(Bloomberg Opinion) -- The euro zone’s largest economy is faltering and its political situation is as unsettled as ever, and yet European equities are among the hottest things in financial markets. Consider Thursday, when the STOXX Europe 600 Index jumped 0.78 percent as the MSCI All-Country World Index was little changed. That’s not just a one-hit wonder: the Europe index has o utperformed the global market since the end of January, gaining 5.53 percent to the MSCI’s 2.86 percent increase.The cynics would say this is solely due to the European Central Bank’s dovish turn, but that only happened last week. The outperformance of European stocks has been fairly consistent over the past six weeks. At its core, the rally seems to reflect the growing notion that Europe’s economy, which slowed before much of the rest of the world last year, may have bottomed. Italy looks to be exiting a recession, France is looking up and Spain is starting to hum. And a slew of industrial production figures over the past week or so in Europe came in better than forecast. Citigroup Inc.’s economic surprise indexes show that the degree to which euro-zone data is missing estimates is the smallest since November. That’s a huge victory, seeing as just a months ago may economists were talking about how the euro zone would lead the global economy into a recession. “Given the low starting point for both sentiment and relative valuations, we believe even a modest incremental improvement in the European macro backdrop should be helpful for European equities’ relative performance going forward,” Bank of America strategists wrote in a research note this week. The firm said Europe saw the biggest increase in equity exposure among any region in the world at $11.8 billion, based on the positioning analysis of 4,900 funds.
LOWER FOR MUCH LONGER The benchmark 10-year Treasury yield closed below 2.65 percent for the sixth straight day Thursday, the longest such stretch since January 2019. Also, it seems fewer people are talking about the bond market being one massive bubble, and instead getting used to idea of lower yields sticking around for longer. That can be seen in the latest yield forecasts of economists and strategists. Released Thursday, they show that yields won’t exceed the 3 percent level until the end of the third quarter of 2020. And even then, yields will only reach 3.02 percent before falling back below 3 percent the following quarter. This is a huge reversal from as recently as November, when yields were seen rising to 3.55 percent by mid-2020. And it’s important because the surge in yields above 3 percent in October and November, eventually reaching as high as about 3.25 percent, was one of the main reasons for the big sell-off in stocks in the last two months of 2018. The Federal Reserve clearly recognized this, and quickly turned dovish out of fear that a collapsing stock market might cause a marked slowdown in the economy, or even a recession. Judging by economists and strategists, it will be quite some time before rising bond yields are a threat to financial markets and the economy. One side benefit is lower home-loan rates. Freddie Mac said Thursday the average rate on a 30-year mortgage fell to 4.31 percent this week, down from last year’s high of 4.94 percent in November.
MORE BREXIT FOLLIESThe Bloomberg British Pound Index held near its highest level since May on Thursday as U.K. Prime Minister Theresa May enjoyed a rare victory, winning the endorsement of British politicians in seeking a delay to Brexit day. The result on Thursday means her Brexit plan – which has twice been rejected by huge majorities in the House of Commons – is still in play, according to Bloomberg News’s Tim Ross. But further gains in sterling aren’t likely, based on positions in the currency market. A gauge of trader positioning from Citigroup shows short bets on the pound at their highest levels since December, according to Bloomberg News’s Ruth Carson. “The closer we get to the Brexit deadline without a clear resolution, the more nervous markets will become,” said Jingyi Pan, strategist at IG Asia Pte in Singapore. “You’re just going to see those short positions build up further.” While sterling has recently rallied as investors latched on to the hope of a Brexit deadline extension, CIMB Bank strategist Marcus Wong is another who feels the euphoria may be short-lived. “This is merely kicking the can down the road as the U.K. is hardly closer toward signing a Brexit deal compared to three months ago,” Wong said. “As such, investors may be increasingly positioning for a retreat in the pound once both sides continue under the vicissitudes of negotiations.”
HITTING THE WALLEmerging-market currencies fell on Thursday, which wouldn’t be unusual except for how it’s becoming impossible to ignore their middling performance of late. After surging 5 percent between mid-September and the end of January, the MSCI EM Currency Index has dropped 1.05 percent. The recent declines would seem to throw cold water on the growing number of reports proclaiming that the worst may be over for the global economy. It’s also surprising the emerging-market currencies are struggling given the Fed’s dovish turn and reported progress in the trade talks between the U.S. and China. Both should be positive for riskier assets such as emerging-market currencies. So what’s behind the slump, and does this mean the worst isn’t over? According to the Institute of International Finance, the reasons are more benign. After jumping on the EM bandwagon last quarter and January, investors are just taking the opportunity to rebalance their exposures. “We see foreign investor positioning as the principal driver,” the IIF noted in a research note Thursday. “After all, the backdrop to EM these days is a decade of ultra-easy G-3 monetary policy, which drove a wall of money to EM in a hunt for yield. Those flows have in some cases built up to large positioning overhangs, so that the same dovish shift from the Fed isn’t the positive impulse it once was.” South Africa, Chile, Mexico and Indonesia are the most over-positioned emerging-market currencies, according to the IIF, while Brazil and Russia.
A SURE THING?It’s been a great year so far for metals, with the Bloomberg Industrial Metals Subindex up 10.4 percent. Iron ore – the key ingredient in making steel – has done even better, gaining 15 percent. Comments Thursday by the largest U.S. iron ore producer suggest that the gains are only getting started. Global output of iron ore will decline by 90 million metric tons this year as production tumbles at Vale SA – the world’s largest iron-ore producer – and some of its rivals, Cleveland-Cliffs Inc. Chief Executive Officer Lourenco Goncalves told Bloomberg News’s Joe Deaux. While prices have already rallied, the market has “totally underappreciated” the impact from the fatal dam disaster in January at Rio-based Vale, he added. Consumption will outpace production by 12 million metric tons next quarter after Vale was forced to decommission the same type of tailings dam as the one that broke in January, Credit Suisse analysts said in a note this week. Rival miners including BHP Group and Rio Tinto Group have said that they do not have additional capacity in the near term to make up for losses from Vale’s operations. Iron ore prices, which closed at $84.86 Thursday in Singapore, may rise to $100 a ton as a supply crunch hits the market in the middle of the year, Citigroup analysts forecast. “The supply side suffered tremendous impact since the Vale catastrophe,” Goncalves said.
TEA LEAVESThe Bank of Japan will be wrapping up its monetary policy meeting in a few hours, and the betting is that policy makers are likely to underscore the cautious tilt of global central banks by downgrading some of its economic assessments. The BOJ will keep its yield-curve control program and asset purchases unchanged at the end of a two-day meeting, according to all 46 economists surveyed by Bloomberg. With signs of a weakening economy, the bank is likely to discuss lowering its assessment of exports, production and overseas economies, according to Bloomberg News’s Toru Fujioka, citing people familiar with the matter. The dovish tilt by major central banks in recent months is the primary reasons for the big rebound in equities, corporate credit and other risky financial assets from the selloff at the end of 2018 despite evidence of a slowing global economy. And if the BOJ signals that its next move is to ease monetary policy even more, look for markets to get a further boots additional.
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Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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