Notes From the Trading Desk – EuropeDec 10, 2018

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 traing desk europe

European equity markets were weaker across the board last week, with Germany’s benchmark stock index hitting bear market territory as economic data continued to disappoint. The picture was not much better in the United States, as the S&P 500 Index moved into negativity territory for the year. Equities in Asia were also mostly lower as investors seemed to favour safe-haven currencies, which strengthened the Japanese yen and hurt Japan-led exports.

The Digest

We saw a number of catalysts for equity markets across the globe last week.

Trade Wars

G20 summit flags

After an early attempt at a rally last week on some positive headlines from the G20 meeting and the United States’ announcement it would postpone an increase in the rate of tariffs payable on Chinese goods, equity markets soon sold off to make new year-to-date lows.

The S&P 500 Index lost 3.25% on Tuesday (December 4) and the Eurostoxx 600 Index followed suit and lost 3% on Thursday (December 6). US National Economic Council Director Larry Kudlow dialled back US President Donald Trump’s claim that there was a deal on auto imports, while Trump said he would maintain tariffs on China if trade tariff negotiations fell through. The arrest of the chief financial officer from a prominent Chinese tech company over potential violations of US sanctions on Iran exacerbated the downward market move, which provoked immediate protest from the Chinese embassy in Canada.

Clearly, some of the equity market moves stemmed from concerns of the potential influence from the arrest. It could reignite tensions between the United States and China, only days after the supposed truce at the G20 meeting.

Yield Curve Inversion and a Potential US Economic Slowdown

Talk about yield curve inversion has gained traction in recent weeks, and could dampen investor sentiment towards the US economy and markets.

The spread between the 2- and 10-year US Treasury—representing the difference in yield between two bonds—moved to the flattest level since June 2007. The 2- and 5-year, and 3- and 5-year spreads inverted for the first time since 2007. The flatter yield curve put US bank stocks under pressure.

federal reserve

Some commentators have expressed concerns about what the flattening yield curve could mean for the future of the US economy—given that this is typically an indicator that investors are worried about the US macroeconomic outlook and the US Federal Reserve’s ability to protect the economy. Investors will likely focus on upcoming data releases, including retail sales and consumer price index, for the latest on the health of the US economy.

The dramatic re-pricing of the yield curve has brought further US interest-rate hikes into question.

In Europe, the German 10-year bond yield fell 8 bps to 0.25%, its lowest level since May. Economic data from the country was once again disappointing, although probably not enough to prevent the European Central Bank (ECB) from ending its quantitative easing (QE) programme as previously announced. The ECB’s interest-rate decision on Thursday will be a focal point for this week, along with the subsequent commentary from ECB President Mario Draghi.

European Politics

The European political landscape remains complicated and uncertain. We continue to watch for headlines on the Italian budget as well as developments in France. Support for French President Emmanuel Macron continues to wane amidst protests and speculations over a vote of no confidence.

Most importantly, UK Prime Minister Theresa May recently called off an all-important vote on the Brexit deal and said if the original vote, scheduled for December 12 were to go ahead, she would have suffered a crushing defeat in parliament. As of this writing, it appears May will head back to Brussels on December 13 to ask for a better deal.

Trump has also been uncharacteristically quiet on Twitter following the death of President George H. W. Bush, meaning we have less insight into his thinking than we might usually have. Only time will tell what happens here, but the headlines are being taken well by markets so far, with a strong rally in China in early trading on Monday this week setting the tone for European markets.

Last Week

Crude Oil

It was a busy week for headlines around oil as members of the Organization of the Petroleum Exporting Countries (OPEC) met in Vienna on December 6, with the focus on the potential for a production cut. As US supply shows no signs of dropping off and concerns grow over global growth, oil prices have come off significantly since the start of October, down about 30%.

US President Trump celebrated the decline in oil prices before OPEC confirmed an overall cut on December 7, which led to a price spike. Of course, with the steep decline in recent months and with Trump making his opinion on the matter clear, how oil prices react in the short-medium term is something to keep an eye on.

Europe

Last week was a drab one for European equity markets, as concerns over the US-China trade war’s negative impact on global growth continues to spook investors. The uncertainty over this and the Italian budget negotiations weighed on sentiment. It was no surprise to see the defensive stocks generally outperform as equity markets went into “risk-off” mode.

