Higher inflation figures in the United States dominated the financial markets in May. Bond yields stabilized and the dollar continued its downward trend.
Our expert, Johan Gallopyn, provides an analysis of the trends in May.
Equity market trends: European stock markets outperform
The stock market indices of the major regions once again closed higher in local currency terms in May, but for the European investor, the currency movement of the dollar and yen pushed the performance of the US and Japanese stock markets into negative territory. Regardless of currency evolutions, the European stock markets were the outperformers last month. The emerging markets also performed well, primarily driven by the Latin American region.
The trend was influenced by several themes. The US markets, in particular, are nervous about US inflation figures, tied in with the debate over when to start tapering the bond purchase program. Other themes included the negotiations between Democrats and Republicans on President Biden’s infrastructure plan, the better-than-expected earnings season (first quarter) in the US and Europe, and the acceleration in the vaccination program in Europe.
Value and growth stocks posted a mixed performance. Growth stocks in the US in particular underperformed owing to their high valuations and uncertainty concerning the policies of the Federal Reserve. In Europe, cyclical stocks that are riding the wave of economic recovery did well. European bank shares had a strong month.
Bond market trends: horizontal trend sets in
On balance, interest rates on US and German 10-year government benchmark bonds remained virtually unchanged in May. US 10-year yields surged to 1.7% briefly after the publication of higher-than-expected inflation figures, only to level off in the following days. US 10-year yields have on balance fluctuated between 1.50% and 1.75% since early March. Meanwhile, the US central bank continues to buy bonds worth USD 120 billion a month, and the market remains convinced that any less accommodative monetary policy in the future will be introduced very slowly and in a measured way. German interest rates rose briefly during the month to -0.10%, the highest level in more than two years. Spreads of countries in the southern eurozone widened slightly. Following comments from ECB members that it would be premature to wind down the bond purchase program, German interest rates and spreads fell again.
Corporate bond spreads (investment grade and high yield) remained fairly stable during the past month.
Central banks: higher inflation figures do not put doubt in central banks minds
The Federal Reserve has indicated that no changes will be made to its monetary policy for the time being. The US inflation rate rose above 4% year-on-year in April, partly due to base effects. The reason for this is that current oil prices are compared to those from a year ago when they were at their lowest point. What was more striking was a rise in US core inflation to 3%. The price increase was primarily observed in the inflation components that had fallen sharply as a result of the restrictive Covid measures (airline tickets, hotel rooms, car rentals). These are reasons for the Fed to adhere to its view that many price increases are transitory. It is not, therefore, the case that the monetary brakes will be applied immediately. Nevertheless, the Fed can be expected to start reflecting soon on when it will start tapering its bond purchase program. ECB President Lagarde has also indicated that there will be no changes to ECB monetary policy for the time being and consequently no reduction in bond purchases.
Currencies: weaker USD
The dollar weakened against most other currencies in May. Increasingly, economic recovery is not just limited to the USA. It is becoming a global driver. The euro strengthened thanks to the steady reopening of the European economies and better than expected economic data. The dollar rose above 1.22 against the euro at the end of May, close to its peak in January. The dollar also continued its downward trend against the renminbi in May. As a result, the Chinese currency reached its highest rate against the dollar in three years.
The weaker dollar meant that emerging market currencies generally performed well last month. The Turkish lira was an exception, as it continued to depreciate in May and has not yet recovered from the March blow.
Cryptocurrencies startled investors with a sharp decline. Following critical statements first, from the Chinese and later from European central banks, the prices of leading cryptocurrencies, including Bitcoin and Ether, fell by double-digit percentages. The Chinese government prohibits financial and payment institutions from providing services related to cryptocurrencies. The US Treasury is also requiring all Bitcoin transactions above USD 10,000 to be reported to the IRS (the US tax authority) to combat tax evasion.
Commodities: gold price again above USD 1,900
After sharp price rises in recent months, industrial metals were still improving at the beginning of last month. Copper set a new historic record price of USD 10,725/tonne. Volatility then increased, which should perhaps be seen in the light of the winding down of speculative positions taken in these commodities.
Brent oil prices improved in May but have been unable to break the USD 70 per barrel level since March. The gradual reopening of economies is reducing inventories, but a new nuclear deal with Iran is reportedly not far off. Lifting the sanctions would, according to analysts, allow Iran to put more than 1 million additional barrels per day on the market (expected as from December), based on the pre-sanctions production levels. Iran itself claims to be capable of producing considerably more.
The price of gold closed above USD 1,900 per ounce for the first time since early January. As a result, gold made up for its loss in the spring. The price is supported by investors who expect possibly higher US inflation and a weaker dollar. The stabilization of US bond yields and the decline of Bitcoin are also positive factors for the price of gold.
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