February brought little rest for investors, as developed markets followed January’s 5.4% decline with a further 1.5% fall. However, disappointing headline performance disguises the significant rebound that risk assets managed in the second half of the month. At one point in early February, developed market equities were down 12% from the end of 2015, marking it the worst start to a year since 2008. From mid-February, markets rallied 6% off their lows, as investor confidence began to improve.
In the US, economic releases in the month reinforced fears of a global slowdown. Although labor market data remained robust (the unemployment rate fell to 4.9% in January, its lowest level since 2008), consumer confidence fell to 91.7 in February, down from 92.0 in January, while US housing showed signs of slowing too, as housing starts unexpectedly declined.
The current economic soft patch, coupled with the volatility in financial assets, has resulted in investors pushing out expectations for the next U.S. interest rate increase. Markets are currently pricing a 10% chance of a rate increase in March and only a 25% chance that the Federal Reserve (the Fed) will raise rates in June. It seems likely that the Fed will remain on hold at its meeting on March 16th as policymakers wait for calm to return to financial markets and for the economic outlook to improve.
In Europe, political headwinds increased as the UK announced a referendum on the country’s membership of the European Union (EU). The pound fell 1.7% against the US dollar to its lowest level since 2009. The polls imply that the vote will be close and this has contributed to volatility in UK asset prices. A soft patch in European data has cranked up the pressure on the European Central Bank (ECB) to unleash another round of monetary policy easing at its meeting on March 10th. After the ECB’s January meeting, ECB president Mario Draghi assured markets that additional monetary policy action was imminent. Markets expect the ECB to expand its asset purchase program, which is currently set at EUR 60 billion per month until March 2017, and to cut its deposit rate by another 20 basis points to 0.5%
The bubble in Chinese equities continued to deflate in February. The main onshore Chinese equity index, the CSI 300, is down 23% so far this year and is now almost back to the level it was at when the bubble in equity markets began in December, 2014. However, while weakness in Chinese equity markets was the blame for much of the volatility that global equities experienced in January, investors seemed more resilient to swings in Chinese equity markets in February.
Nervousness among global investors has continued to benefit bonds. The Barclays Global Aggregate Index returned 2.23% in February and has generated a return of 3.11% year to date, the best start to a year for global debt since 1993. The Barclays U.S. Aggregate was up 0.71% for February and is up 2.10% year-to-date. However, investors in government bonds are contending with a growing income challenge. As central banks begin to experiment with negative interest rates, yields in fixed income markets are starting to slide. Some 27% of global government bonds are now yielding below 0%, while 65% of the global government bond market yields less than 1%.
Major Index Returns
|Dow Jones Industrial Average||Stock||+0.75%||-4.68%|
|MSCI All World ex-U.S.||Stock||-1.11%||-7.83%|
|Barclays U.S. Aggregate||Bond||+0.71%||+2.10%|
|Barclays Global Aggregate||Bond||+2.23%%||+3.11%|
|BofA Merrill Lynch US High Yield||Bond||+0.47%||-1.12%|
|Barclays 1 – 10 Year Muni||Bond||+0.27%||+1.27%|