Notes From the Trading Desk – EuropeFeb 26, 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.

notes from trading desk Europe

Hopes that a trade deal between the United States and China could finally be reached underpinned a generally positive performance for global equities last week. Sector moves were mixed, with corporate earnings remaining a driver for now. Basic resources and autos were among the more notable outperformers, with these specific sectors generally well correlated with any trade negotiations headlines of late.

The Digest

Global Trade Negotiation Progress

US capitol

A fresh round of trade talks between the United States and China commenced on Tuesday in Washington, D.C.

Detailed feedback from the meetings through the week was limited, and markets were buoyed by a sense of optimism rather than substantive commentary.

The pinnacle of this round of talks came when President Trump met Chinese Vice Premier Liu He on Friday. Once again, there was no clear feedback from the meeting. However, optimism about the progress rose again with news that Liu is extending his stay in the United States. Liu also commented that a deal was “very likely to happen”.

Over the weekend, President Trump has been tweeting about the talks and mentioned the “very productive talks” on Saturday.

Late on Sunday he tweeted that he was delaying an increase in US tariffs on US$200 billion of Chinese goods. The increase—from 10% to 25%—had been due to come into force on March 1.

Trump also confirmed he was planning a summit with Chinese President Xi Jinping in Florida to finalise an agreement between the two countries.

Chinese equities responded positively to this news in early trading this week. We expect any further details around the potential summit to be a potential driver for markets.

EU negotiations with United States

Last week we also saw headlines on the trade relationship between the United States and Europe. These centred mainly around European autos. On Monday last week, European Commission President Jean-Claude Juncker said: “Donald Trump gave me his word that there won’t be any car tariffs for the time being. I believe him.”

Juncker added that if Trump reneged on his word it would be met with retaliatory measures by the EU. Juncker’s spokesman suggested the Europeans were prepared to apply tariffs on €20 billion of US goods.

The US automotive industry also spoke out against the introduction of tariffs. The president of the American Automotive Policy Council saying it would “undermine—and not help—the economic and employment contributions” the industry makes to the US economy.

Dovish Central Banks

Central banks were in focus last week with equity markets buoyed of late by dovish commentary from both the European Central Bank (ECB) and US Federal Reserve (US Fed).

With the slowdown in the European macro picture in mind, the ECB’s Chief Economist Peter Praet commented that the central bank’s guidance could be changed: should the Eurozone economic slowdown worsen then the bank would be willing to respond by adapting forward guidance, he suggested.

central banks

Earlier this month, the ECB’s Benoit Coeuré indicated the ECB was considering another round of Targeted Longer-term Refinancing Operations (TLTROs) to stimulate lending to the real economy.

Last week Praet commented that TLTROs had been “a very useful tool” and that they would be discussed at March’s meeting of the ECB Governing Council.

Minutes from January’s ECB meeting were released last week. They included this observation: “The technical analyses required to prepare policy options for future liquidity operations needed to proceed swiftly.” We reckon this could be a positive catalyst for the European financials.

US Fed dovishness continued with more explicit language on the likely interest-rate trajectory for this year. Federal Open Market Committee minutes released on Wednesday detailed Fed plans to complete balance sheet normalisation by the end of 2019.

The minutes also committed to keeping reserves at US$1.25 trillion or more, and advised that interest-rate hikes are likely done for the year. More specifically, the minutes noted that the Fed was willing to be patient and that it believed policy was in a good position given current market conditions.

Market reaction to the news around interest rates was fairly muted, as this had been largely expected by investors.

Finally, we also saw dovish commentary from the Bank of Japan Governor Haruhiko Kuroda. He said the bank might be willing to act if yen strength was seen to be negatively impacting inflation as well as the country’s economy.

Brexit Update: A Memorable Week

central banks

It proved to be a memorable week in UK politics. Both Jeremy Corbyn’s Labour Party as well as Prime Minister Theresa May’s Conservatives were hit with resignations. A total of 11 pro-EU members of parliament (MPs) left their respective parties to form a new Independent Group.

The Tory deserters explained their reason for leaving centred on their belief that the party was now under the influence and control of right-wing hardliners.

This heaps more pressure upon Theresa May to seek greater concessions from the EU to stop further MPs leaving her party, and adding weight to the push for a second referendum.

Some observers argue these resignations have reduced the risk of a hard Brexit as the working majority of the Conservative-DUP coalition has been cut from 13 to seven. As it stands, it would take just four more pro-EU Conservative MPs to defect to potentially trigger snap elections. Given that, May is being pushed further than ever to rule out the potential of a “no-deal” Brexit.

Over the weekend, there was confirmation that there will be no meaningful vote in the UK Parliament on the deal this week while negotiations continue in Brussels.

However, we do still expect the UK Parliament to vote this week on amendable motions. The most meaningful of those will be the Cooper-Letwin amendment, which would give parliament a vote on how the government should proceed should no agreeable deal be in place by March 13.

This would offer parliament the chance to debate next steps, such as a second referendum. It’s likely that this amendment will have support from both sides of the house. We also expect to see more substantive commentary in the week ahead around a delay to Brexit. Some reports in the UK press suggest that the EU is discussing a lengthy delay of two years.

This Week

Europe

European markets were mostly higher last week; however, the United Kingdom underperformed other major stock markets in the region.

