A strong start to Q1 earnings as well a relatively stable currency market along with could mean better days, however high worldwide debt loads, adverse demographics, and the threat of protectionism makes the sky clouded, according to a report by IIF (Institute of International Finance). Noting that the investors are willing to move toward riskier assets, IIF says that signs of risk appetite have been blossoming in financial markets amid a strong start to the Q1 earnings season (some 80% of U.S. firms and 60% of European firms have beaten estimates to date). “High-yield bond spreads look to be narrowing towards January lows, mature equity markets are back to positive returns for the year, currency market volatility has subsided and U.S. 10 year yields are approaching 2018 highs,” the report notes.
However, the expansionary U.S. fiscal policy remains under scrutiny, even as the IMF estimates that U.S. debt/GDP will hit 117% by 2023 (higher than in Italy)—and that the U.S. will be the only advanced economy to see debt ratios rise over this period. The report notes that the global supply of safe assets (in nominal terms) may well see a cyclical peak next year. “ Demand for Treasuries from foreigners seeking alternative safe assets could thus help keep a lid on U.S. long-term yields,” said the IIF report.
According to the Institute, robust Q1 earnings for major banks in the United States, have contributed to an overall better tone in financial markets. Further, lower corporate taxes, cost-cutting, and strong trading revenue (on the equity side rather than FICC, helped by higher volatility) have boosted aggregate net income to a post-crisis high. “Loan growth has also begun to pick up amid signs of some revival in business lending, reversing the broad deceleration in loan growth since 2015,” said the report.
Despite these positives the bank stocks in the country have underperformed their respective benchmarks. Decoding the various factors that could decide the future course of stock markets, IIF said that the continued flattening of the U.S. yield curve—as well as debate about what this signals for economic growth prospects—would be another headwind. The report also notes that financial conditions in mature economies are somewhat tighter this year.