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Rothschild October Monthly Letter

For the first time since 2010, the pace of the economic expansion is expected to accelerate this year and growth is now more synchronized globally. That said, the recent economic upturn is partly explained by a substantial policy easing by the Chinese authorities to prepare for the 19th National Congress of the Communist Party which will open on October 18. Therefore, the lasting character of this trend is subject to debate. Meanwhile, wage growth remains modest in most countries and maintains inflation at low levels whereas for several years now a majority of central banks still fail to reach their targets. The effects of prolonged recourse to unconventional policies and the possible withdrawal of these measures raise considerable challenges and central bankers will have to find the right balance. For a short period, volatilities spiked somewhat due to rising political risks in the United States and increased geopolitical tensions relating to North Korea, but even as political tensions remained high, they returned to low levels. In fact, the volatility of the bond and equity markets is extremely low all over the world. As it often happens during periods of low volatility, a risk-taking phase has emerged, especially as the dollar has continued to decline.

Several factors explain the descent of the greenback. First, uncertainty about the pace of Fed policy normalization and the increased unpredictability of the Trump Administration's economic policy have weighed on the dollar. Fed chairwoman Janet Yellen has for the time being relegated to the second level the conflicting messages from the bond market, both in terms of low inflation expectations and flatter yield curve, to stay the course with a further rate hike in December and three increases in 2018. However, the recent downward trend in the inflation rate and the weakness of wage growth are factors that could influence the Fed if they were to continue.

In addition, macroeconomic data have been below expectations for several months and it is still difficult to assess the extent to which fiscal easing and regulatory reforms can generate additional momentum in 2018. While fixed capital investment is well oriented and business confidence indices – notably the ISM indices – have reached record highs for more than 12 years, the U.S. housing sector is rapidly losing momentum and household consumption is less dynamic than it was. Thus, as macro news was better than expected globally while relatively disappointing in the United States, the dollar depreciated vis-à-vis all major advanced economy and emerging currencies. The dollar lost most ground against the euro, given the strengthening economic outlook in the Eurozone and the anticipation of several observers of a slightly less accommodating posture on the part of the ECB (European Central Bank).

Indeed, growth in the Eurozone has exceeded expectations in the first half of 2017, and is now more broad-based thanks to favorable financial conditions, rising employment and a positive contribution from external trade. Moreover, political uncertainty is less significant than at the beginning of the year, although the results of the elections in Germany and the polls related to the October 15 election in Austria are a reminder that the popularity of extreme right parties and the fears related to the immigration that they feed are still important. What’s more, the adverse effects on economic activity of the recent appreciation of the euro are likely to penalize economic activity, although they are nevertheless difficult to pin down. The negative impact of the higher euro on the dynamics of inflation will complicate the task of the ECB which is still struggling to reach its target. Thus, the next meeting of the monetary committee on October 26 contains a part of uncertainty regarding the quantitative easing program. Recent ECB commentary underlines debate over the trade-off between the pace and the duration of asset purchases. The benefits from a longer intended purchase horizon, combined with a greater reduction in pace, are compared with those from a shorter period of purchases and larger monthly volumes. Yet, some ECB members have expressed fears that the former could be interpreted as too hawkish and risks putting even more upward pressure on the euro.



CRN: 2017-1011-6189 R

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Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.