From a sector perspective, basic resources was the strongest performer, followed closely by autos and construction names. Optimism around trade progress drove the strength in these areas, with basic resources given an additional boost by strength in the underlying metals and a weaker dollar.

On the other hand, last week’s macro data mostly painted a bleak picture. Eurozone consumer confidence came in slightly ahead of estimates, but still at its lowest level since May 2017.

Alongside this, construction output for the region contracted month-on-month in December. New orders data also remained in contraction in January, with manufacturing orders falling at the sharpest rate in almost six years.

The slide in Germany’s Manufacturing Purchasing Managers Index (PMI) was stark, with the figure down almost 25% in the past year, showing no sign of respite for the traditional powerhouse’s economy.

It wasn’t all gloomy, however. Wage growth continued to pick up in Europe. Despite this, break-even inflation rates continue to fall. The lack of impact of the better wage growth on the bond market shows that focus remains on other more dismal data points, as investor concerns over the state of the economy remain elevated.

All of this is important to watch, especially in the context of ECB commentary.

We are now a decent way through earnings season in Europe, with the aggregate growth rate standing at a disappointing 2.97%, down from 8.25% at the end of last week.

Much of this weakness is coming from EU banks, tying in with the ECB’s commentary. The banking sector is unsurprisingly one of the underperformers across Europe year-to-date, with just telecommunications putting in a worse performance.

Americas

A holiday-shortened week saw US equity markets grind higher thanks to familiar themes of dovish Fedspeak and optimism that there will be positive end to US/China trade talks.

In terms of sectors, telecommunications and utilities led the way higher, while food & staples were the clear laggard.

Look Out For... (February 25 - March 4):

Monday, February 25

  • Singapore January Consumer Price Index Link

Tuesday, February 26

  • US Federal Reserve Chair Jerome Powell Delivers Testimony Before the Senate Banking Committee Link
  • UK February Inflation Report Link
  • New Zealand January Trade Balance Link

Wednesday, February 27

  • US Federal Reserve Chair Jerome Powell Delivers Testimony Before the House Financial Services Committee Link
  • US December Factory Orders Link
  • Canada January CPI Link
  • Japan January Industrial Production Link

Thursday, February 28

  • China February Manufacturing Purchasing Managers’ Index Link
  • US Fourth-Quarter GDP Link
  • French Fourth-Quarter Gross Domestic Product Link
  • Sweden Fourth-Quarter GDP Link
  • Spanish February CPI Link
  • Italian February CPI Link
  • German February CPI Link

Friday, March 1

  • Holiday in South Korea
  • German February Unemployment Link
  • Eurozone January Unemployment Link
  • Canada Fourth-Quarter GDP Link

Monday, March 4

  • Holiday in Brazil and India

There wasn’t too much in terms of macro data last week. Of note, PMI data was a mixed bag, the Markit Composite PMI improved from the prior reading. Manufacturing PMI came in below expectations while services PMI was higher. Elsewhere, the February Philadelphia Fed Business Outlook missed expectations, as did durable goods order and January existing home sales.

The price of crude oil continued its strong performance, making year-to-date highs last week as the trade talks progressed.

Asia

Last week saw a strong performance for Asian markets as optimism around the US/China trade talks grew. Chinese equities led the way higher.

Elsewhere, Japanese stocks had a strong week as weakness in the yen helped exporters. Yen weakness was on the back of dovish rhetoric from the Bank of Japan (BOJ), which suggested it could lower interest rates further or buy more assets.

In Australia, the Reserve Bank of Australia (RBA) followed the global central bank trend of dovish rhetoric, as the minutes from the latest RBA meeting highlighted its ongoing concern for the housing market.

Week Ahead

Corporate earnings will remain a focus for the week ahead, but it is a quieter week on the macro data front. Any progress in trade relations will likely impact markets and further Brexit developments will continue to generate headlines.

Economic Data

  • Europe: Germany Consumer Climate and France Consumer Spending data is scheduled on Tuesday, Eurozone M3 Money Supply figures for January and Italy Consumer/Business Confidence results for February are scheduled for Wednesday. Inflation data for the euro area will be in focus on Thursday, and final Manufacturing PMI figures for the euro area are likely to confirm the weaker outlook on Friday.
  • US: Housing Data and Consumer Confidence on Tuesday, fourth-quarter gross domestic product (GDP) on Thursday, and ISM Manufacturing results on Friday.
  • Asia: Japan Industrial Production figures for January and China’s February Manufacturing PMI on Thursday (with both expected to contract in reaction to the trade spat), Japan unemployment and China Caixin Manufacturing PMI on Friday.

Politics

  • President Trump and North Korean Leader Kim Jong Un are expected to meet on Tuesday.
  • Brexit negotiations continue in Brussels, but there will be no meaningful parliamentary vote on the deal this week. Theresa May said over the weekend that she will ensure a vote on the deal happens by March 12 as negotiations continue in Brussels.

Monetary Policy

  • Bank of England Governor Mark Carney and Deputy Governor Dave Ramsden will speak on the central bank’s Inflation Report on Tuesday.
  • Federal Reserve Chairman Jerome Powell is scheduled to address the Senate Banking Committee as part of the semi-annual testimony before Congress. It is a two-day event that starts on Tuesday morning, with observers looking for a continued dovish tilt.
  • We hear from a number of other Fed speakers throughout the week.
  • The Bank of Korea is due to give its interest-rate decision on Thursday.

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