Investors entered 2015 feeling confident about the US economy and hesitant about the prospects for Europe. The mood has shifted since then, as news flow from the eurozone started to turn positive and US corporates felt the pinch of a rising dollar. But the strength of the US recovery and the timing of the first US rate rise are still top of the agenda for most global investors, says Stephanie Flanders, chief market strategist for Europe, JP Morgan Asset Management.
Key considerations for investors this quarter include:
- The dollar: on balance, the strength of the greenback has been helpful to global growth. But a further race to the bottom on currencies could pose risks to global stability and the US.
- Recovery in Europe: there are good reasons for investors to feel more optimistic about the eurozone but we need to see corporate earnings perform well in order to match these higher expectations.
- A murky outlook for the UK: political uncertainty could dampen investment and increase market volatility in 2015 but we do not believe it will throw the recovery off course.
US monetary policy should still be top of the agenda for most investors
Our best guess is that the US central bank will raise its key policy rate in the second half of 2015. But its decision has been complicated by plummeting inflation, a rising currency and a slight pullback in US economic growth. The Federal Reserve would like to start the US on the road to higher rates but senior officials continue to believe the risks of tightening too soon are greater than the risks of tightening too late,” said David Stubbs, global market strategist for JP Morgan Asset Management.
Federal Reserve policy-makers believe they can “look through” the fall in the inflation rate so far this year, because it has been caused by a fall in the oil price which should be a net positive for US growth. However domestic wage growth is still weak, despite continued strong jobs growth, and the strength of the dollar will inevitably put a dent in economic growth this year.
As the chart below shows, US stock market valuations have historically been positively correlated to the dollar. This shows that US equities can continue to move forward in this environment but also highlights the potential negative impact of the stronger currency on corporate earnings. In the last three months of 2014, the more domestically oriented companies in the S&P 500 enjoyed 10% growth in earnings but export-oriented companies only saw profit growth in the low single digits.
As we highlighted at the start of this year, a period of dollar strength could be helpful for the global economy if it slows the pace of rate rises in the US, while supporting faster growth in Europe and Japan. But a further race to the bottom on currencies would be counterproductive for markets and global growth, as well as posing deeper problems for the Federal Reserve,” said Flanders.