1 – Markets are once again positive about European equities
Markets are turning positive again on Europe. Overall, the risks of interest rate hikes and low credit spreads are leading investors to remain underweight and neutral on the sovereign bond and credit markets. Overexposure to equities is therefore significant.
To this end, initial disappointment with the Trump administration, in response to its failure to repeal Obamacare, is fueling bearish expectations for US indices, whose valuations remain at historic highs. Investors’ confidence in the limited risk of Marine Le Pen being elected in France (estimated at between 15% and 20%) is leading them to reconsider the political risk in Europe and to reposition themselves ahead of the elections.
Three factors support this repositioning:
– First, the potential for European equities to catch up with their US counterparts remains historically significant, while a medium-term correction is expected across the Atlantic.
– Second, statements by Mario Draghi and Peter Praet (ECB) ruling out any consideration of potential tapering are maintaining favorable financial conditions in Europe. Core inflation and weak wage growth mean that price increases are not sustainable or persistent at the level that defines price stability.
– Thirdly, while a strong euro could result from Ms. Le Pen not being elected, this would penalize European exporting companies and therefore their profit growth. The market believes that a second factor, the acceleration in activity and order books, would more than offset the negative effect of a strong euro, thereby supporting an upward revision in earnings growth, which would be favorable for European equity markets.
2 – The ECB does not wish to change its easing policy
At the end of March, bond markets were concerned about the removal of the statement that the ECB would use all the tools at its disposal within its mandate to achieve its price stability objective. There are three reasons not to discuss tapering at this stage:
– First, core inflation remains low, with a significant decline in the contribution from services, confirming that wage growth remains sluggish despite the continuing decline in unemployment (9.5%).
– Second, economic activity remains on an upward trend ,but the fiscal and budgetary measures called for by Mario Draghi are still not in place inmost member countries.
– Finally, there will be no rate hike before the end of the asset purchase program, as its effectiveness would be reduced if the deposit rate were to be raised, which would weigh on real short-term interest rates. This potential brake on economic activity confirms that monetary policy in the eurozone will remain accommodative.
