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Declining Political Risk Pushes Unpredictability To Multi-Year Lows

Published 09/05/2017, 16:05
Updated 03/08/2021, 16:15

Europe

After yesterday’s falls, European markets have rebounded today with a firmer tone in the more cyclical areas of the market, with an air of almost indifference starting to descend on investors, as concerns about political risk fade into the background.

The successful navigation around the latest in political risk appears to have prompted a significant degree of complacency with respect to hedging potential downside moves, with the VIX down at levels last seen in 1993.

Even in Greece, the yield on Greek 10 year bonds is back at levels last seen in 2014, when the country was able to sell €3bn of 10 year bonds, before the government fell out with its creditors over the terms of its third bailout in 2015, as it became clear it wouldn’t meet its fiscal targets.

Despite further weakness in iron ore prices, mining stocks have enjoyed a welcome respite, with some signs of a potential short term base which has helped underpin the FTSE 100 helped by a positive update from Macquarie, which has helped push Glencore (LON:GLEN), Rio Tinto (LON:RIO) and BHP Billiton (LON:BLT) to the top of the index.

The utility sector has underperformed today with Centrica (LON:CNA) and SSE (LON:SSE) both lower after it was confirmed that the Conservative manifesto would include a commitment to introduce a cap on domestic energy prices, and on standard variable tariffs. It has also raised concerns that Centrica might be forced to cut its dividend.

Two years ago when the Labour party announced a similar policy it was branded economically illiterate by the Conservatives, making you wonder what’s changed. Is it only economically illiterate when Labour propose it? While such a cap would be politically popular it could also have long term unintended consequences, by actually pushing average prices higher, and pushing out some of the smaller competition. It could also make longer term decisions regarding investing in future UK power infrastructure much more difficult.

Microfocus International is also having a bad day after reporting that revenues at its HP Enterprise business were down 10% in Q1.

US

With the VIX at levels last seen in 1993, US markets have again hit new record highs on the S&P 500 and NASDAQ Composite as investors continue to adopt a sanguine approach to downside risk, which in itself is worrying as it suggests a significant level of complacency.

On the earnings front Marriott Hotels (NASDAQ:MAR) announced quarterly profits that beat expectations with revenues also coming in higher than the consensus, with higher occupancy and room rates driving the improvement.

Apple (NASDAQ:AAPL) shares have continued their relentless march higher after yesterday’s recommendation from a US broker that it could go on to become a $1trn company.

FX

The US dollar has continued to drift higher, rising to a two week high against a basket of currencies as the more benign trading environment prompts additional capital flow out of the haven currencies of the Japanese yen and Swiss franc which are the worst performers on the day, with the yen moving back to the 114.00 level for the first time since mid-March.

The Australian dollar has had another tortuous session after retail sales for March saw a surprise decline of 0.1% following on from a weak February number, raising further questions as to whether we might see the Australian economy contract in the first quarter. This weakness has raised speculation that the RBA might be forced to cut rates if this period of economic weakness continues.

Commodities

Recent chatter about the prospect of the OPEC output quotas being extended into 2018 don’t appear to be helping support oil prices in the short term, with countries like Libya pumping at ever increasing levels. The prospect of a near term decline in inventories is likely to become much harder, particularly at a time when US shale producers have their feet pressed hard on the floor, as they continue to up production.

Iron ore prices have also declined further, dropping to their lowest levels since last October as concerns about Chinese demand continue to weigh on sentiment.

The decline in demand for safe haven assets continues to weigh on gold prices, as they drift back towards levels last seen at the beginning of March, around the $1,200 an ounce level.

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