The CIO office’s view of the week ahead.This week saw a significant fall in oil prices as OPEC and Russia looked set to boost oil output. Unless geopolitical risk escalates further, it may be that USD80 a barrel turns out to have been the high point for oil, leaving oil bulls dangerously exposed. Meanwhile, euro area purchasing manager indexes for May continued to disappoint. This latest indication of a ‘soft patch’ in the euro area, together with the arrival of a populist government at the gates of power in Italy, was enough to boost the US dollar again last week. But data still point to a broad-based economic expansion and our central scenario remains that the European Central Bank will soon announce that quantitative easing should end in December this year. The first actual rate hike
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The CIO office’s view of the week ahead.
This week saw a significant fall in oil prices as OPEC and Russia looked set to boost oil output. Unless geopolitical risk escalates further, it may be that USD80 a barrel turns out to have been the high point for oil, leaving oil bulls dangerously exposed. Meanwhile, euro area purchasing manager indexes for May continued to disappoint. This latest indication of a ‘soft patch’ in the euro area, together with the arrival of a populist government at the gates of power in Italy, was enough to boost the US dollar again last week. But data still point to a broad-based economic expansion and our central scenario remains that the European Central Bank will soon announce that quantitative easing should end in December this year. The first actual rate hike may not come until late 2019, but the mere fact that the ECB is moving toward normalisation, and that markets have already been pricing in further rate hikes from the Fed, suggests that the dollar may find the going tougher later this year.
But in the nearer term, there might still be some limited potential in the US dollar against the euro (more if the situation in Italy continues to sour). This weekend, the nomination of 81-year-old eurosceptic economist Paolo Savona as finance minister was rejected by Italian president Sergio Mattarella. Market anxiety about the euro area can be expected to return ahead of possible fresh elections, especially as the euro and its effects on the Italian economy remain right at the centre of the political debate.
While they underperformed last week, European equities outside Italy have held up relatively well as events have unfolded in Rome. This may indicate market confidence in the underlying strength of the euro area economy. It is bond markets and the euro that have been proving especially squeamish. Yields on short-dated Italian debt have reached their widest spreads against German Bunds since 2013. Some contagion and the increasing risk of early elections in Spain mean that Spanish spreads have also been widening. We do not believe that spread widening on Italian bonds fully reflects the risks, so that even though we do not believe the Italians will end up abandoning the euro, recent developments are reason enough to be cautious on euro area peripheral bonds in general for now.
Cesar Perez Ruiz,
Head of Investments & CIO, Pictet Wealth Management