Return to the rate-tightening cycle and Brexit fallout could boost equities

Although the probability of a key rate hike this summer was estimated to be close to zero a few days ago, it has increased significantly after the latest statements by Fed representatives. The Federal Reserve seems to have ticked off its fundamental checklist, now that the outlook for inflation and economic growth has improved and financial market conditions have eased after the turbulent start to the year. Even so, uncertainty surrounding a Brexit continues to pose a forecasting risk. Fed chairwoman Yellen gave a speech on 27 May, which bond market observers hoped would provide new hints with regard to an interest rate move. We have been anticipating another interest rate hike in June for quite some time now. An increase in June will send out a signal to the capital markets that the Fed's rate-tightening cycle has not ended already after the first hike in December, as was hoped for by many market participants given the weaker Chinese economy.

We expect a normalisation of the rate-tightening cycle will meet with a positive response on the equity markets after the overall frustrating trend of the last twelve months (the S&P 500 reached its all-time high exactly one year ago, while 14 months have passed for the DAX). Long-term comparisons show that key rate hikes are not necessarily a bad thing for equity market developments, as they document the confidence expressed by the central bank in economic growth. The most recent phase of economic weakness in the US appeared to be only temporary in nature, not least due also to the negative impact of the fall in the price of oil. Given the marked recovery in the meantime, corporate profits are likely to bottom out in a matter of months. A disproportionate earnings recovery should then set in in the energy and related sectors, which should in turn help stabilise the earnings development. Furthermore, rising crude oil prices have helped curb further major defaults on the credit markets, thus significantly easing the nervousness that prevailed in spring. This is also reflected in the sustained low level of the VDAX and VIX volatility barometers. If the Fed raises interest rates in June and a Brexit can be avoided, we believe that equity prices will most likely pick up again. However, a transition to a pronounced ascent is unlikely, as economic growth remains muted overall, the focus is shifting increasingly to the forthcoming presidential elections in the US and the associated uncertainties, and the US equity market remains overvalued (PER 2017e: 17.9).