Weekly Market Update - May 21

Posted by FlexShares on May 21, 2018 10:00:00 AM

UpdateImage_21May2018

Global equities still positive YTD, Fed’s response to yield curve flattening and what’s next for Flash PMI? Find out more in this edition of “The Week in Review.”

Last Week Review

Emerging markets struggle in quiet week for global equities. Emerging market equities dropped 2.1% last week,1 we believe pressured by recent U.S. dollar strength. U.S. equity market returns had a 0.3% decline2 and non-U.S. developed markets had a 0.4% decline.3 The year-to-date return for global equities remains in positive territory at 1.6%.4 Oil prices moved higher, with Brent crude oil topping $80 per barrel.5 We believe the recent rise in oil prices has been largely driven by concerns on less supply from Iran and the ongoing collapse in Venezuela oil production.  

Fed officials acknowledge yield curve flattening. A number of Federal Reserve leaders mentioned the flattening yield curve in recent public comments.6 With the 2-year and 10-year U.S. Treasury yield spread near the lowest level observed in the last ten years at the start of last week,7 three Fed officials noted potential signaling concerns of a flat yield curve, with some confirming they would not intentionally invert the yield curve.8 An inverted yield curve has been viewed in the past as an indicator of a future recession by many investors. We believe a Fed rate hike in June is fully priced in by the markets,9 while markets are expecting between 3 and 4 rate hikes in calendar year 2018.10 The spread between the 2-year and 10-year U.S. Treasury yields widened last week to 55 basis points (bps),11 after the 10-year U.S. Treasury yield moved above 3.1% last week12 – its highest level since July 2011.13

Populist movement in Italy set to form coalition government. Last week, the populist Five Star Movement and far-right League party worked on finalizing a coalition agreement. Markets reacted to the parties’ call for increased fiscal spending and lower taxes,14 which helped drive Italy’s 10-year yield to 2.22%, its highest level since October 2017.15 Over in the UK, Prime Minister Theresa May announced her intent to keep the UK in the European Union (EU) customs union after 2021. May wants to resolve the Ireland border issue and establish an independent trade policy for the UK. In economic data last week, Europe core Consumer Price Index (CPI) was in-line with expectations at 0.7% year-over-year (y/y). The reading, which was 0.3% lower than the prior month’s figure, we believe does not make it any easier for the European Central Bank (ECB) as it looks to normalize monetary policy.

Q1 2018 earnings season largely complete. 464 S&P 500 companies (93%) have reported earnings, with earnings growth of 23.5% y/y exceeding expectations by 7.1%.16 Revenue growth remains ahead of consensus, with revenue growth of 8.1% y/y beating expectations by 1.2%.17 Despite these results for the quarter, U.S. equities are only up about 2.3% since the start of earnings season in mid-April.18

This Week Preview

Flash PMIs expected to remain healthy and in expansionary territory. Flash manufacturing Purchasing Managers’ Index (PMI) readings will be released starting Tuesday with Japan. After a few modest declines in recent months, Japan’s PMI recovered to 53.8 in April. The rest of the major regions report on Wednesday with slight expected moderation from Europe and Germany to 56.0 and 57.9, respectively. Surveys expect the U.S. flash PMI reading will be close to the prior month’s level at 56.5.19 All regions remain comfortably in expansionary territory (above 50), which we believe should help keep investors constructive on the outlook for global growth.

U.S. set to continue trade talks and nuclear negotiations. Trade dialogue between the U.S. and China is set to continue as the countries work toward reaching agreement before significant tariffs go into effect. The comment period for the U.S. tariffs ends on Tuesday, meaning the proposed $150 billion in U.S. tariffs could go into effect this week. The U.S. will also keep aiming for an end to the North Korea nuclear program, though recent talk from North Korea implies a quick resolution is highly unlikely.

House expected to vote on partial Dodd-Frank rollback. On Tuesday, the House is expected to vote on a Senate bill that would provide regulatory relief to community and regional banks. The bill raises the asset threshold from $50 billion to $250 billion to determine which banks are systemically important and subject to stricter regulation.

Click here to view the full report.

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Unless otherwise noted, all opinions expressed in this post are those of the author and do not necessarily represent the views of Northern Trust. Information contained herein is current as of the date appearing only and is subject to change without notice.


End Notes

  1. Bloomberg, MSCI Emerging Market Equities Index returns 14May2018 – 18May2018.
  2. Bloomberg, MSCI U.S. Equities IMI Index returns 14May2018 – 18May2018.
  3. Bloomberg, MSCI ex-U.S. Equities IMI Index returns 14May2018 – 18May2018.
  4. Bloomberg, MSCI World Index returns 02Jan2018 – 18May2018.
  5. Bloomberg, Dow Jones Crude Oil Commodity Index returns 14May2018 - 18May2018. The index is designed to track the Brent Crude market through futures contracts. All Dow Jones Commodity Indexes are broad measures of a commodities futures market that emphasizes diversification and liquidity utilizing an equal-weighted approach.
  6. Boesler, M. and Rich Miller. “Kaplan Backs Three 2018 Fed Hikes, Warns on Inverted Yield Curve.” Retrieved on May 18, 2018 from https://www.bloombergquint.com/global-economics/2018/05/15/kaplan-says-fed-should-avoid-knowingly-inverting-yield-curve#gs.gRz1voQ.
  7. Bloomberg, In this analysis we are making a comparison between the difference of the 2-Year nominal Treasury rates versus the 10-Year nominal Treasury rates using data available as of 18May2018. Basis Point (BPS) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%, or 0.0001, and is used to denote the percentage change in a financial instrument.
  8. Boesler, M. and Rich Miller. “Kaplan Backs Three 2018 Fed Hikes, Warns on Inverted Yield Curve.” Retrieved on May 18, 2018 from https://www.bloombergquint.com/global-economics/2018/05/15/kaplan-says-fed-should-avoid-knowingly-inverting-yield-curve#gs.gRz1voQ.
  9. Bloomberg, Fed Funds Futures Index 18May2018. Fed funds futures are used by banks and fixed-income portfolio managers to hedge against fluctuations in the short-term interest rate market. They are also a common tool traders use to take speculative positions on future Federal Reserve monetary policy.
  10. Bloomberg, In this analysis we are making a comparison between the difference of the 2-Year nominal Treasury rates versus the 10-Year nominal Treasury rates using data available as of 18May2018.
  11. Bloomberg, 10-Year Treasury Rate 14May2018 – 18May2018.
  12. Bloomberg, 10-Year Treasury Rate 01July2011 – 18May2018.
  13. Wearden, G. “Markets Shrug Off Prospect of New Italian Government.” Retrieved on May 18, 2018 from https://www.theguardian.com/business/live/2018/may/14/markets-new-italian-government-m5s-league-euro-bonds-business-live?page=with:block-5af95ff6e4b0b4a9a77ca3a6.
  14. Bloomberg, 10-Year Italian Government Bonds Rate 01Oct2017 – 18May2018.
  15. Aurelio, D. “S&P 500 Earnings Dashboard, May 18.” Thomson Reuters. Retrieved on May 21, 2018 from http://lipperalpha.financial.thomsonreuters.com/2018/05/sp-500-17q1-earnings-dashboard/.
  16. Bloomberg, MSCI U.S. Equities IMI Index returns 15Apr2018 – 18May2018.
  17. Stone, A. “Markit’s U.S. Flash PMI ‘Still Looks Somewhat Underwhelming’.” Retrieved on May 21, 2018 from https://www.barrons.com/articles/markits-u-s-flash-pmi-still-looks-somewhat-underwhelming-1495549467.
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