Do Markets Still Care About Central Banks or Are Elections More Important?

As we step into the third quarter of 2024, European markets are gearing up for a bumpy ride, driven largely by political events in France and the UK, as well as the upcoming US elections. Interestingly, the usual heavyweights – monetary policies from the Federal Reserve (Fed) and the European Central Bank (ECB) – seem to be taking a back seat in the current market mindset. Yet, beyond these major headlines, several overlooked risks warrant our attention.

Political uncertainty is a major concern, particularly with elections in France and the UK on the horizon. This, coupled with the unpredictable nature of US politics, is making investors cautious. Investors flows around the world indicate a preference for safety, with a noticeable lack of confidence in a strong global recovery. This sentiment is mirrored by US GDP growth forecasts for Q2, which are falling below 2%, highlighting the adverse effects of prolonged high-interest rates.

 Source: Philadelphia FED  Amid the focus on politics and economics, the threat of a new pandemic, especially from bird flu, is not being adequately considered. The European Union (EU), still reeling from the Covid-19 pandemic, must stay vigilant. A health crisis has the potential to significantly disrupt markets and economies, yet this risk seems largely ignored in current market pricing.

Adding to the political uncertainty is the possibility of a snap election in Germany. With unexpected political shifts in the UK and France, a sudden election in Germany could further destabilize the market. The upcoming state elections in September will be crucial in gauging the political climate and potential market reactions, but this risk is not yet reflected in German bonds or the DAX index.

Geopolitical tensions remain a persistent issue, particularly in Eastern Europe. The ongoing conflict between Ukraine and Russia continues to be volatile. While there is hope for peace talks, a swift resolution seems unlikely. The EU and US's steadfast support for Ukraine, despite a desire for peace among EU voters, adds complexity to the geopolitical landscape.

The Mood indicator, which tracks equity buying versus short-term bill purchases, turned positive for the first time since March. Historically, these positive Mood periods last an average of 19 trading days, suggesting a short-term optimism. However, this optimism is not widespread across all sectors. Investors are selling more in sectors like materials, industrials, healthcare, IT, communications, utilities, and real estate than they are buying.

Another notable development is the recent positive correlation between equities and bonds, a shift from their usual negative relationship. This suggests investors are favouring bonds over equities, likely in anticipation of the Federal Open Market Committee (FOMC) easing policies in September. In the foreign exchange (FX) markets, the trend has also turned positive, driven by unwinding positions in currencies like CHF, SEK, MXN, and BRL, rather than carry trades. However, this trend is expected to be short-lived, indicating a temporary market adjustment.

CME FedWatch Tool 

 Source: CMEThe mix of political uncertainty, underappreciated pandemic risks, and geopolitical tensions, along with fluctuating market sentiment and investment flows, creates a complex environment for investors. The current market landscape is characterized by sharp reactions to new information rather than steady trends.

Investors should stay cautious and vigilant. Diversifying portfolios and keeping abreast of both macroeconomic indicators and geopolitical events will be crucial in navigating the challenges of the third quarter of 2024.

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