Markets shrug off geopolitical tensions

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  • S&P 500 Index reaches a new record high as investors shrug off North Korea provocation and UK terrorist attack.

  • GBP bears pounded by rising interest rate hike expectations.

 

Last Friday brought another round of geopolitical tensions for investors as North Korea launched a missile over Japan while London faced a terrorist attack. North Korea’s missile launch appeared to be a reaction to the new economic sanctions imposed by the United Nations Security Council. However, markets shrugged off these two unfortunate events as investors have become used to provocations. We believe that headlines around North Korea will continue to create volatility in markets. Still, the probability of a military conflict remains low with the US and its allies focused on finding a diplomatic solution to the issue.

As such, the risk-on behavior in markets continued on Friday with the S&P 500 Index powering past the 2,500 mark, recording a new high, led by financials as the US 10-year bond yield gained two basis points to 2.2%. While European equities closed marginally lower, we remain positive and believe that the robust environment in Eurozone economies will support their performance. Though a stronger EUR/USD is negative for European equities, the impact is partially offset by a stronger growth outlook.

In the currency space, despite a higher yield, the USD fell 0.27%, led by the GBP as the currency extended its gains from Thursday after the Bank of England’s (BoE) hawkish rhetoric. At a conference on Friday, Gertjan Vlieghe – one of the most dovish members of the Monetary Policy Committee –indicated that the “appropriate time for a rise in bank rate might be as early as in the coming months.” This further fuelled the rally in GBP/USD with the currency jumping by 1.5% to 1.36. While we believe that the probability of a rate hike at the November meeting has risen, much will depend on the incoming economic data. As such, we prefer to express our sterling view by maintaining our negative EUR/GBP stance. The prospect of a softer Brexit and rising expectations of an interest rate hike could lead to a further appreciation of the GBP against the EUR. Conversely, a stronger GBP is weighing on UK equities with the FTSE 100 Index falling by 1.1% on Friday. We remain negative on UK equities given their high overseas exposure.

Looking ahead, the market will focus today on the release of the House Price Index in China, which will provide some indication on the health of China’s economy following the release of soft macro data in recent weeks. The inflation print in the Eurozone and remarks by BoE Governor Mike Carney in his lecture at the International Monetary Fund will also be keenly watched.

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