Macro update - February

Macro update prepared by Rokas Grajauskas, Danske Bank Chief Baltic Analyst

Volatility on the increase but equities still well supported

After a very strong start to the year in global equity markets, the long-awaited correction came very abruptly with the beginning of February. The epicentre of the sell-off was the US stock market, but the contagion spread to all other key markets as well.

Should we be worried? We see it mainly as a technical correction and after a period of nervous trading, we look for the uptrend in equity markets to continue. We see the following reasons to stay positive about the equity market.

  1. Profit growth set to stay robust in 2018. Global growth data continue to point to a strong and broad-based recovery – both geographically and across sectors.
  2. Market sentiment had become extreme. Our indicators measuring market sentiment indicated that the market was very technically ‘overbought’ and thus prone to a correction. Following the equity market correction at the beginning of February, our sentiment indicators have now returned to a more neutral position.
  3. Technical factors exacerbated the move. Investment funds that trade on the short-term trend in the equity market were stopped out. In other words, ‘machine selling’ contributed to the sell-off due to mechanical stop-loss orders.

While we still look for equity outperformance in 2018, we also expect to see a year with more volatility – not least in the short term. In addition, we are moving into the mature phase of the global business cycle, where we typically see higher volatility and lower returns on risk assets. However, historically, it is still a part of the business cycle where risk assets outperform government bonds and cash. The markets are likely to be nervous in the short term but six months from now, we expect equities to have reached new highs for this year.

Global cycle continues to underpin global equities

 MSCI Equity World Index (rhs)Source: Bloomberg, Macrobond, Danske Bank

 Bond yields on the increase
This year has started with a fixed income sell-off that has pushed 10-year German yields higher by approximately 30bp since the start of the year and close to 45bp since mid-December 2017. If we compare the sell-off with the US induced 2013 tapering sell-off or the 2015 German led bond sell-off, the market moves are still smaller. In 2013, the 10-year US Treasury yield rose close to 100bp in the first two months of the sell-off – and in 2015 the 10-year German yield rose 60bp in two months of the sell-off and peaked 2.5 months later more than 80bp higher in total.

The current bond sell-off is driven by higher inflation expectations and a move higher in real interest rates. It is noteworthy that the global equity turmoil has not been very supportive to bonds – yields decreased somewhat but bounced back quickly to the pre-sell-off level. In other words, we have not seen the usual move into the global bond markets as risk sentiment has weakened.

We see a risk that the sell-off in the bond market will continue over the next few weeks or months. Global central banks do not seem to be ready to become more dovish, the global recovery is still firmly on track and the market is focusing on the fiscal easing in the US over coming years, which we expect to come as wage growth has finally picked up and unemployment remains low.


Another bond market sell-off – no big effect from equity market decline
 US 10-year gov yieldSource: OECD, Macrobond, Danske Bank

Latvian GDP growth jumped in 2017
Latvian GDP last year expanded by 4.5%, the fastest rate since 2011. This made Latvia one of the fastest growing economies in the EU.

The key factor that contributed to growth last year was consumption, which expanded by 4.8%, the fastest rate in four years. Consumption was first and foremost driven by higher wage growth (+7.5% on average in 2017, compared to 5.0% in 2016).

Another important factor was significantly higher (+17.9%) investment growth. Investment last year rebounded after a very weak 2016. Key reasons behind stronger investment growth – a pick up in EU funding, higher capacity utilisation rates and increasing business sentiment. Over the next few years the majority of EU structural funds for the 2014-2020 financial perspective, in total EUR4.4 billion, will reach the Latvian economy, thus stimulating investment and overall economic activity.

Last but not least, exports expanded by a healthy 3.8% last year. Key markets to which exports increased were Russia, United States and Germany. Main categories to expand were beverages, metal and wood products.

In 2018 we expect the Latvian economy to grow by 3.4%. Growth will be lower than in 2017 mainly due to base effects, especially with regard to investment. However, it should still be significantly higher than during most of the post-crisis years. The Latvian economy will benefit from rising domestic demand as well as favourable dynamics in key export markets.


Change in Latvian GDP, constant prices (%)
 Change in Latvian GDPSource: Statistics Latvia, Danske Bank