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Monetary morphine: side-effects?

4 February 2014, Wealtheon


After a very good year in 2013 for equity markets in the developed countries, the cards fell differently in January. All indices declined significantly last month. The year had started quite well, especially considering the overperformance of countries on the euro zone periphery. Where did it go wrong?

Everything points towards the emerging countries being the main contributors to the decline. However, their 2013 performance had been largely negative. The Fed’s announcement of its tapering had been one of the triggers for capital exoduses, with the creation of liquidities in the United States enabling investors to put more money into some of the emerging zones (particularly India and Brazil). The new declines in January therefore came as a surprise. Emerging currencies again retreated, prompting the central banks to intervene in a range of different ways. The slowdown in Chinese growth also added a few concerns in the wake of a manufacturing PMI of 49.6 (compared with 50.5 in December), indicating a return to contraction. Although growth in American GDP in 4Q13 was 3.2% (including the shortfalls created by the shutdown last October, estimated at 0.3% of GDP), US equity markets underwent a correction last month. The Dow Jones lost 5.3%, while the S&P 500 fell slightly less, losing 3.57%.

With lacklustre forward indicators, although still relatively good (Conference Board in the right direction, fall in the Chicago PMI ongoing since November) the talk was mainly of profit-taking. Back in Europe, the indices lost 3% on average. Eurostoxx 50 shed 3%, as did the CAC 40 and the DAX. Belgium fared a little better, losing 1.1%. By contrast, Spain and Italy stood out from the crowd with respective gains of +0.04 % and +2.38%. Fears of deflation in the euro zone returned to the forefront. In fact, price rises in December fell back to 0.7%, well below the target of 2%. However, upon detailed examination, energy made a major contribution to the fall (-1.2%). Excluding energy, inflation remained stable at 1%. The ECB had responded at the end of last year by lowering its Refi rate again, but the effect was not as expected. This means the ECB might take action again soon if the situation does not improve.

Japan put in a pretty poor performance, down 8.45%, with the yen having played the role of safe haven in January. Staying in Asia, the Hang Seng lost 7.4%, while Brazil, China, Australia, India and Russia also suffered in January. So, can we count on the ‘January effect’: As January goes, so goes the year? Statistically speaking, January sets the trend for the year ahead (although this is not always the case). After a very good year in 2013, a technical correction was always on the cards, and 2014 promises good things for the equity markets.

Rates & Credit

The Fed acted again at the end of January on its famous tapering programme. It had every reason to, given the strong improvement in the American economy. Last year, the Fed injected large doses of liquidity into the market by purchasing $85 billion of Treasuries & MBS each month. In January, the programme was tapered to $75 billion, then $65 billion for February ($35 billion of Treasuries and $30 billion of MBS). This should have had an effect on long rates in the US, and even in Europe. Very surprisingly, rates have relaxed significantly. Sovereign wealth funds appeared to be the place to be in January. 10-year US rates fell by 36 bps to 2.66 after being at 3% at the beginning of the year. The Bund, Germany’s 10-year bond, also declined by 26 bps to 1.65, with the French OAT down by 32 bps.

Massive purchases of peripheral debt by investors drove rates down across the board. Spain’s Bonos gave up 37 bps to 3.74%, while the BTP in Italy fell by 27 bps to 3.77%. In Portugal, -95 bps in a month took it below the 5% mark. S&P also withdrew its negative outlook on the country’s BB rating. For the first time since it exited the €85 billion international rescue plan, Ireland made a successful return to the primary market, placing a 10-year issue of €3.75 billion at 3.543% on an order book of €14 billion. Some of the PIIGS countries that were the contributors to a possible break-up of the euro zone up until just a few months ago are now borrowing at the lowest rates since the creation of the single currency. For some indicators, such as the unemployment rate, manufacturing production, bad debts, etc. attention is now focused on the other side of the coin!

The primary market was very active at the beginning of January, with the aim of making the most of the low rates. EDF launched a good number of operations, including hybrids, senior, fixed, floaters, multi-currency, etc. The group also issued a tranche of £1.35 billion and $700 million… maturing in 2114: with the idea of locking in favourable financial conditions for a hundred years! Another noteworthy event in January in the wake of Moody’s Ratings Agency Event, was the unexpected exercise of Arcelor’s call on $650 million of hybrid bonds yielding 8.75%, at 101% of face value, whereas the market had been trading the security at 108%. This really put the cat among the pigeons and was certainly no gift for bondholders! And there could be other cases, too. Spreads widened on the iTraxx indices: +11 for Main Europe (83), +30 for CrossOver (324) and +20 for HiVol (129), which were fairly intense movements. On interbank rates, while the Euribor 3M tightened further in January, there has been the recent relaxation following the release of the inflation figures, which should prompt the ECB to act. The Eonia fell back below the Refi rate to 0.228, albeit with 4 consecutive fixing rates above mid-January.


Taken overall, commodities fell back in January, apart from a few exceptions. Gas rose by 14% to its highest level since July 2001, with stockpiles shrinking significantly due to the very cold winter in the United States. The traditional safe haven of gold proved its worth for once, with a gain of 3.7%.  In cereals, wheat and soya fell on record harvests, while corn gained over 3%. Orders from China continue to be monitored closely.

Foreign currency

Starting off the year at 1.37 / 1.38, the dollar rose against the euro by falling to 1.35 on good numbers from the US. The yen also appreciated against both the euro (moving from 145 to 137) and the dollar, which had a very negative impact on the Japanese market. Emerging currencies were hit hard. Numerous central banks responded, with Turkey, India, Brazil and South Africa raising their rates. Argentina has seen its currency fall by around 23% since the beginning of the year (12% on 23rd January alone!). As for Russia, the sales are on for the Winter Games!



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