Notes from the Trading Desk – EuropeMay 20, 2019

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.


As expected, trade-war rhetoric dominated headlines and drove markets last week. This saw markets start the week lower, but most European indices still managed to make gains on the week after a boost on Tuesday from an apparent US about-turn on auto tariffs. Equity markets in the United States and Asia Pacific regions underperformed.

The Digest

Trade Tensions Continue to Make Waves

Sea port cargo loading

Trade tensions were the real market driver throughout last week. A US equity drop on Monday set the tone for the rest of the week as neither the United States nor China appeared willing to back down on tariffs.

On Monday last week, China announced it would be raising tariffs to 25% on US$60 billion of US imports in response to the US escalation of tariffs on Chinese goods. China’s tariffs are set to take effect on June 1.

However, there was some respite for equities on Tuesday after the media reported that US President Donald Trump may delay his auto tariff decision by six months.

Tensions intensified through the week, culminating with the Chinese authorities essentially indicating on Friday that their patience was wearing thin.

Chinese officials commented that they saw little “sincerity” in Trump’s recent approach after a high-profile US crackdown on Chinese technology company Huawei. On Thursday, the US Commerce Department had formally placed Huawei Technologies and 68 affiliates in more than two dozen countries on its so-called “Entity List,” a move that bans the telecom company from buying parts and components from American firms without US government approval.

Technology stocks felt the heat in early trading on Monday of this week, with the sector leading Europe lower.

No Respite for Emerging-Market Currencies

Emerging-market currencies continued to feel the feeling the pain from the US/Chinese tensions last week. The yuan was impacted in particular.

Markets had seemed to have priced a deal between the United States and China the previous week. That optimism proved premature, but there was also a sense that the Chinese authorities had stimulus in their pocket should a deal not happen.

However, on Friday, for the first time, Chinese equities completely ignored a Chinese government reminder that it stood ready to act. Shanghai-listed stocks failed to stage any recovery after the attempted reassurance and closed the day down 2.5%. It wasn’t only equities that ignored the promise of a helping hand from China either: the country’s central bank, People’s Bank of China (PBOC), announced on Friday that it stood ready to defend the yuan, but the currency hardly flinched.

On Wednesday of last week, stimulus hopes had underpinned a rally in Chinese equities after some poor economic data (April retail sales were their lowest in 16 years). The lack of market response after Friday’s attempt at reassurance implies to us a serious deterioration in sentiment. Clearly, this theme will likely continue to drive markets this week.

Brexit and European Parliamentary Elections

Away from trade, concerns over an elusive Brexit deal and polling worries ramped up ahead of European Parliamentary elections this Thursday.

The latest on Brexit

Cross-party UK parliamentary talks on a Brexit deal continued for much of last week but ended on Friday with no resolution.

EU flag

A deadlock in the UK Parliament looks set to drag things out further, with any deal unlikely to make it through. Prime Minister Theresa May’s Withdrawal Agreement Implementation Bill (WAIB) will be brought to the House with a vote for the further time: likely on the week of the June 3. Should this be defeated, May has finally confirmed that she will give a date for her exit as leader.

A UK General Election on the Cards?

While the risk of a no-deal Brexit has fallen, the likelihood of a snap general election has increased.

A general election piles domestic policy risks on top of those associated directly with Brexit. In particular, a Labour government is seen as a market negative given the party’s left-leaning policies and the potential for the nationalisation of public services.

In addition, the possibility of a coalition between Labour and the Scottish National Party (SNP) raises doubts of the integrity of the United Kingdom, with the potential for another Scottish independence referendum.

Over the weekend, it was reported that the Scottish National Party plans to unveil a timeline for a second independence referendum bill immediately following this week’s European elections.

With this backdrop of concerns, sterling suffered its worst week in a year last week and completed a record 10-day decline versus the euro. In turn, the UK exporters dramatically outperformed the more domestically exposed names.

We can expect a wealth of European political headlines into and following Thursday’s European elections, and see sterling the key asset to watch as a barometer for sentiment.

Last Week

Europe

European markets started last week lower, but showed resilience later in the week despite continued trade headlines and concerns over the upcoming European elections. Oil and gas names led the way higher, with strength in underlying commodity prices lending a boost.

Meanwhile, European banks suffered, with noise from Italy weighing on sentiment. Italian equities in general underperformed broader markets.

