Calm before the storm?
- Moderate recovery in Europe and continued robust growth in the USA.
- Inflation rates continue to fall but are still above the central banks' target values in the USA and the eurozone.
- The SNB and the ECB are cutting interest rates, while expectations of interest rate cuts in the US are being pushed further and further back on the timeline.
- The AI trend supporting the stock markets, but volatility is expected to increase in the run-up to te US presidential elections.
- Credit spreads, particularly for USD corporate bonds, are also expected to increase in the medium term.
- Real estate is benefiting from the lower interest rate environment.
- The decision by the USA and the EU to increase import tariffs on Chinese goods is leading to increasing tensions in relations between the major powers. There is a risk of a comprehensive trade dispute.
- The geopolitical situation remain fragile. An escalation in the Middle East could affect supply chains in the longer term. This poses a significant risk to inflation.
The economic situation continues to vary greatly from region to region. Growth in the USA is significantly stronger than in Europe. In both regions, unemployment is at or near record lows and real incomes are rising due to falling inflation. However, high interest rates are leaving their mark.
In the USA in particular, more and more households are finding it difficult to pay their credit card bills or car loans. The average interest rate on credit cards has risen to a record high of over 20%. As a result, retail sales in the USA have been subdued in recent months. We expect the economy to lose momentum in the second half of the year, but do not anticipate a sharp downturn. Mortgages are the biggest burden for many households. However, as over 90 per cent of households have a fixed-rate mortgage, the interest rate shock has hardly been felt so far.
The Swiss economy is only growing moderately. Industry in particular is suffering from stagnation. However, Switzerland is benefiting economically, at least statistically, from the European Football Championship and the upcoming Summer Olympics in Paris. As UEFA and the IOC are based in Switzerland, all of these organisations' income will be credited to Switzerland's gross domestic product. SECO anticipates an additional growth stimulus of 0.4 percentage points. This means that GDP growth should increase to 1.5 per cent in 2024 thanks to these sporting events.
The eurozone is experiencing a moderate upturn. This has so far been driven by the service sector. Momentum in industry has developed positively over the course of the year. However, the Purchasing Managers' Index for industry has been below the growth threshold of 50 for almost two years, signalling a contraction in the sector. The outlook remains cautious, as a renewed slowdown in the services sector and a decline in industrial production were already recorded in June.
The European debt rules were suspended for almost four years due to the pandemic and the war in Ukraine. They are now back in force and the debt issue is gaining in importance, as was recently the case in the French elections. The situation is critical for Belgium, France, Hungary and Italy. These countries have high debts and deficits. The EU initiated an excessive deficit procedure against some of these member states in June. In the coming months, the states must therefore present clear plans for debt reduction.
In Switzerland, inflation has been back within the National Bank's target range for around a year. Even the higher rents included in the inflation calculation for the first time in May have not significantly increased inflation. At the same time, the Swiss franc appreciated significantly against the euro again in June. This gave the Swiss National Bank (SNB) the opportunity to lower the key interest rate again to 1.25 per cent on 20 June. Investors expect the SNB to cut the key interest rate for a third time, meaning that the key interest rate is likely to be 1 per cent by the end of the year.
Inflation is much more persistent in the eurozone and the USA. In both regions, it is still above the target of 2 per cent and is likely to remain so at the end of the year. However, there are signs of a slow decline here too.
Although the European Central Bank (ECB) lowered its key interest rates for the first time in June, it also emphasised that the fight against inflation is not yet over. It has even revised its inflation forecast for 2024 slightly upwards. The ECB is therefore likely to wait and see how inflation develops before lowering interest rates again. Investors currently expect the ECB to cut interest rates one or two more times before the end of the year.
The US Federal Reserve System has not yet dared to cut interest rates. Price pressure is still too strong for this. The most recent Fed meeting also showed that, on average, the committee members only expect one interest rate cut this year. Investors are currently somewhat more optimistic with regard to the inflation trend and expect up to two interest rate cuts. However, the timing of the first rate cut is highly controversial. While at the beginning of the year investors were already expecting a rate cut in March, the majority are now predicting September or even November. However, every new piece of economic data is currently influencing investors' expectations.
There are risks in relation to the decline in inflation. On the one hand, an escalation of the situation in the Middle East could lead to rising energy prices and a strain on supply chains. On the other hand, increasing punitive tariffs on trade between China and the US and between the EU and China could make goods more expensive.
Review: Credit spreads have moved almost exclusively sideways in the last three months, both for investment grade bonds and for sub-investment grade corporate bonds.
In the European elections, many parties from the political centre suffered heavy defeats. In France, this prompted President Macron to dissolve parliament, a move that posed a further challenge to the political landscape in Europe. On the one hand, this can be seen in the significant widening of the yield spread between 10-year French and German government bonds. The difference rose to over 80 basis points in the middle of the year, the highest level since the euro crisis. An increase was also observed in the credit spreads for euro-denominated corporate bonds, albeit to a much lesser extent.
The credit spreads of CHF-denominated bonds also increased in the 2nd quarter. Issuers once again had to pay a slightly higher new issue premium for new issues, resulting in a revaluation of the secondary curve for these companies.
Although the presidential elections in the US will not take place until November, the first televised duel between President Biden and his challenger Trump took place at the end of June. The US credit market remained unimpressed by this. Credit spreads for USD corporate bonds remain at a very low level.
Outlook: We are starting the second half of the year with increased uncertainty. Even after the elections in France, investors are still focussing on the high debt burden in parts of Europe.
