Die zwei Gesichter des September

The two faces of September

The summer months have been surprisingly positive for the financial markets, in stark contrast with last year. The share price gains of the past weeks were largely due to what can be called the central banks’ “put”: that  is to say, investors are now convinced that if the situation demands it, the central banks will not hesitate to take action. Against this background, weak economic figures lose some of their hard edges.

This sentiment clearly dominates with regard to China: disappointing figures, which are all too real, steadily feed the expectation of stimulation measures. In principle that is logical enough. The policies of central banks and governments (in so far as they have elbow room) must be aimed at supporting the economy when it is in a downward phase. (Even central banks whose mandate is restricted to price stability will take steps to ensure that the economy avoids deflation.) The same is also evident in the United States, where the latest report by the Federal Reserve’s Open Market Committee makes clear that, unless the figures suddenly improve, it will signal at its 12-13 September meeting that the fed funds rate will remain at the current level for a longer period (until now it had been “at least through late 2014”).

In the eurozone, Mario Draghi “wrote a put” with his declaration in London on 26 July: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” Talking about clear language. The disappointment after his press conference on 2 August, when the ECB president talked about conditionality (a country first has to ask for help from the ESM and accept its conditions before the ECB will intervene) was only fleeting, and the equity markets have continued to rise. This reflects the anticipation of a clearly defined scenario. The first step: on 12 September the German Federal Constitutional Court gives its approval of the ESM. The second step: Spain calls on the EFSF/ESM and accepts the conditions. A key point here is that Standard & Poor’s earlier this week reassured the Spanish government, by stating that asking for help would not affect its credit rating, thus removing a potential obstacle. On top of that, the markets will also exert some pressure. If the Spanish do not ask for help, surprised investors might push up Spanish bond yields by refusing to buy the country’s bonds. The third step: the ECB intervenes to drive down the Spanish spread.

The anticipation of this scenario implies, by definition, that a large slice of the positive impact on the equity markets has already been factored into share prices. It means that the realisation of the three steps will lead to profit taking on the equity markets (“buy the rumour, sell the fact”). Greece could be a possible catalyst. The markets will speculate about the content of the troika’s report in October and the consequences for that country. Another catalyst could be concern about the sluggish growth in the world economy. And a third catalyst is the US presidential election. The first debate between the candidates will take place on 3 October, and inevitably the precarious fiscal situation will be major focus (anything else would be disturbing). With regard to the budget, the United States finds itself between a rock and hard place. As the Congressional Budget Office made clear in its revised forecasts published on 22 August, the two options are either accepting the planned spending cuts and tax increases, and thus pushing the economy over the “fiscal cliff” into a recession, or kicking the can down the road, which will cause problems at a later stage.

It seems, then, that September will be a month with two faces: first eagerly looking forward to eurozone developments and the Fed’s decision; but then being confronted with the reality of weak global economic growth and the United States having to live more within its means.
 
William De Vijlder
Chief Investment Officer, Strategy & Partners
BNP Paribas Investment Partners