William De Vijlder

Group Chief Economist BNP Paribas

Markets and financial investments

William De Vijlder analyses the relations between the economy and the markets (including bond, equity, commodity, capital and currency markets), investor behaviour, and their appetite for risk taking, in keeping with economic data and the level of uncertainty.

Wall Street

The US stock market and the labour market worlds apart?

In the US, the behaviour of the equity market versus the level of employment is very different in the current recession compared to previous recessions. The recession this year stands out because of its sudden, enormous job losses, which were quickly followed by a significant albeit very incomplete recovery. The equity market, after a huge drop, has rebounded swiftly and made new highs although earnings –on a 12 month moving average basis- still have to rebound. For 2021, more than anything, earnings growth matters.

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Does forecast uncertainty matter? It depends

The publication by the ECB of different economic scenarios illustrates the extent of uncertainty which at present surrounds the forecasts for key macroeconomic variables. As a consequence, companies may hold off investing, preferring to wait for better visibility. While understandable at the micro level, such a wait-and-see attitude could act as a drag on growth and reinforce the view of companies that their caution was warranted.The large increase in the dispersion of earnings forecasts points to huge uncertainty at the individual company level. However this has not stopped the US equity market from rallying. Although several factors help to explain these different reactions to uncertainty, such dissension cannot last forever. At some point company cautiousness or investor bullishness will have to give in.

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Wall street

The COVID-19 pandemic and the US equity market

Fed Chair Powell’s comment about what would happen in case of a prolonged recession has weighed heavily on equity markets. Historically, recessions are accompanied by major equity market drawdowns. The year-to-date decline is more limited, which stands in stark contrast with the plunge of activity. Massive monetary and fiscal policy support has led to a reassessment of the distribution of risks, which goes a long way in explaining the rebound of equity markets. The focus is now shifting to the outlook for corporate earnings, hence the importance of the debate on the shape of the recovery.

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Financial markets and the coronavirus: what price for uncertainty?

In theory, and all other things being equal, an increase in uncertainty results in a fall in the price of risky assets and an increase in the price of safe haven assets. In a way, this can be considered as the “price of uncertainty”. The reality is rather more complex. Greater uncertainty also affects growth prospects, which in their turn influence asset valuations.

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Marchés financiers

The strange relationship between markets and uncertainty

Economic sciences teach us that financial markets fear uncertainty as it introduces volatility in prices of financial assets. Based on the reaction of markets since the beginning of the year, one could conclude that economic textbooks need to be rewritten. In spite of a high level of commercial and geopolitical uncertainty, markets have recently set new records.

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Question marks

Markets and geopolitical uncertainty: (ir)rational complacency?

There is a considerable gap between what are considered to be the geopolitical ramifications of the escalating tensions between the US and Iran since the start of the year and the subdued reaction of markets. The market reaction probably reflects the investors’ view that the probability-weighted impact on growth should be very limited because the risk of a major escalation is considered to be small and/or because of an expectation that the impact of higher oil prices on the economy is limited. What also may play a role in the market reaction thus far is that, leaving the geopolitical uncertainty aside, the economic environment is considered to be conducive to taking risk: stabilisation of survey data, reduction in trade-related uncertainty and accommodative monetary policy.

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Eurozone: QE and market instability risks

The ECB’s monetary policy meeting account illustrates the dilemma it is facing: inflation is subdued and risks to growth are tilted to the downside, yet the financial stability implications of the very accommodative policy need to be closely monitored. These implications are covered in sobering detail in the ECB’s Financial Stability Review. A possible side effect of very low to negative interest rates is that borrowing and spending become more procyclical. Quantitative easing (QE), by modifying the risk structure of investment portfolios (less government bonds and more exposure to assets with a higher risk), will probably increase the sensitivity of portfolio returns to the business cycle.

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Financial Markets

What drives the recent rise in bond yields and equity markets?

In recent weeks, equity markets performed well. Focussing on the US, it is hard to argue that this reflects an improvement in the earnings outlook or a perspective of more rate cuts than hitherto expected. This would imply that a decline in the required risk premium was the key driver. US treasury yields also increased significantly, which probably reflects to a large degree an increase in the term premium. The decline in the equity risk premium and the increase in the bond term premium were driven by a common factor, namely a reduction in economic tail risk on the back of progress in the trade negotiations between the US and China and a stabilisation of certain survey data.
The reduced likelihood of very negative economic developments, which has boosted equity markets, has also reduced the attraction of bonds as a hedge against equity risk. As a consequence, bond yields have moved up in sync with equity markets.

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US: the signal and the noise

US: the signal and the noise

Asset prices can play a useful role when assessing the economic outlook. The big drop in treasury yields during August has raised concern although a nowcast points to satisfactory third quarter growth in the US. This would mean that increased uncertainty about the trade dispute has caused a flight to safe havens and a decline in long term interest rates. Swings in the communication about the trade dispute cause swings in investor uncertainty and hence in risk premiums. This reduces the signal quality of asset prices, which may end up weighing on the real economy.

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Tipping points

US long-term rates rose sharply in early October, which brings to mind the sudden rise in early February. Upside surprises in terms of wages and inflation triggered February’s upturn, while the catalyst in early October was a strong rise in non-manufacturing ISM, an indicator that is usually not monitored very closely. That this indicator should have such a big impact already shows how nervous the markets are.

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Understanding the market’s volatility

In Wall Street stock market fell sharply again, pursuing a bearish trend initiated several weeks earlier. For an economic understanding of these trends, it is worth comparing equity market behaviour with that of the other asset classes, an exercise that is all the more difficult given that the correlation between asset classes tends to increase as pressures rise.

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investor risk appetite

A sudden drop in risk appetite

The eruption of US equity market volatility, with global spillover effects, is a delayed reaction to a rather significant increase in bond yields since the second part of August. Market-implied inflation expectations didn’t move that much so the rise in long term rates reflects an increase in real yields which in turn is related to strong growth numbers. Historically the relationship between weekly changes in yields and stock market performance is weak. This implies that one should focus on drivers of investor risk appetite and in particular signs of slower growth.

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Conflicting perspectives raise eyebrows

Speculative positioning in VIX futures shows investors expect volatility to remain low, which implies an absence of growth or inflation shocks. The flattening of the US yield curve shows investors expect slower growth. These conflicting views may reflect differences in investment horizon but in the end, only one of the two can get it right, which is a source of concern.

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