Economic upswing vs. geopolitics



  • Economic recovery despite geopolitical tensions
  • Central banks stay the course
  • EUR/USD: plenty of room for USD appreciation
  • Growth optimism on global markets
  • Balanced equity vs. bond weighting

“After a very good start into the year 2014, the severe winter weather in the USA, worries about weak performance in the Emerging Markets (EM), especially in China, and, first and foremost,
the conflict between Russia and Ukraine showed their impact as risk factors. The last two points in particular are factors which investors will continue to focus on in the second quarter, along with factors providing positive economic momentum. In our baseline scenario for the Russia-Ukraine conflict, we project further sanctions from the West towards Russia but no harsh reciprocal economic embargoes. In this environment, we see our GDP forecasts for this year well supported and unchanged at 1.5 per cent for the euro area and at 2.5 per cent for the USA“, says Valentin Hofstätter, department head of Bond Market & Currency Research at Raiffeisen Bank International AG (RBI), his presentation of the “Financial Markets Global Strategy”.

It must, however, be clearly noted that an escalation of the conflict with severe economic sanctions would weigh heavily on sentiment for private fixed investment in the euro area and, in conjunction with lower net exports, could lead to slower growth or even stagnation starting from the second half of 2014. “This could cost the euro area up to 1 percentage point of GDP growth cumulatively over the next two years, with corresponding negative ramifications for the capital markets. The USA would be less affected due to their weaker direct economic ties with Russia and their independence from Russian energy exports,” explains Hofstätter possible consequences 1 of the conflict on GDP growth.

Central banks stay the course

The latest phase of weaker US economic data has not resulted in any change to the announced monetary policy stance of the US Central Bank (Fed). The Fed continues to reduce its purchases of bonds. The monthly volume of purchases has now fallen to just USD 55 bn (down from the peak of USD 85 bn). A step-by-step reduction of USD 10 bn has been announced for each Fed meeting. As the analysts of Raiffeisen Research expect a significant improvement in the US labor market in the months to come, it is possible that the pace of tapering will ultimately even be increased. They also expect to see the first increase in interest rates in early 2015, which is earlier than currently postulated by the Fed.

The European Central Bank (ECB) continues to signal an easing bias. It may be prompted to take further monetary policy measures, mainly in the event of a further decline in inflationary pressure and tightening in financing conditions. In this context, the analysts see the risk of deflation in the euro area as rather low. Even if the rate of inflation should fall again in March, there are no signs of a persistent downward spiral in prices, wages and economic activity. Furthermore, the analysts do not expect any new tensions in the financial system.

EUR/USD: plenty of room for USD appreciation

“Nothing has changed with regard to our principle expectation of a sideways movement in EUR/USD for this year within a historically rather narrow range around 1.35, even though we were surprised by the weakness of USD during the first quarter of 2014,” analyzes Hofstätter the current currency trends.

The temporarily weaker US economic data were probably only partially behind this, as no significant strengthening of USD has been seen even after their recent improvement. Nor have the geopolitical tensions – which usually bolster the USD as a global reserve currency – in relation to the Crimean conflict provided much support for the currency. It is possible that this is related to worries that Russia could part with its USD reserves in the event that the conflict escalates, which would generate short-term selling pressure. We think this kind of development is very unlikely, as the alternatives to the USD and other Western currencies are still too limited,” continues Hofstätter.

What remains is the expectation that the USD should bounce back from its currently too weak level as a result of the anticipated improvement in US economic data, especially as the ECB maintains its easing bias until the autumn. If there are brief peaks of over 1.40 in the EUR/USD rate, we should see stronger verbal intervention by the ECB.

Regarding bonds, Hofstätter prefers short-terms for the second quarter (and also throughout the year), as the decline in prices for long-term bonds due to the improving economy are only a matter of time. The outperformance of periphery government bonds within European government bonds is likely to continue. Also company bonds, although already quite expensive, are expected to show a better performance than government bonds from core European countries in the second quarter of 2014.

Growth optimism on global markets

“At the moment, it is necessary to take into consideration geopolitical uncertainties, in addition
to the factors which traditionally affect the equity markets, such as liquidity, economic performance, earnings growth and valuations. In the event of escalation of the tensions in the Crimean crisis, these geopolitical aspects could weigh on the European stock markets,” begins Helge Rechberger, head of the Equity Market Research department at RBI, his outlook on the global equity markets. “For equities, geopolitical tensions may be a possible trigger for temporary periods of weakness. We would view these periods of correction as a good buying opportunity for a longer investment horizon. In general, the favorable valuation and the emerging economic recovery are supportive for European equity markets,” continues Rechberger.

According to Rechberger, fundamentals are positive for US equities as well, in an environment marked by a strong, self-sustaining economic upswing and a stronger USD, which should also support performance. The Japanese equity market continues to be marked by strong volatility.

The situation in the Emerging Markets (EM) will not improve sustainably before the second half of 2014. On the one hand, because of the ongoing conflict between Russia and Ukraine, and on the other hand, because of China and Brazil, which continue to fight structural problems. Only the Indian Sensex was able to build on and consolidate its good performance from 2013.

Balanced equity vs. bond weighting

A continuing conflict between Russia and Ukraine could have a supportive impact on save haven bonds, such as German government bonds. On the whole, however, the performance outlook in the bond segment looks clouded, not least due to the gradual normalization of US monetary policy. Furthermore, the analysts of Raiffeisen Research view bonds in the high-yield segment as being overvalued.

“Our portfolio for the second quarter of 2014 is balanced. The equity segment is neutral at
50 per cent, the bond segment is 45 per cent, while the remaining 5 per cent are invested in alternative investments such as real estate,” ends Rechberger his analysis of the investment strategy.

1You can find more on the possible consequences of the conflict in the chapter “Crimean crisis: Hopes for stabilization”

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Raiffeisen Bank International AG (RBI) regards both Austria, where it is a leading corporate and investment bank, and Central and Eastern Europe (CEE) as its home market. 15 markets of the region are covered by subsidiary banks, additionally the Group comprises numerous other financial service providers, for instance in the fields of leasing, asset management and mergers and acquisitions. RBI is the only Austrian bank with a presence in both the world's financial centres and in Asia, the group's further geographical area of focus.

In total, around 58,000 employees service about 14.6 million customers through more than 3,000 business outlets, the great majority of which are located in CEE.

RBI is a fully-consolidated subsidiary of Raiffeisen Zentralbank Österreich AG (RZB). RZB indirectly owns around 60.7 per cent of the common stock, the remainder is in free float. RBI's shares are listed on the Vienna Stock Exchange. RZB is the central institution of the Austrian Raiffeisen Banking Group, the country's largest banking group, and serves as the head office of the entire RZB Group, including RBI.

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