Italy’s Deputy Prime Minister Matteo Salvini escalated his government’s conflict with the European Commission (EC) over Italy’s budget deficit throughout last week. He made it clear that he was willing to break the EC’s fiscal rules by allowing the Italian deficit to run above 3% of gross domestic product (GDP) in 2020. Coming into the elections, it will be interesting to watch the headlines this week.

European auto stocks saw a boost on Tuesday from speculation on the delay of US tariffs, but nonetheless ended the week lower.

Americas

Last week proved volatile for US equities as the newsflow around trade tensions primarily drove investor sentiment. Monday saw a sharp move lower as President Trump took a tough line with China.

Defensive utilities stocks outperformed, whereas financials were the laggards.

Other geopolitical factors also played their part in the volatility, as rising tensions in the Middle East saw the price of crude oil rise on the week. The Trump administration’s continued confrontation with Iran was the main focus; the United States withdrew non-essential staff from Iraq.

US macro data didn’t offer enough clarity to drive sentiment, as the data points were mixed. Retail sales and manufacturing production both missed expectations. On the flip side, the May Philadelphia/Empire indices, Michigan confidence survey, and National Association of Home Builders (NAHB) housing report were better than expected.

Asia

Trade tensions drove markets in the Asia Pacific region last week too, and Asian equities continued to face selling pressure.

Look Out For... (May 20-27):

Monday, May 20

  • Holiday in Canada and Singapore
  • US Federal Reserve Chair Jerome Powell Speaks at the Federal Reserve Bank of Atlanta Financial Markets Conference Link
  • Japan First-Quarter Gross Domestic Product Link
  • Japan April Industrial Production Link

Tuesday, May 21

  • Reserve Bank of Australia Publishes Monetary Policy Meeting Minutes Link
  • UK Inflation Report Link

Wednesday, May 22

  • US Federal Reserve Publishes Monetary Policy Meeting Minutes Link
  • Japan April Trade Balance Link
  • UK April Consumer Price Index Link
  • UK April Producer Price Index Link

Thursday, May 23

  • Indian Election Results
  • European Parliament Elections Held in the UK and the Netherlands—Other Countries Voting Over the Next Few Days
  • German First-Quarter GDP Link
  • European Central Bank Publishes Monetary Policy Meeting Minutes Link
  • ECB Financial Stability Review Link

Friday, May 24

  • Japan April CPI Link

Monday, May 27

  • Holiday in the UK and US

The trade-weighted yen strengthened as risk-off sentiment dominated. Losses in Japanese equities were more muted, while mainland China and Hong Kong markets both underperformed.

Australian equities proved to be a bright spot ahead of elections in the country, with underlying commodity strength helping drive gains last week.

There were elections in both Australia and India over the weekend, with both results looking market-friendly.

The Australian dollar rallied in early trading on Monday after the ruling centre-right Liberal Party won what has been dubbed a “miracle” win. The Liberal-National coalition remained in power, despite the opposition Labor party leading opinion polls in the past couple of years.

In India, exit polls are pointing to a win for the ruling Bharatiya Janata Party-led coalition. The final result will not be known until later this week but on Monday (May 20, 2019), Indian equities recorded their strongest rally in more than three years. The rupee also strengthened versus the US dollar after a period of underperformance amid rising oil prices.

Week Ahead

Macro Data

  • Tuesday: Eurozone Consumer Confidence; US Existing Home Sales.
  • Wednesday: Japanese Machine Orders, UK consumer price index (CPI), US Fed Minutes.
  • Thursday: Eurozone, Germany, France, Japan and the United States all release May Manufacturing and Services purchasing manager index (PMI) data.
  • Friday: US Durable Goods and UK Retail Sales. Japanese CPI.

Politics

Geopolitics will remain centre stage this week with trade talks, tension in the Middle East and European elections in the mix.

  • The narrative around US/China trade talks will no doubt continue drive markets. No talks are scheduled for this week.
  • European Parliamentary elections will be closely watched on Thursday. Equity market reaction on Friday will be a focus.
  • Tensions between the United States and Iran show no sign of cooling down, so commodities and energy names will likely be barometers for sentiment.

Central banks

  • The most notable fiscal data point this week is likely to be the release of the US Fed’s meeting minutes on Wednesday afternoon.
  • Fed speakers: There are due to be multiple speakers through the week, including chairman Jerome Powell, Patrick Harker and Charles Evans.
  • ECB President Mario Draghi and Chief Economist Peter Praet are talking on Wed.
  • ECB Minutes of April Monetary Policy Meeting.

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