It’s been a ‘will they, won’t they’ time for Euroland equity investors in recent weeks, as they consider speculation that the Fed is about to raise interest rates in the US.
And the overriding question is, if so, how close really is the link between the US and European economies.
Jacques Van der Borght, senior fund manager at Petercam in Brussels, comments: “Everybody is predicting a rate increase, and we have already priced in a 25 basis point hike to our projections. If we see a 50 basis points jump then this would certainly calm the market.”
However, he adds that the important issue is over the US/Europe correlation. “We take the view that the two are extremely strongly connected, despite the difference in the economic cycles, and if we don’t see US interest rates go up we are predicting a price correction of between 5-10% in Europe.”
Van der Borght says he certainly senses the US needs the rise to calm nerves.
On the European front, he says, continued sector consolidation has been boosting investor confidence.“The momentum is picking up again to levels we were seeing in January and February after a dampening down in activity in March and April, which is a positive sign.”
He says M&A activity in the Portuguese and French banking sectors are looking particularly fruitful, alongside ever more intense action in the telecoms sector. “The emphasis is moving on from consolidation within the fixed, land-line companies into the mobile and cable operations. And there is a magnet effect happening with everything internet related coming together - so things are looking up.”
Nick Stevenson, head of European equity strategy at Paribas in London, sums up the US/Europe debate taking place at the moment. “You have to say whether the European interest rate is essentially the same as or different from the US. “If the European yield curve remains on an upward trajectory with bond yields rising, do you take a sector approach for equities that is more aggressive as a result, looking to say engineering, chemical or oil stocks. Or do you sit tight and look to the US?
“Some people say you should be bold, some disagree, but the question is certainly forcing people to review their portfolios a lot.”
Stevenson says the Paribas strategy is towards the aggressive approach, but says that the crux question is how much of a flattening effect on the yield curve a US interest rate hike will have.
Should the Fed tighten interest rates by 50 basis, he points out, then the bond market might well like it, but the rate dispersion, averaging about 5.5% on the short end and 6.5% at the long end give a pretty flat yield curve.
“Suppose this produces a flight from Wall St because everyone takes this as a sign that the US is slowing down. If you have a US-centred investment view then you immediately say this will have an effect on Europe. On the other hand, the European yield curve is upward sloping and there are many signs that growth is accelerating - not least because the currency has been cut by over 12% - so fundamentally you would say there would be an acceleration of growth in Europe at the same time as deceleration in the US.
The issue then appears to be whether there is a decoupling of growth rates between Europe and the US. One view is that if the US slows then the chips are down for Europe. The other is that there can indeed be a Europe/Japan decoupling of growth from the US.
A major growth surprise on the up side would though, he says - creating a steepening of the European yield curve to push it above the US long end. “Such a scenario could really move Europe in a fundamentally different way.”