Fed View: Markets almost fully priced for a September hike – The FOMC kept monetary policy on hold today, as was widely expected. The accompanying statement contained little of note for investors beyond a very slight upgrade to the assessment of the economy (from ‘solid’ to ‘strong’). This is consistent with well-above trend growth in Q2 observed last Friday, which showed the economy expanding at 4.1% qoq annualised.
We continue to expect the Fed to hike rates a further four times, taking the upper bound of the target range for the fed funds rate to 3.00% by next June, and with the next 25bp hike expected in September. A September hike is now almost fully priced by financial markets, although the market’s conviction in rate hikes further out remains somewhat tempered by concerns over President Trump’s trade policy. Both growth and business confidence have held up remarkably well so far in the face of trade policy uncertainty, and while we see an elevated risk that trade worries start to dampen confidence and in turn investment, our base case remains that the macro implications will be limited. (Bill Diviney)
Euro Financials: Banks finishing strongly, to make July the best month in 2018 – Bank credit has performed strongly recently. July was the best month of this year, with an excess return of roughly 40bps for the benchmark for the month. The majority of European banks reported good annual results in February and March for 2018, which makes us still positive on the earning potential of European banks for those still to report in the next few weeks. The bank market has suffered this year, but we argue this is predominately due to a softening of global market sentiment from the lofty heights seen in at the turn of the year. At the end of 2017, expectations were high as the world moved to a global synchronised growth story and the outlook was rather rosy. This year however, the sentiment has declined under a haze of trade wars, politics in Italy and a slowdown in eurozone economic growth. The realisation that trade wars could become a reality, combined with the Italian political drama, was largely not priced in by the market at the start of the year. Furthermore, as the ECB announced their final plan to wind down QE, a normalisation of spreads began to take hold. Yet, we argue that investors should stick to the earnings at bank level, and not be swayed (too) greatly by the macro headlines. The banking landscape has changed tremendously over the last four years, and bank balance sheet improvements will continue for the next few years. Almost every measure across bank balance sheets has improved. Banks are to have stable earnings this year, and still easy monetary policy will continue to be broadly supportive. Furthermore, legacy litigation costs have almost all been paid and restructuring plans are in the mid-to-late cycle. Earnings should stay strong and stable for Q2. Consequentially we prefer to choose slightly riskier banks to take a premium in the market conditions, although we are very wary of the impact that Carige poses to volatility after summer. (Tom Kinmonth)