Correlation interest rates-equities: Divergence between US and EZ - Natixis

In view of the Nathalie Dezeure, Research Analyst at Natixis, the correlation between interest rates and equity markets tends to move in sync in the US and Europe (UK and Germany, as a proxy for the Eurozone).

Key Quotes

“However, this is not to say there will not be spells marked by a significant disconnection between the different markets due to factors specific to each country or economic area.”

“Recent weeks are an excellent case in point: the correlation between interest rates and equity markets has turned markedly more negative in the US (around -0.4) than in the Eurozone or the UK (where it has hovered between 0 and -0.2).”

“This recent disconnection occurred in a context marked by a relatively homogeneous shift in fundamental factors, featuring notably a rise in inflation expectations, concurrently with a more or less pronounced rise in sovereign interest rates in the different geographies considered.”

“This configuration is clearly explained by one factor specific to the US, which has to a large extent fuelled investment flows into equities. Investors are visibly playing a reduction in the tax burden of the US corporate sector along the lines proposed by Donald Trump (cut in corporation tax rate, reduced taxation of profits generated abroad). Since Donald Trump’s election, net cumulative investment flows into US equities on the part of non-residents (EPFR data) have totalled $65bn, while net cumulative outflows from US bonds have reached $4.4bn. By comparison, investment flows have been far more modest and relatively balanced according to the EPFR data published for the UK ($0.29bn for equities, $0.24bn for bonds) and Germany ($0.15bn and $0.11bn, respectively). EPFR data confirms these trends, with cumulative inflows of $97bn for US equities versus cumulative outflows of $3.9bn for US Treasuries.”

“Besides the asset rotation observed in the US, inflation is a factor that could contribute to some divergence, as inflation expectations will be far more aggressive in the US and UK for quite some time, rather more fleetingly so in the Eurozone.”