Notes from the Trading Desk – EuropeMar 25, 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 the trading desk europe


Global equities traded lower overall last week after a sharp market selloff on Friday. The perceived dovish attitude of the US Federal Reserve and disappointing macro data releases out of Germany and France drove the late-week move. Defensive sectors outperformed, with utilities, telecommunication firms and consumer staples the relative winners. Banks, insurance companies and autos generally lagged.

The Digest

The Brexit Impasse Spills Into Another Chapter

The United Kingdom’s chaotic exit from the European Union (EU) took another twist last week as the EU granted the United Kingdom a short extension to Article 50.

While this allowed the UK to take a step back from the cliff-edge scenario of a no-deal Brexit on March 29, the EU imposed a number of conditions:

ecb

  • Brexit would be delayed until May 22 if the UK parliament votes through a withdrawal deal this week.
  • Brexit will be delayed until April 12 if the UK parliament does not vote through a withdrawal deal this week. Responsibility would then pass back to the UK government to come up with a way forward.

Over the weekend, UK Prime Minister Theresa May has held talks with some of the more ardent Eurosceptics within her party. However, reports early this week suggested the meeting had failed to secure the support May needs to get her current withdrawal deal through parliament.

Questions over May’s ability to remain as prime minister have resurfaced. However, two of the obvious candidates to succeed her—David Lidington and Michael Gove—have distanced themselves from the position, claiming now was the wrong time to change leader. If May were to be forced out of her position, we believe that would increase the chances of a general election.

Looking at the week ahead, we can expect several debates and votes, potentially including a third meaningful vote on May’s deal. All options will remain open to the UK until April 12, including a no-deal Brexit, the possibility of a further extension, or no Brexit at all.

However, a further extension would need the approval of all 27 EU member states and would mean the United Kingdom would be required to participate in the European elections in late May.

Market Reaction

Last week, the pound rallied in a knee-jerk response to the EU’s decision to push back the Brexit deadline, although this came after two days of weakness following commentary from French President Emmanuel Macron that the UK was set for a “chaotic no-deal” if May’s deal is rejected again.

While the pound was higher, some commentators believe the probability of a no-deal Brexit has now increased, and the probability of May’s deal passing has decreased.

To us it appears Theresa May’s unwillingness to ask for further concessions on the terms of the withdrawal agreement make her “my deal or no deal” stance clear. This is particularly concerning given that the market does not appear to be pricing in a no-deal scenario.

Fed’s Dovish Tone Underpins Friday’s Selloff

US and European markets experienced a strong downturn on Friday amid a dovish Federal Open Market Committee (FOMC) tone, as well as some fairly discouraging macro data out of Germany and France.

Initially, Wednesday’s US Fed announcement was taken well, driving a rally in US equities on Thursday. Fed Chair Jerome Powell said the key objective was to maintain economic expansion. The FOMC detailed a shift in the “dot plot” to no further hikes in 2019 and just one hike in 2020.

Shanghai_China


The Fed also downgraded its economic outlook, dropping projections for US real gross domestic product (GDP) growth from 2.3% to 2.1%.

Despite this, Powell tried to remain positive, stating: “FOMC participants continue to see growth this year around 2%, just a bit below what we saw back in the end of last year. Part of that is seeing that underlying economic fundamentals are still very strong. You have strong labour markets by most measures, you have rising incomes, you’ve got very low unemployment.”

An initial rally post-announcement in US equities was undone on Friday after a dip in US Treasury 10-year yields resulted in the inversion of the three-month/10-year US Treasury yield curve. This happens when long-term rates fall below short-terms ones, causing concerns of a market recession to resurface.

Bond yields were also in focus in Europe as 10-year German government bond (Bund) yields fell 0.11%, pushed lower by weak economic data. Continued Brexit chaos also led UK 10-year Gilt yields to fall 0.20%.

On Friday morning, eurozone composite purchasing manager index (PMI) figures were announced, showing a decline for March. Disappointing releases from France and Germany primarily drove the decline. This set the tone for the rest of the day in Europe on Friday.

With key indicators reaching historic levels and data showing global equities to be so out of favour at present, we think it’ll be interesting to see how markets respond to these pressures this week.

Last Week

Europe

Risk-off sentiment saw European equities trade lower last week. Much of the selloff came on Friday on the back of lacklustre macro data, as headlines remained focused on the Brexit debacle.

