August is traditionally a month when most of Europe goes on holiday. Looking back at July, despite the many brickbats, major developed indexes had held up pretty well, until the last day of the month. With these uncertainties still in the background, the sharp correction could well be a collective de-risking into the big holiday season, Thursday’s unexpected fall in the Chicago Purchasing index being part of the catalyst. One cannot argue that there have been a few warning signals that perhaps a modest pull back was possible. The stronger US dollar being one, weakness in high yields another, along with softness in the mid-caps.
Another part of the blame for the correction was put down to the release of the latest eurozone inflation data on Thursday. Despite the signs of a general improvement in the region over the past few weeks, inflation once again came in below expectations. The figure for the month of July was 0.4%, down from 0.5% in June. The euro fell to new lows for the year, currently trading below $1.34 as speculation increases the Fed and ECB monetary policies will continue to move in opposite directions. We have long argued that the ECB will introduce a form of QE at or around the time the Fed completes its bond purchase program, today’s figures only reinforce that view. Next Thursday is the monthly ECB rate meeting; Mario Draghi will be once again facing many questions on the subject of inflation.
It may be worth noting that European equities offer a median yield of 3%, after Thursday’s inflation figure that equates to a real return of over 2.5%. As yields in European bonds continue to fall, Spanish ten-year yields now stand at 2.52%, and whilst the earnings season remains robust this inflation figure should perversely only add to the attraction of European equities for investors.
As Geopolitical events and earnings continue to dominate headlines, the possible default by Argentina on its debt obligations has not seemed too high on investors’ concerns. Latin America has a history of defaulting on its debt obligations, which makes it even more remarkable that Mexico managed to raise capital with a maturity of 100 years at 5.75%. A country that has in the previous 100 years, defaulted three times on its government debt.
Friday we get a further raft of employment data, including the unemployment rate for July. As the US dollar continues to rally, a sharper fall in the employment rate along with a higher than expected non-farm pay-roll number could add to the rate rise speculation.