The EU heads of state have come up with a list of nominees to head the European institutions. The chairwoman of the IMF, Christine Lagarde, has emerged as the (dovish) compromise candidate for the ECB. If confirmed – Lagarde would be the first ECB president ever without any experience in monetary policy. We think her management experience, including time as chairwoman of the IMF, would help her to lead the ECB as an institution. However, Lagarde will likely face many challenges along the way:
The ECB is aiming to counteract a prolonged period of economic weakness with relatively limited firepower. The key policy rate is already -0.4%, so the central bank has less leeway than the Federal Reserve does.
The Eurozone economy is highly sensitive to global demand, which has been undermined by concerns over the global trade situation. This may improve after the recent truce. But at present, the new orders component of the composite global purchasing managers’ index is at just 52 — barely above the 50 level that separates business expansion from contraction— and has been trending lower. The ECB has also downgraded its Eurozone economic growth forecasts. It sees the rate of expansion as significantly lower than in the US.
In the Eurozone, core inflation excluding food and energy rose just 1.1% in June. The nominations are still tentative, as there is a high risk that the European Parliament rejects the current package of nominations. But whatever the outcome, we continue to expect the ECB to remove the tightening bias from its interest rate forward guidance on 25 July, and we see no rate hike next year. And while the IMF chief is considered a qualified candidate, that won’t necessarily make Europe a more attractive place to invest over a tactical horizon. Within international developed market stocks, we continue to recommend an underweight to Eurozone equities, where market gains have outpaced economic fundamentals. Eurozone stocks still aren’t cheap, at 13.6x 12-month forward P/E, versus our fair value estimate of 12x.
Caught our attention
Weak manufacturing sentiment data takes edge off trade relief stock rally. The US ISM manufacturing index slipped to 51.7 in June from 52.1 in May: the new orders component fell 2.7 points to 50, a postDecember 2015 low. At least the headline reading remained above the 50 level that separates expansion from contraction. In the EU, of the 13 countries that reported manufacturing PMI data on Monday, only five had readings above 50. The data is likely to support expectations for US and Eurozone rate cuts. Barring unusually strong economic data in the run-up to its July meeting, the Fed is likely to act pre-emptively and reduce rates to protect economic growth and underline its commitment to avoiding recession.
Oil plunges as economic fears mount. Oil took a dive on Tuesday, experiencing its worst loss in two weeks – WTI crude fell 4.8% to USD 56.25/barrel, while Brent crude dropped 4.0% to USD 62.45/bbl. Despite OPEC+’s agreement to extend production cuts over the next nine months, fears remain that demand could slow to a point that renders supply cuts insufficient. Recent weak manufacturing data hinted at an economic slowdown, which investors interpreted as a threat to global oil demand. Markets seem disappointed that OPEC+ failed to agree on a larger production cut. Although oil prices have come under pressure since OPEC+’s agreement, we expect ongoing high compliance to the production deal and further disruption in Iran and Venezuela to trigger further oil inventory draws in the coming weeks. As such, we still expect Brent prices to move above USD 70/bbl over the next three months.
US raises the stakes in subsidy spat with EU over aircraft. Since US President Donald Trump said that talks with China were “back on track” at the G20 meeting, the US Trade Representative’s office has released an additional list of USD 4bn worth of EU goods that may be targeted with tariffs, on top of the products worth USD 21bn announced in April. The US and the EU have been arguing at the World Trade Organization (WTO) for almost 15 years over subsidies paid to Boeing and Airbus. The WTO is expected to decide this summer what countermeasures the US can impose. Within international developed market stocks, we recommend an underweight to Eurozone equities, where market gains have outpaced economic fundamentals. We are overweight US stocks, which we consider better placed than Eurozone equities in this environment of heightened risk and growth uncertainty.
Mark Haefele, Global Chief Investment Officer GWM, UBS AG; Vincent Heaney, Strategist, UBS AG; Kathy Li, CFA, Analyst, UBS AG
