French toast for Christmas

French government collapses, yields shoot higher
South Korean war that never was confuses the markets
European Central Bank (ECB) keeps the pace with an interest rate cut
The Federal Reserve (FED) startles the markets

The first half of December has turned out to be a yet another seasonally strong period for the financial markets that brought plenty of festive vibes for investment portfolios of wide range. No matter the political drama or occasional macroeconomic data disappointments, markets have largely continued low volatility optimistic trading, inspired by reignited strength in the market-leading sectors. However, with only few days left until Christmas, FED has announced their plans to slow down the pace of interest rate reductions next year, sending the financial markets into the tailspin.

As a result, developed markets’ equities (measured by MSCI World index in EUR) have tanked by 0.74%, while emerging markets’ equities (measured by MSCI Emerging Market index in EUR) have risen by 1.86%. During the same period yields on bonds were climbing, with 10-year U.S. Treasury bond yields rising to 4.57% from 4.18% a month ago, while German 10-year Treasury bond yields have risen to 2.37% from 2.08% a month ago.

French government collapses, bond yields surpass Greece

The election gamble that French president Emmanuel Macron has placed just before the summer Olympics seems to have been in the focus for several months in a row. Even though the president has picked a moderate Michel Barnier (former Brexit negotiator on the EU side) to lead the minority government, the political deadlock has appeared too challenging even for such an experienced politician to navigate. As there seems to be lack of political will to limit spending in the French parliament post the parliamentary elections, Barnier’s proposals to curtail the spending and balance the budget were met with resistance and resulted in “no confidence” vote. That leaves France unable to reform and seemingly stuck with a massive hole in the budget and increasingly lacking ideas how to fill it. As the French political drama continues, financial markets are voting with their feet by selling down French government debt and other related assets. Ironically, over a decade past the Greek financial crisis, the yields on the French government bonds have surpassed those of Greek government bonds, as investors apparently grew ever more concerned about the finances of France.

Yields on 10 year government bonds of Greece and France

Source: Investing.com

Confusion in the markets over South Korea’s martial law

On the other side of the world in South Korea, the political drama early December has spilled over into uncharted territory. President Yoon Suk Yeol has unexpectedly announced martial law in the country to deal with perceived threats from the neighboring North Korea. At least in theory it would mean that the previously functioning democratic system would be curtailed by accumulating power in the hands of a single person and increased army presence in the society. Trouble is, there was no perceived spike in North Korean threat at the time and the wide range of policymakers have lined up to disagree. The confusion has peaked as parliament members brawled their way through the soldiers to vote the martial law down in just a few hours’ time after it was imposed. While feared to be verging onto increasingly dangerous and unexpected path, South Korea has experienced some extremely shaky financial market’s reactions with equities’ Kospi index diving over 5% in a few days and the Korean Won dropping sharply in the currency market. Naturally, as South Korea constitutes a substantial portion of the Emerging Markets positioning in the investment portfolios, investors will be following the situation closely so as to assess the medium-term impact of this heightened confusion in the otherwise Asian success story.

ECB delivers another rate cut

In tune to the festive mood in mid-December, the European Central Bank has announced its decision to lower the interest rates for the fourth time, already, this year. The key ECB deposit rate was lowered by 0.25% to the new level of 3%, thus indicating further push by the central bank to stimulate the economy. While commenting on the decision during the press conference, ECB representatives have shared their intention to lower the rates further still towards a less restrictive level. As investors are pretty much accustomed by now to a regular lowering of interest rates by ECB, the attention of the market will shift on to eventual target level of interest rates. While the medium-term target level of interest rates is obviously unknown, many market participants forecast the key Euro zone interest rate will move closer to 1.75-2.5% range in time.

FED serves a hawk for Christmas

On the other side of the Atlantic, FED has seemingly delivered just as uneventful decision to lower the interest rates for the third time in a row to the new range of 4.25-4.5%. While the decision itself was widely expected, Federal Reserve has caught the markets by surprise in updating their plans for the next year. According to the updated forecast, the US central bank is going to reduce the rates twice next year by 0.25% each time. That is less than some market participants were expecting, as the many of them forecasted three quarter-point cuts in 2025. As the slightly changed FED stance signals there will be less monetary stimulus than expected, the markets have reacted substantially, with S&P 500 brushing off all the gains for the first half of the month in a single session by dropping nearly 3%, while US Dollar has gained versus other currencies to reflect the higher expected interest rates on the currency.

Market view

The investors’ optimism seems to sustain itself in the face of political challenges, while supported by the ongoing easing of interest rates by central banks, in general. With that said, any changes in the monetary policy can and will affect the markets substantially, with investment portfolios affected by the fluctuations in the asset prices as well as the currency movements. Going forward, financial market participants will keep a curious eye on the future profit developments of the leading market companies to assess the further direction for the financial markets. In addition, the extra scrutiny will be directed at the policy set by the central banks to assess the impact on the fixed income portion of the portfolios.

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