BNP AM

The sustainable investor for a changing world

Dolomites Mountains

With investor confusion rife, it’s been a rocky few days for financial markets: Erratic equities moves, wild corrections in bond markets and the EUR/USD exchange rate dropping to below 1. The question now is whether central banks can remove some of the many uncertainties and curb market volatility in the coming weeks.  

The sharp swings in (particularly European) equity markets and the euro’s stuttering performance against the dollar could be a reaction to the perceived increased likelihood of recession in the eurozone over the energy crisis. Meanwhile, the significant rise in long-term bond yields seems to contradict a poor short-term economic outlook.

Poor business surveys  

The flash purchasing managers’ indices for the eurozone and the US released on 23 August disappointed, especially in the services sector. The US marker fell to its lowest since May 2020, at 44.1 down sharply from 47.3 in July.

The drop in the eurozone PMI was less severe due to manufacturing activity holding up better than expected (figures in green, Exhibit 1). Composite PMIs (manufacturing and services) fell in France, Germany and for the eurozone as a whole and now stand at below 50, pointing to a contracting economy.

In the last few days (23, 24 August), despite the poor PMIs, bond yields have risen to levels not seen since the end of June – with the US 10-year T-note yield reaching 3.1% and the yield on the German 10-year Bund 1.37%.

These moves largely undid the fall in yields between 14 June and 1 August, which came in the wake of disappointing PMIs for July. Understandably, the opposite market reactions to equally poor numbers is confusing investors.

Mixed messages from surveys

Recent national business surveys have surprised to the upside. The French business climate appears to be stabilising at above its long-term average (despite the figure for manufacturing weakening).

There was a smaller-than-expected decline in Germany’s Ifo index. However, at 80.3 in August, the index of companies’ expectations is at its lowest since April 2020 due, in particular, to higher production costs. The Ifo Institute highlighted that ‘uncertainty among companies remains high’ and concluded that ‘the German economy as a whole is expected to shrink in Q3’.

For the eurozone as a whole, the modest rebound in consumer confidence in August from its all-time low in July left the index still slightly below the low reached during lockdown in 2020.

Euro struggles  

The EUR/USD exchange rate fell to below parity on 22 August, continuing a downward trend that seems likely to last some time, unlike the one-off move in mid-July.

Risks to eurozone growth, investor positioning in the currency and questions about the ECB’s monetary policy all suggest that the euro could continue to depreciate.

Gas prices threaten European growth  

The continued rise in the price of natural gas poses a risk to growth in Europe. While the build-up of gas stocks ahead of winter has been quicker than planned, many uncertainties remain including: 

  • How severe will the weather be this winter?
  • What is the likelihood that Russia imposes a complete cut-off of gas supplies? What is the impact of announced pipeline maintenance?
  • What is the availability of substitute products after recent heatwaves reduced production? 

Europe’s benchmark gas price at the Dutch TTF hub rose to above EUR 300/MWh on 25 August. That threshold had not been crossed since early March following the invasion of Ukraine.

At the same time, after a virtually uninterrupted decline since early June, oil prices bounced back this week after the Saudi energy minister hinted at a possible cut in production by OPEC and its partners.

Inflation back to the forefront?  

Recent moves in energy commodity prices have been accompanied by a slight rise in inflation expectations as reflected in the 5-year/5-year inflation swap rate.

This may not bad news for central banks. This might be preferable to the ‘pivot’ scenario that had dominated markets in July. Talk of recession capping inflation had led to a rise in equities as well as an easing of bond yields and financial conditions since mid-June.

We believe central banks will to continue prioritising their inflation targets. They do not really have a choice. For most, this is their one and only mandate. While the US Federal Reserve has a ‘dual mandate’ (‘to foster economic conditions that achieve both stable prices and maximum sustainable employment’), we believe that right now, it clearly considers the main risk to be high – and seemingly entrenched – inflation. We expect it to act accordingly.

Convincing investors – not only by words but also by action in the coming monetary policy meetings – appears to be the only way that central banks can clear the fog that is making judgment calls complex and limiting the effectiveness of the rise in key rates.

Adjusting our bond exposure

The sharp rise in bond yields in the US and the eurozone has prompted us to make another adjustment to our short positioning in considering valuations and profit-taking.

We have tactically raised (especially European) duration in a move symmetrical to the one we decided upon at the start of August.

Extreme market volatility offers opportunities that we want to take advantage of. However, our fundamental analysis has not changed and argues for remaining strategically short.

We are convinced that central banks will raise their key rates to beyond what the markets currently expect. At the very least, they will hold rates at the higher terminal level for longer than expected before considering a policy pivot in the face of slowing activity.

Disclaimer

Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Related insights

Weekly market update – US Federal Reserve to slow tightening pace. So what?
Weekly market update – Downshifting in December?
BNPPAM

In the U.S., this material is for Institutional use only – not for public distribution. This material is provided for educational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Reliance upon information in this material is at the sole risk and discretion of the reader. The material was prepared without regard to specific objectives, financial situation or needs of any investor.

These documents and video clips may also include information obtained from affiliated investment management companies within BNP Paribas Asset Management, the brand name of the BNP Paribas group’s asset management services. The documents and video clips are produced for informational purposes only and do not constitute: 1. an offer to buy nor a solicitation to sell, nor shall they form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. Any opinions included in these documents and video clips constitute the judgment of the author/ presenter at the time specified and may be subject to change without notice.

This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, and estimates of yields or returns. No representation is made that any performance presented will be achieved by any funds, or that every assumption made in achieving, calculating or presenting either the forward-looking information or any historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BNP PARIBAS ASSET MANAGEMENT USA, Inc. to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

FOR INSTITUTIONAL AND FINANCIAL PROFESSIONAL INVESTOR USE ONLY. THIS MATERIAL IS NOT TO BE REPRODUCED OR DISTRIBUTED TO PERSONS OTHER THAN THE RECIPIENT.

BNP PARIBAS ASSET MANAGEMENT USA, Inc. is registered with the U.S. Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940, as amended. BNP PARIBAS ASSET MANAGEMENT USA, Inc. is a registered trademark of BNP Paribas or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. © 2022 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.

BNP PARIBAS ASSET MANAGEMENT is the global brand name of the BNP Paribas group’s asset management services. © 2022 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.

BNP Paribas Asset Management seeks to integrate environmental, social and governance (“ESG”) factors into all of our portfolios as a means to mitigate certain short, medium and long-term financial risks, identify better long-term investments, and encourage more responsible corporate behavior. We will never subordinate our client’s interests to unrelated objectives. Certain issuers and industries are excluded from our actively managed portfolios based upon our view of their ESG performance and risk profile. As a result, we may pass up certain opportunities when these excluded issuers or industries are in favor. Due to significant gaps in disclosure regimes around the world, we may need to rely upon voluntary disclosures by issuers, which are often not audited. We therefore may not have consistent access to complete, accurate or comparable information about the ESG performance of our holdings. Please consult the applicable offering document for more information about the specific ESG strategy employed by each investment strategy since a given strategy may not have specific ESG guidelines, and investments are not limited to securities that are ESG compatible.

To access insights from our teams worldwide visit:
BNP AM
Explore VIEWPOINT today