Easing Trade Tensions Lift Sentiment
14 Pages Posted: 17 Dec 2019
Date Written: December 8, 2019
An easing of US-China trade tensions in October triggered a risk-on phase in global financial markets.1 In September, risky asset prices across the globe stayed range-bound, supported by additional monetary accommodation in a context of subdued prospects for global activity. As sentiment shifted, stocks posted large gains in most markets but China, and credit spreads tightened. Term spreads in advanced economies (AEs) initially widened in line with the change in market sentiment. But their upward momentum petered out after a few weeks.
Faced with persistently low inflation and a still tepid outlook for growth, central banks eased further in several major economies. Policy rates were lowered in the United States, the euro area and a number of emerging market economies (EMEs), including Brazil, China, Indonesia and Mexico. The ECB restarted its programme of government bond purchases.
As sentiment shifted with more constructive developments in the US-China relationship (and better prospects for an orderly Brexit), equities rose across the globe, with the notable exception of Chinese stocks, which lost ground in October and November. In the United States, stock prices reached historically high levels, with risk appetite spurred by a still resilient consumer sector, early signs of stabilisation in manufacturing and earnings reports that came in line with - or slightly ahead of - expectations. Sentiment was also helped by still patchy evidence in October's activity gauges that several economies, advanced and emerging, were bottoming out.
Corporate spreads fell globally and long-term sovereign yields rose in AEs. Spreads on euro area and US corporate bonds declined, especially for investment grade issuers. In the high-yield segment, and also EME corporates, spreads widened in late September but compressed again in mid-October as the news turned more positive. Government bond yields rose, steepening yield curves, but long bond yields traced back some of their gains in November.
As the demand for safe assets retreated, the US dollar weakened broadly, in particular against EME currencies. EME sovereign yields, little affected by sentiment swings, continued on the downward trend that prevailed for most of the year.
Loose financial conditions intensified the focus on the sustainability of asset valuations. Corporate bonds appeared relatively expensive, particularly in the light of the still comparatively subdued economic outlook. Equity valuations seemed high in the United States compared with historical averages, but were moderate in most other countries and relative to sovereign yields. However, investors' compensation for bearing equity risk seems to hinge on the term premium; to the extent that the premium is unusually low, it may flatter valuations.
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