Originally published by Rivkin Securities
In Europe German producer prices which exclude the more volatile items such as food & energy (MoM Oct) beat forecasts, up +0.7% compared with -0.2% prior and estimates of only +0.2%. Month-to-month these numbers can be quite volatile so we tend to look at longer-term measures, year-on-year prices declined -0.4% compared with -1.4% previously and -0.9% forecast. While a -0.4% decrease in costs on its own does not sound encouraging for the outlook, we look at the trend. Prices have declined at a decreasing rate each month since bottoming in April 2016 at -3.1%, so it’s a story of an improving outlook. Producers will generally pass on their increases in costs to the consumer in order to protect their own profit margins, hence producer prices can provide insight into inflation. Given Germany is the largest economy in the EU it will contribute significantly to Euro-zone figures.
Despite the better than anticipated data the Euro continued to weaken against the US dollar shown on the first chart below. The currency has reached the weakest levels in eleven months as the US dollar has broadly gained on interest rate expectations while the Euro is weighed on by negative sentiment leading up to the Italian referendum on the 4th of December. German bond yields declined on Friday as investors sought safe havens in the two-year securities which declined -2.5 basis points to -0.664%. To give you an idea of the risk premium associated with Italy at the moment we look at the spread for similar maturity securities. Italian two-year government bonds currently yield +85 basis points more than German counterparts at +0.188%.
Equity markets were generally lower, both the Euro Stoxx 600 and DAX finished trading -0.36% & -0.20% weaker respectively. In the UK the FTSE100 was also lower, down -0.28% as was the British Pound, down -0.56%.
The US dollar continues to strengthen gaining a further +0.45% on Friday on expectations that president elect Donald Trump will stimulate inflation through fiscal stimulus. The odds calculated by the FedWatch tool by CME Group (NASDAQ:CME) are pricing the probability of a hike in interest rates at the December 14th meeting at 95.4%. As the markets continue to price in higher inflation expectations we continue to see a global sell-off in bonds, US two-year treasury yields rose +3.4 basis points on Friday to +1.06%.
The longer end of the yield curve is more sensitive to changes in inflation expectations, this is because of the bond’s duration, which is the amount of time it takes for you to receive your money back. The higher the interest rates the lower the duration. We can see this reflect in the ten-year yield which increased +5.9 basis points on Friday to +2.337%, up from 1.862% immediately before the US election results.
The prospect of higher interest rates as the economy improves further will likely see a rotation out of defensive sectors (healthcare, telecommunications, utilities) and into more cyclical sectors (consumer-cyclicals, financials, basic materials, technology). Defensive sectors typically have consistent cash flows throughout any stage of the business cycle hence they outperform when rates are low and the economy is weakening.
In the US equity markets were modestly lower on Friday, both the S&P 500 & Nasdaq 100 down -0.24% & -0.38% respectively. 95% of S&P500 companies have now reported third quarter results, of those 72% have topped earnings estimates and 55% surpassed revenue forecasts. Previously earnings were estimated to decline -2.2% (YoY Q3) however this has been revised with earnings now growing at 3% compared with a year early. This marks the first year-on-year earnings growth since quarter one 2015 and is a very encouraging sign that should help justify some of the loftier P/E ratios in the S&P500, which currently has a P/E ratio of 19.93.
In commodities oil gained on optimism ahead of a potential deal when OPEC meets formally in Vienna on November 30th to attempt to finalise an agreement around production cuts. Both Crude Oil & Brent crude gained +0.59% & +0.80% on Friday despite an increase in the U.S. rig count following an informal meeting between OPEC and Russia in Doha. The hope is that once OPEC have agreed to their allocation of output cuts, non-OPEC members such as Russia will also agree to some type of production freeze in order to help rebalance the market.
Elsewhere natural gas jumped +5.18% shown on the second chart below as colder weather forecasts for the next few weeks are expected to help reduce a supply glut in the US Copper meanwhile finished -0.94% weaker as it continues to consolidate following its recent rally that went too far too quickly after Trump’s victory. Copper is often referred to as “Dr Copper” as it is an important indicator of economic health, while it has pulled back from the November 11th high of 271.8 US cents per pound it is up approximately +18% from the October 20th low of 208.
Locally the S&P/ASX 200 was +0.39% higher on Friday and we can expect a modestly stronger start to trading this morning with ASX SPI200 futures up +7 points. The Australia dollar reached the lowest levels in five months as commodity prices, namely iron ore & coal, take a breather following their recent strong performance. Australia bond yields also rise, the yield on two-year debt gained +5.6 basis points to +1.833% and the ten-year yield also increased +13.3 basis points to +2.728%.