The elections in the USA should also cause volatility; it is not possible to identify a clear favourite at this stage, although the first TV duel is unlikely to have increased the probability of President Biden being re-elected.
The large number of interest rate cuts by the European and US central banks expected by the market at the start of the year failed to materialise. Inflation rates are falling more slowly than expected at the beginning of the year. Interest rates are therefore likely to remain high in the coming months. This is particularly painful for issuers with high refinancing requirements and low free cash flows. They will face a significantly higher interest burden in the medium term, which will further reduce the earnings power of these companies. Due to global uncertainties and the persistently high level of interest rates, we expect a moderate increase in credit spreads in the medium term and favour companies with less cyclical end markets and sufficient pricing power.
Review: The first half of the year was pleasing for equity investors. One of the main drivers was the trend towards artificial intelligence (AI). The "Magnificent 7" (Nvidia, Meta, Apple, Alphabet, Amazon, Netflix and Tesla) increased in value by 37 per cent. However, the frontrunner was the US chip manufacturer Nvidia with a performance of 150 per cent in six months. The company has now reached a market valuation of USD 3.35 billion, making it the world's most valuable company. The broad American index benefited with a half-year performance of 15.2 per cent. Excluding the "Magnificent 7", the increase in value was only 7.3 per cent.
Although the European stock markets benefited less from the development of AI, they also rose at the beginning of the year thanks to the brightening economic environment. Towards the end of the quarter, however, momentum in the eurozone slowed somewhat, partly due to the announcement of new elections in France. The EuroStoxx 50 rose by around 12 per cent in the first half of the year and the Swiss SMI by 11 per cent.
Outlook: The AI trend and political events are likely to continue to characterise the stock market environment in the coming months.
Many AI companies were able to impress investors with their corporate results for the first quarter. However, profit expectations remain high, which harbours the potential for disappointment. Investors are also likely to become increasingly selective and look for companies that can demonstrate that their investments in the new technology can generate clear added value or higher returns.
While elections caused turbulence on the European markets towards the end of the first half of the year, the US presidential elections are likely to influence investor sentiment in the second half of the year. There is no clear answer to the question of whether a Democratic or a Republican president is better for the stock market. After all, a large number of other factors such as monetary policy, the economic environment and structural trends have a simultaneous impact on market developments.
In election years, however, there is a clear tendency towards higher market volatility one to two months before the election, followed by a rapid decline. Investors should therefore expect increased price fluctuations from September to early November in these years.
Review: The depreciation of the Swiss franc from the first quarter continued until May. The trend reversed at the end of May. From the end of May to mid-June, the euro lost over four per cent against the Swiss franc. The US dollar lost slightly less, but here too the trend reversal was clearly recognisable.
With the SNB's interest rate cut on 21 June, the appreciation of the Swiss franc has come to an end for the time being. One euro cost CHF 0.9628 again at the half-year mark, and one US dollar CHF 0.8987.
Outlook: The shift to the right in the European elections and the subsequent elections in France weighed on the euro at the half-year mark. While we also expect higher volatility on the US equity markets in the run-up to elections, there has been no clear trend for the US dollar in election years in the past.
Instead, monetary policy and the interest rate differential are likely to continue to characterise currency developments in the coming months.
Review: Following the SNB's monetary policy assessment on 20 June 2024, the SXI Real Estate Funds Broad Total Return Index rose by 1.3% until 26 June 2024, closing at 484.82 points on 26 June 2024. The index closed the first half of the year with a performance of 4.9 per cent. The share price therefore fell by 0.9 per cent in the second quarter.
Transactions on the capital market picked up speed again in the first half of 2024. Capital increases were carried out by a number of property funds and investment foundations.
According to the survey conducted by Fahrländer Partner on 15 June 2024, the minimum discount rates for apartment buildings in Switzerland fell slightly to 2.03% (2.06% in March 2024). This reflects the decline in long-term interest rates and the above-mentioned reduction in the SNB's key interest rate.
The reference interest rate of the Federal Office for Housing remains at 1.75 per cent.
Immigration has declined at a high level. According to the State Secretariat for Migration, net migration in the 1st quarter of 2024 totalled around 21,500 people. On the supply side, a further decline in the volume of investment in rental flats is expected (forecast for 2024: - 2.6%). Compared to the previous year, asking rents increased by 5.9 per cent in May 2024.
Office space available within three months fell again for the first time since the end of 2022, from 4.2 per cent (Q4 2023) to 4.0 per cent (Q1 2024). This is primarily due to a decline in construction activity.
Construction prices fell by 2.3% in the 2nd quarter of 2024 compared to the previous year.
Outlook: Increasing demand can still be expected on the income side of the property market. The structural supply deficit in the rental flat market will be further exacerbated, which will result in further increases in asking rents.
Despite the SNB's interest rate cut, it can be assumed that the reference interest rate will remain at 1.75 per cent for the time being, as market participants' long-term interest rate expectations have remained stable.
In the office space market and the market for retail space, demand and supply are expected to remain constant, although there are regional differences.
The SNB's interest rate cut should increase the relative attractiveness of property and property products again.
In indirect property investments, various funds and investment foundations have published capital increases for the third and fourth quarters of 2024.
Melanie Rama
Head of Economic Research
melanie.rama@baloise.com
Dominik Schmidlin
Head of Quantitative Portfolio Management
dominik.schmidlin@baloise.com
Dominik Sacherer
Portfoliomanager Fixed Income
dominik.sacherer@baloise.com
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Four times a year, editorial deadline: 2 July 2024
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