Lower US inflation allows the Fed to maintain zero-interest rate policy for longer

David Kohl, Head of Currency Research, Julius Baer - Miercoles, 22 de Octubre

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Today’s release of US inflation is expected to confirm the view that price pressure has rolled over. September inflation is expected to have fallen to 1.6%, marking the fourth month in a row that inflation is moving lower. With this reading, the six-month trend would turn negative. Although lower energy prices do contribute to this development, the core inflation rate − which excludes volatile energy and food prices − displays a very similar trend. The lower inflation reading should allow the Federal Reserve (Fed) to adopt a more relaxed attitude towards ending its zero-interest rate policy; however, we do not expect the Fed to deviate from its intention to end its large-scale asset purchasing programme this month. We expect the Fed to start normalizing interest rates not before the last quarter of next year; a lower-than-expected inflation reading today could move the expected take-off date even into 2016.

 

The US inflation trend is turning down, allowing the Fed to maintain its zero-interest-rate policy for most of 2015.

Equity Strategy

 

Global equities: Still volatile

Christoph Riniker, Head of Strategy Research, Julius Baer

Equity market volatility has come down to levels below 20% which has also led to a normalised term structure of the volatility index VIX again. However, as outlined in earlier publications, there remain a number of uncertainties which will lead to ongoing daily swings in equities as currently experienced. With constructive results being reported during the earnings season, equity markets made another move upwards yesterday. However, we still see risks for lower equity market levels ahead, although our expected year-end level should remain above current levels.

 

Equity markets further build on a stabilising pattern on current levels. Earnings season results underpin the positive development in the short term.

 

FIXED INCOME

 

Reuters story on ECB corporate bond buying plans triggers rally of riskier assets

Markus Allenspach, Head of Fixed Income Research, Julius Baer

European peripheral bonds, high-yield bonds and equities sparked higher on Tuesday after Reuters ran an article that the ECB would decide on purchases of corporate bonds on the secondary market already at its December meeting and that the purchases might start in early 2015. Reuters refered to “several sources familiar with the situation”. Other news agencies, however, later objected the Reuters story and clarified that such a topic would not be on the agenda yet. From our point of view, the credibility of the Reuters story is very low. To start with, the ECB has no mandate to purchase corporate bonds when the market is functioning well. The yield of the BBB-rated European corporate bonds is at all-time lows. It would have made sense with hindsight for the ECB to intervene in early 2009 when BBB-corporates had to pay 6% to 9% for new money, but not when yields are at 1.5%. We acknowledge that the ECB will hardly find sufficient covered bonds and high-quality asset-backed securities to achieve its balance sheet target of EUR 3 trillion anytime soon. Yet there is a lot of opposition within the ECB against the Mario Draghi’s private target. In addi-tion, purchases of corporate bonds on the secondary market would fail to improve the fund-ing position of small and mid-sized European companies in Portugal and Greece that need the money most, since these companies lack access to the capital market.

 

The rumour helped the ECB to achieve its aim to weaken the euro vs. the dollar but has not changed our view that yields of riskier segments of the bond market have fallen too far too fast. We still see more room for correction as liquidity becomes even tighter towards the end of the year and recommend waiting for higher yields before returning to the high-yield segment or peripheral debt again.

 

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