The euro lost 1.3% versus the US dollar on the week, with the macro data likely weighing. But it’s interesting to note how range-bound the euro has been since last September amid the ongoing Brexit uncertainty.

Banks and insurers were the underperformers last week, with the drop-off in yields hurting the space alongside some concerns over earnings. Also suffering were chemicals and construction names as macro slowdown concerns weighed. At the other end of the spectrum, the skew was clearly defensive as utilities, telecommunications and food & beverage sectors outperformed and were the only sectors in the green.

Italian equities outperformed last week, but Italian government bonds underperformed. Continued issues over the country’s budget appear to be driving this dynamic, as the League and Five Star movement struggle to reach an agreement on their coalition’s tax cut plans.

The Bank of England (BOE) Monetary Policy Committee voted unanimously to keep interest rates on hold, as expected.

On a positive note, UK growth expectations for the first quarter increased in February. Brexit continues to loom, however, and the central bank’s hands currently seem to be tied. With this, there was little in the way of further forward guidance, other than an acknowledgement that Brexit has the potential to trigger policy moves in either direction.

Americas

US equities markets sold off into the end of last week as banks slumped on the post-Fed Treasury yield moves.

Unsurprisingly, the defensive utilities and consumer staples outperformed as investors looked for yield plays.

Look Out For... (March 25 - April 1):

Monday, March 25

  • Holiday in Greece

Tuesday, March 26

  • French Fourth-Quarter Gross Domestic Product Link
  • US February Housing Starts Link
  • New Zealand February Trade Balance Link

Wednesday, March 27

  • US January Trade Balance Link
  • New Zealand Interest Rate Decision Link

Thursday, March 28

  • Spanish Consumer Price Index Link
  • German March CPI Link
  • US Fourth-Quarter GDP Link

Friday, March 29

  • German March Unemployment Change Link
  • French March CPI Link
  • Italian March CPI Link
  • Japan March CPI Link
  • Spanish Fourth-Quarter GDP Link
  • UK Fourth-Quarter GDP Link
  • Canadian January GDP Link

Sunday, March 31

  • China March Manufacturing Purchasing Managers’ Index Link

Monday, April 1

  • Eurozone March CPI Link


There wasn’t too much new on the all-important US-China trade talks last week. Some press reports suggested China had been pushing back on US demands and an April summit for Presidents Donald Trump and Xi Xinping seems less likely now.

In addition, President Trump said the US expects to keep tariffs on Chinese goods for “a substantial period of time”. This week may bring more material news as senior US officials are in China for further talks.

In macro data developments, the US Composite PMI fell to a 21-month low. We also saw a weaker-than-expected durable goods order print for January.

Asia

Markets in the Asia-Pacific region were closed for the weekend by the time Friday’s market sell-off hit, so they managed to post gains across the board last week.

A rebound in China’s export data for March buoyed equities, which were also helped by further hopes for stimulus measures from Beijing.

Trade-talk rhetoric turned incrementally more negative as US negotiators fear a pushback from China. Treasury Secretary Steven Mnuchin and Chief negotiator Robert Lighthizer will both be in Beijing this week, so we can expect further newsflow.

Continued strength in commodities helped to boost Australian equities, which saw gains, albeit more muted ones.

The yen was stronger as currencies clearly reflected the dampening of risk sentiment.

Despite the strength seen in equities last week in the region, we did also see some signs of a slowdown in growth. Japan’s February exports fell far more than expected, and imports fell sharply.

Export data from Taiwan and South Korea were also weak. Unsurprisingly, given the trade-balance data, Japan’s manufacturing PMI remained in contraction. All of this, coupled with disappointing European and US data, plays into existing concerns around global growth.

Week Ahead

In Europe, the noise around Brexit looks set to dominate once again, with a fresh series of UK parliamentary votes ahead. Aside from that, US-China trade talks are likely to be in focus as Mnuchin and Lighthizer travel to China for further talks.

Politics

  • The Brexit situation will likely dominate in Europe.
  • The US delegation travels to China on Thursday for two days of talks.
  • In Asia, watch for the results of election over the weekend in Thailand.

Monetary Policy

  • There are several Fed speakers talking this week, which will no doubt garner a lot of attention given the dovish Fed statement last week.
  • In Europe, there are some leading members of the European Central Bank (ECB) talking at events this week, including ECB President Mario Draghi.



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