for longer, therefore—but the U.S. 10-year yield responded by plummeting to levels unseen since the start of 2018. By Friday, the three-month and 10-year points on the yield curve, which is the favorite indicator for some recession watchers, had inverted for the first time since 2007. Last week, fed funds futures were pricing in a full quarter-percent cut for this year, and another one next summer.
Again, bond markets appeared to be asking themselves, “What terrors does the central bank know about that we don’t?”
Who’s Right and Who’s Wrong?
What do equity markets make of all this?
For sure, when bonds have rallied over the past couple of weeks, equities have generally sold off, with those European bank stocks being a notable exception. But let’s put those moves into perspective.
As you’ve seen already, bond market moves have taken us to extremes we haven’t seen for 12 months, 24 months—even 12 years. By contrast, equity markets are nowhere near the lows they reached as recently as December. The S&P 500 finished the quarter up by almost 14% while the EuroSTOXX 600, MSCI Emerging Markets and TOPIX indices gained 11%, 10% and 8%, respectively.
So, is the bond market cautious or confused? Is the equity market confident or complacent? When it comes to the real state of the economy over the next 12 to 24 months, who’s right and who’s wrong?
My colleagues on both the equity and the fixed income sides of our business agree: The bond market is confused and the equity market better reflects our market and economic outlook.
In our view, the central banks’ looser-for-longer adjustments are not a response to something forbidding in the future, but a recognition of what’s required to keep on track for a soft landing of the economy. They could help extend this cycle, and therefore lend support to both equities and higher longer-dated yields: It is always useful to remember that the level of interest rates drives economic activity while the valuation of equity markets reflects economic activity.
It’s true that our fixed income teams have recently seen some powerful technical factors at work in their markets. Two major factors have been a large amount of short covering and hedging activity, evidenced by swap spreads dropping much faster than Treasury yields, as well as a surge of offshore investors into dollar bond markets as currency-hedging costs have declined from recent highs. Nonetheless, bond market price action itself still appears confusing.
For the pessimists among us, there are still plenty of worrying things in the economic data releases, particularly those coming out of the manufacturing sectors in Europe and China. We need improvements there to justify equity markets’ confidence in a soft landing, and we believe we will begin to see that over the coming months. If we change our minds, it will be in response to the fundamental data, not in response to signals coming from the fixed income markets, which are beset by technical tides and overreacting to the complex, confusing messages currently being put out by central banks.
Joseph V. Amato is President of Neuberger Berman Group LLC and Chief Investment Officer—Equities at Neuberger Berman. He is also a member of the firm’s Board of Directors and its Audit Committee. To learn more, see Mr. Amato's bio or visit www.nb.com.
In Case You Missed It
- U.S. Housing Starts: -8.7% to SAAR of 1.16 million units in February
- U.S Building Permits: -1.6% to SAAR of 1.3 million units in February
- S&P Case-Shiller Home Price Index: January home prices decreased 0.2% month-over-month and increased 3.6% year-over-year (NSA); +0.1% month-over-month (SA)
- U.S. Consumer Confidence: -7.3 to 124.1 in March
- U.S. 4Q 2018 GDP (Final): +2.2% annualized rate
- U.S. Personal Income and Outlays: Personal spending increased 0.1%, income increased 0.2%, and the savings rate decreased to 7.5% in February
- U.S. New Home Sales: +4.9% to SAAR of 667,000 units in February
What to Watch For
- Monday, 4/1:
- U.S. Retail Sales
- ISM Manufacturing Index
- Euro Zone Purchasing Managers' Index
- Euro Zone Consumer Price Index
- Tuesday, 4/2:
- U.S. Durable Goods Orders
- Wednesday, 4/3:
- ISM Non-Manufacturing Index
- Friday, 4/5:
- U.S. Employment Report
Statistics on the Current State of the Market – as of March 29, 2019
|S&P 500 Index||1.2%||1.9%||13.6%|
|Russell 1000 Index||1.3%||1.7%||14.0%|
|Russell 1000 Growth Index||1.3%||2.8%||16.1%|
|Russell 1000 Value Index||1.2%||0.6%||11.9%|
|Russell 2000 Index||2.3%||-2.1%||14.6%|
|MSCI World Index||0.8%||1.4%||12.6%|
|MSCI EAFE Index||0.0%||0.7%||10.1%|
|MSCI Emerging Markets Index||-0.1%||0.9%||10.0%|
|STOXX Europe 600||0.5%||0.6%||11.0%|
|FTSE 100 Index||1.1%||3.3%||9.5%|
|CSI 300 Index||1.0%||5.5%||28.7%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.2%||0.7%||1.0%|
|Citigroup 10-Year Treasury Index||0.6%||3.0%||3.3%|
|Bloomberg Barclays Municipal Bond Index||0.4%||1.6%||2.9%|
|Bloomberg Barclays US Aggregate Bond Index||0.3%||1.9%||2.9%|
|Bloomberg Barclays Global Aggregate Index||-0.1%||1.3%||2.2%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||-0.2%||-0.5%||5.1%|
|ICE BofA Merrill Lynch U.S. High Yield Index||0.4%||1.0%||7.4%|
|ICE BofA Merrill Lynch Global High Yield Index||0.1%||0.7%||6.5%|
|JP Morgan EMBI Global Diversified Index||0.3%||1.4%||7.0%|
|JP Morgan GBI-EM Global Diversified Index||-0.7%||-1.3%||2.9%|
|U.S. Dollar per British Pounds||-1.4%||-2.0%||2.3%|
|U.S. Dollar per Euro||-0.5%||-1.4%||-1.8%|
|U.S. Dollar per Japanese Yen||-0.8%||0.6%||-0.9%|
|Real & Alternative Assets|
|Alerian MLP Index||-0.1%||3.4%||16.8%|
|FTSE EPRA/NAREIT North America Index||1.3%||3.2%||16.0%|
|FTSE EPRA/NAREIT Global Index||1.0%||4.1%||15.0%|
|Bloomberg Commodity Index||-0.8%||-0.2%||6.3%|
|Gold (NYM $/ozt) Continuous Future||-1.1%||-1.3%||1.3%|
|Crude Oil (NYM $/bbl) Continuous Future||1.9%||5.1%||32.4%|
Source: FactSet, Neuberger Berman.