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December 8, 2023

The ECB as “pivot” first-mover, equity strategies and money markets

This week’s edition begins with the dovish noises from the ECB; the market expects Europe to lead the global pivot to rate cuts, while German yields are compressing. We examine unrealised bond losses at US banks, OECD inflation forecasts, Ireland’s tax receipts, money market inflows, and provide visualisations for investors considering US and Latin American stocks.
articles in this chart pack
Usama Karatella
Siwat Nakmai
Karl-Philip Nilsson
Denys Liutyi
Hank Rainey
Keith Campbell
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The ECB might lead the pivot to rate cuts

Markets are convinced that central banks will pivot to interest-rate cuts next year. Who will lower rates first – the Bank of England, the Federal Reserve, or the European Central Bank? 

This visualisation tracks the evolution of futures markets to show when a quarter-point cut from the terminal rate has been priced in.  This month, the ECB has taken the lead in the pivot race: its first cut is expected in April, compared with May for the Fed and July for the BoE. (Our next chart discusses the ECB comments that might have prompted this, and explores the effect on German bond yields.)

The three lines have moved in unison since the summer – showing how the pivot is expected earlier in 2024 than previously assumed.


Germany’s yield curve is compressing

German bonds have rallied since ECB official {{nofollow}}Isabel Schnabel recently suggested there is a limited likelihood of further interest-rate hikes in the eurozone, citing a “remarkable” inflation slowdown.

This chart shows the effect on the German yield curve versus very recent history – the current quarter. From 1-year to 30-year securities, yields are at their quarterly lows.

The right side of the chart tracks the deviation from the quarterly and yearly average yields. 


In search of stock bargains, Latin America appeals

US equities have rallied on the strength of mega-cap tech companies, optimism about a soft landing and hopes for lower interest rates next year. But as a result, they are also richly valued, potentially limiting their upside potential. 

Investors looking for cheap alternatives might use our chart to consider emerging markets. Latin America is the most undervalued, based on relative price-to-earnings (P/E) valuations versus US stocks.

In November, the relative 12-month forward P/E of Latin American versus US equities was lower than its 10-year interquartile range. By contrast, emerging markets in Europe, the Middle East and Africa (EMEA) were relatively close to the 10-year median. 

Some of the political and economic headwinds in the region are easing. {{nofollow}}Brazil has started cutting interest rates; in Argentina, markets responded positively to the election of libertarian populist Javier Milei.


The OECD raises (and lowers) inflation forecasts again

The Organisation for Economic Cooperation and Development has released its latest economic outlook, which includes revised 2024 inflation targets for member nations and other countries around the world.

This chart visualises the changes, comparing the latest national or regional figure to the previous OECD estimate (in green). The bottom pane expresses this a different way, showing how much the inflation forecast has gone up or down.

Some nations are faring better than others. For the OECD as a whole, consumer prices are expected to rise more than 4 percent next year – but that's down notably from the previous 5 percent forecast.

Slovakia and Colombia stand out, with the OECD raising their inflation forecasts to about 5 percent next year. Consumers in Spain, Lithuania and Costa Rica are among those breathing a sigh of relief.


The lurking losses inside US banks

The historic increase in interest rates has had a similarly unprecedented effect on banks’ balance sheets – driving down the market value of the Treasuries and government-backed mortgage securities these institutions hold.

Unrealised losses on securities at FDIC-insured commercial banks jumped by USD 126 billion from the prior quarter. Total unrealized losses now stand at USD 684 billion.

Our chart expresses this sum as a percentage of banks’ equity capital: this ratio has crept up to 30.5 percent, near the level seen when Silicon Valley Bank and other institutions failed in mid-2022.

Typically, these losses aren’t realised because banks can hold these assets to maturity. However, in times of panic, these assets are sold at market value – the primary driver of SVB’s collapse. 

Our chart breaks down the FDIC’s differentiation between “available-for-sale” securities and their “held-to-maturity” counterparts, which must stay on a financial institution’s books. Unrealised HTM losses are not reflected in financial statements. 


Ireland’s surging tax receipts, thanks to US multinationals

November is the key month for corporate tax receipts in Ireland – and the nation’s treasury is raking it in.

Our chart tracks November corporation tax receipts over recent decades. Last month, the government received EUR 6.3 billion, a 27 percent increase from a month earlier.

Ireland’s economic strategy has long been to {{nofollow}}attract tax-sensitive foreign investment with one of the world’s lowest corporate-tax rates. Reportedly, {{nofollow}}only three companies accounted for a third of all such taxes collected between 2017 and 2021. Most famously, {{nofollow}}Apple has said it’s Ireland’s largest taxpayer; the tech giant’s Cork-based entity is the “umbrella firm” for most non-US operations.

The surge in the early 2000s is notable. {{nofollow}}Ireland phased in this tax policy between 1996 and 2003.


How funds have moved between stocks and money markets

This is a visualisation of how money sloshes around between equities and “safe” cash investments over time. 

The blue line charts the ratio between the total assets of US money market funds and stock-market capitalisation; we’ve added a median line for that ratio. We then compare that to US interest rates (in green, pushed forward 18 months) and overlay periods of recession, in gray. Currently, assets in money-market funds stand at about 16 percent of the value of the stock market.

The experience of the 2000s stands out: rates rose, then the global financial crisis tanked the economy and stocks; investors fled to money markets for a safe return, and the ratio we are tracking soared. During the period of ultra-low rates that followed, money markets lost their appeal and equities recovered. A less pronounced version of this correlation occurred in the pre- and post-pandemic cycle.

History might not repeat itself. Currently, the US economy is facing a unique situation: short-end rates are at their highest levels in decades – increasing {{nofollow}}the appeal of money markets– but the economy might still be on track for a soft landing, which would be less damaging for stocks than the GFC or 2019-20 cycles. 


Visualising an analyst-driven investment strategy using FactSet

Wall Street analysts are {{nofollow}}sometimes derided for being behind the curve, but we’ve constructed a chart showing that it can pay to listen to them.

This chart taps the FactSet Connector for historic analyst ratings on Ford Motor Co. The bottom panel assigns weightings to “underweight,” “sell,” etc. to generate a month-by-month average rating from 1997. 

The top panel compares buying and holding Ford stock with a dynamic strategy: whenever the average analyst view descended to the midpoint of the “hold” range, our theoretical (and perhaps jaded) investor decided analysts were actually saying it was time to sell. Once the average crept above that level, the strategy would buy Ford again.

Ford avoided the bankruptcy that hit Detroit rival General Motors after the GFC, but on a 25-year basis, the stock was still dead money. A dynamic strategy based on analyst ratings, meanwhile, would have made five times your initial investment – and sometimes more.

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