Italian Prime Minister Giuseppe Conte will lead negotiations with European Commission President Jean-Claude Juncker on December 12. We shall see whether Italian Deputies Matteo Salvini and Luigi Di Maio amend the spending plans lower, potentially diluting election pledges in the process.

In France, the fourth week of anti-government protests and violence by the “Gilets Jaunes”, the yellow vests movement, continued despite the government rowing back on unpopular fuel tariffs. In response to the protests, the French central bank slashed fourth-quarter growth estimates from 0.4% to 0.2%.

Look Out For... (December 10-17):

Monday, December 3

  • Japan Third-Quarter Gross Domestic Product Link
  • German October Trade Balance Link
  • UK Third-Quarter GDP Link
  • UK October Manufacturing Production Link
  • UK October Trade Balance Link
  • US October Job Openings and Labor Turnover Survey Link

Tuesday, December 11

  • UK December Labour Market Statistics Link
  • French Third-Quarter Nonfarm Payrolls Link
  • US November Producer Price Index Link

Wednesday, December 12

  • Eurozone October Industrial Production Link
  • Organization of the Petroleum Exporting Countries (OPEC) Monthly Market Report Published Link
  • US November Consumer Price Index Link

Thursday, December 13

  • German November CPI Link
  • French November CPI Link
  • ECB Monetary Policy Meeting Link
  • US November Import and Export Price Indexes Link

Friday, December 14

  • China November Fixed Asset Investment Link
  • China November Industrial Production Link
  • US November Industrial Production Link

Monday, December 17

  • Eurozone November CPI Link
  • Eurozone October Trade Balance Link

In Germany, an ally of Angela Merkel, Annegret Kramp-Karrenbauer, was elected leader of Germany’s Christian Democrats (CDU). This should likely help a smoother transition of power given she was Merkel’s favoured candidate to succeed her as party leader.

A lot of European macro data was published last week, including mixed European manufacturing purchasing managers’ indexes and the third-quarter eurozone gross domestic product reading, which stood at 0.2%, in line with expectations.

Americas

US equities came under pressure last week as optimism over a potential truce with China waned as the week went on. It was a four-day trading week as US markets closed on Wednesday (December 5) for the funeral services of former US president George H.W Bush.

In terms of Fed-speak, it was a mixed picture. Fed Chair Jerome Powell highlighted the strong US economy and labor market after previously stating the Fed’s benchmark rate was “just below” neutral. New York Fed President John Williams made slightly more hawkish comments. Meanwhile, Dallas Fed President Robert Kaplan said he would encourage patience next year amidst slowing growth and muted inflation, while Fed Governor Lael Brainard said gradual rate hikes would remain the best course in the near term. Clearly, there is still some difference of opinion on the pace of any rate rises next year.

In terms of macroeconomic data, November nonfarm payrolls rose by 155,000, below consensus estimates of 195,000. Hourly earnings were up 0.2%, but also below what forecasters had been anticipating. Overall, wage growth was unchanged while the unemployment rate was constant.

Asia

In Asia, Japanese equities lost some ground as demand for the Japanese yen weighed on exporter-oriented companies. China’s market was mixed, while Australia was the bright spot, boosted by a rally in mining and energy stocks on the initial news from the G20 meeting.

We also saw some comments from central banks in Asia. The Reserve Bank of Australia kept interest rates on hold, while the People’s Bank of China Governor Yi Gang commented that Chinese monetary should be flexible. Bank of Japan Governor and Deputy Governor Haruhiko Kuroda and Masayoshi Amamiya confirmed that the central bank would continue to deliver large stimulus in an effort to achieve the 2% inflation target.

Week Ahead

Politics

  • UK Prime Minister Theresa May has called off the all-important vote on her Brexit deal to travel to Brussels for talks with EU leaders to ask for better terms on her Brexit deal on Thursday (December 13)—the most controversial part being the plan for the Irish border. We’ll be watching for the subsequent market impact this will have on sterling.
  • Trade-spat headlines will remain in focus. The World Trade Organization will meet in Geneva on December 12 so we will also be watching for any news therein.

Economic Data

  • Europe: UK GDP and eurozone industrial production
  • United States: Job openings and labor turnover survey, producer price index, consumer price index, import prices and industrial production.
  • Asia: China aggregate financing data and Japan producer price index.

Monetary Policy

  • The ECB will meet on December 13 for its monetary policy meeting. We expect the ECB to announce an end to QE, but there will likely be a cautious tone. We’ll keep an eye out for ECB President Mario Draghi’s post-meeting speech for more insight.

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