Deutsche Bank sees upside to European stocks, warns of unstable equilibrium

Dovish guidance from the US Federal Reserve reduces the risk that sovereign bond yields will rise in 'real' terms, which in turn should support European equities, including the likes of Rio Tinto, but tensions in credit markets and other segments of global capital markets could resurface in the second half of 2016, strategists at Deutsche Bank said.

Less risk of US dollar strength should bolster European stocks both by lessening the pressure on commodity prices - and hence credit markets and the Chinese yuan - and by capping the upside to yield on US Treasuries in inflation-adjusted terms.

In real terms, Eurozone sovereign bond yields tended to move in tandem with those in the States, Deutsche Bank explained.

Co-ordinated or not, that triple central bank policy-action should reduce 'tail-risks' for stocks and also means less of a risk of a near-term yuan devaluation.

"We would not be surprised if European equities showed some upside over the coming weeks, as a weaker dollar supports commodity prices, leading to further tightening in credit spreads. Among sectors, resources, financials and autos should benefit the most in this scenario. ING, BASF, Continental and Rio Tinto feature on our screen of European stocks that [...] tend to outperform when the dollar falls, credit spreads tighten and the oil price rises", strategist Sebastian Raedler said in a research note sent to clients.

Indeed, now there were upside risks to Chinese economic growth in the near-term, courtesy of the People's Bank of China's dramatic $500bn of credit loosening in January, Raedler added.

However, the underlying problems were still in place, he cautioned.

In particular, Deutsche Bank's credit strategists continued to be concerned about the outlook for the US high-yield credit market, where balance sheets were still deteriorating, leading them to describe the current situation as an "unstable equlibrium".

A Fed rate hike - perhaps in June - might yet be put back on the table by markets and the boost to Chinese growth should begin fading in the second half of the year, he said.