Notes From the Trading Desk – EuropeOct 15, 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.


A number of negative catalysts combined last week to trigger a broad selloff across markets globally. European equities closed the week down, with all sectors affected. US equities markets suffered the biggest weekly decline since late March. In Asia, Chinese equities also suffered, weighing on the region as a whole.

The Digest

Several Catalysts Drive Market Pullback

Last week proved to be a difficult week for many asset classes, with a number of catalysts contributing to a slump across markets on Wednesday. Rising US Treasury yields set the scene for the mid-week selloff, but didn’t account for the full scale of it. Concerns about growth slowdown, trade tensions, and the pace of interest rate rises also played their part.

In the United States, the technology sector led the selloff in equities, but there were also signs of investors short-selling CBOE Volatility Index (VIX Index)1 futures. The same behaviour had exacerbated stock market volatility back in February this year.

In addition, the geopolitical climate also continues to weigh on global stock markets, with political concerns about Brexit, Italy and now Germany dominating headlines.

China’s Market Reopens Lower After Golden Week

Shanghai China highway

China’s equity market reopened last week following a week’s holiday for Golden Week, but it was not a pretty start to proceedings. The Shanghai Composite fell more than 10% between Monday and Thursday.

In a clear indicator of sentiment, two large chemical manufacturers issued profit warnings last week, citing concerns over a slowdown in China and trade war tensions.

On Tuesday, we saw another stark reminder of how precarious China’s position is. The International Monetary Fund (IMF) warned Chinese output could fall 1.6% next year should tensions with the United States continue.

It wasn’t just China in the IMF sights. The fund also downgraded its world outlook for the first time since July 2016, citing escalating trade tensions and stresses in emerging markets.

On Tuesday, IMF Chief Economist Maurice Obstfeld told reporters in Bali: “Not only have some downside risks we identified in the last World Economic Outlook been realised, the likelihood of further negative shocks to our growth forecast has risen.”

The US and Europe Follow Suit

On Wednesday, the S&P 500 Index experienced its biggest one-day drop since February, and Europe’s STOXX 600 followed suit on Thursday.

The move lower in Europe did feel a little more orderly than the United States and Asia. With many investors already underweight European equities, the selloff appeared less aggressive to us.

green traffic light wall street

In Europe, some of the more defensive names were buoyed by a risk-off tone, while the diversified financials, technology, and basic resources sectors suffered. The oil and gas sector was Thursday’s biggest underperformer as we saw profit taking following the sector’s impressive run in recent weeks.

Growth concerns weighed on the industrials sector, and financial services struggled as a result of the flatter yield curve and earnings in the space.

On the other hand, the week’s clear outperformers in Europe were telcommunications, retail and real estate names, which are considered defensive sectors.

It was a similar story in the United States, with the utilities, consumer staples and real estate sectors the relative winners. These sectors were still in the red, but losses were more muted.

Brexit Summit Approaches

UK EU flags arrows brexit

Headlines were relatively upbeat on Brexit throughout the first half of the week, and the pound reacted accordingly, trading higher. However, as another week passed without anything concrete, the currency lost some of its strength.

Over the weekend, Brexit talks reached a dramatic standoff. Theresa May warned on Sunday night that a draft treaty to take Britain out of the European Union was a “non-starter”.

All further talks were suspended until Wednesday of this week, when May will travel to Brussels for a Brexit summit with other EU leaders.

A breakthrough is looking more unlikely as the days progress, with the EU said to be intensifying its contingency work for a no-deal scenario.

Germany Cuts Growth Expectations

Amid all the other noise last week, one important data point seemed to go unnoticed: Germany cut its growth expectations. It is now forecasting gross domestic product growth for 2018 of 1.8%, versus 2.3% previously, citing “international trade conflicts” and “protectionist tendencies”.

That’s a significant cut of more than 20%. More importantly, if the European powerhouse is feeling the pinch, then we can expect a similar story Europe-wide. We’ll be keeping an eye on how this story develops.

Germany flag

In addition to this, there was disappointing news on the political front for German Chancellor Angela Merkel after her coalition allies performed poorly in an election in Bavaria.

The Christian Social Union (CSU) lost its absolute majority in the region and the Social Democrats shed half its support to place fifth. Merkel’s position looks more and more precarious and this is something we will be sure to keep an eye on.

Last Week


There was a somewhat hawkish tone from the European Central Bank (ECB) last week. Governing Council Member Klaas Knot said officials may consider speeding up monetary policy normalisation if the economy evolved as expected.

In addition, ECB President Mario Draghi said that uncertainty around the inflation outlook is receding. With this, the euro gained 0.3% on the week versus the US dollar.

As well as a growth cut, Germany also saw industrial production decline for the third month in a row. French industrial production also slowed. Eurozone investor confidence fell more than expected, playing into slowing growth concerns.

UK macro data continued to decline, with the trade deficit worse than expected. Meanwhile, final September inflation readings were in line with previous releases in the case of France and Germany and revised higher for Spain, supporting Draghi’s commentary.


US markets were broadly weaker last week.

The key theme was the rotation out of growth and into value sectors through the week, driven by the rise in US Treasury yields.

Hawkish commentary from US Federal Reserve (US Fed) members the previous week had pushed yields to inflated levels and there was no real change in tone last week.

New York Fed President John Williams said he believed rate hikes would assist in achieving sustained economic expansion and would also reduce risk-taking in financial markets.

Dallas Fed President Robert Kaplan said he was “comfortable” with another three rate rises in the next 12 months or so and that he doesn’t believe “inflation is going to run away from us”.

Meanwhile, US President Donald Trump was once again critical of the Fed, berating the pace of interest-rate rises.


Rising US bond yields as well as a re-escalation in US-China trade war rhetoric contributed to a broad selloff in equities in Asia last week.

In Japan, a stronger yen weighed on equities as some investors looked for so-called “safe havens”.

Last week started with The People’s Bank of China (PBOC) announcing a 1% cut in the reserve requirement ratio (RRR) for most of the country’s banks from October 15. This was substantially higher than the 0.25% cut that recent polls had predicted and represented the fourth RRR cut this year.

Bank rates are now 2.5% lower than they were at the beginning of the year. It’s believed the timing and the extent of the cut is a direct attempt by the PBOC to stabilise financial markets in the face of continued trade tensions.

Strained trade tensions show no sign of fading. US Secretary of State Mike Pompeo visited Beijing at the start of the week and this seemed only to raise tensions even further.

Chinese Foreign Minister Wang Yi said the US government’s recent actions against China had “directly impacted our mutual trust and cast a shadow over our bilateral relations”. He urged the United States to “stop such misguided activities”.

In the United States, the new Committee on Foreign Investment in the US (CFIUS) regulations were put in place requiring all foreign investors in certain deals involving critical US technology to submit to national-security reviews or face steep fines. This is designed to prevent China from capturing technology through buying, investing in, or partnering with US firms.

Chinese macro data was positive. The country posted another record trade surplus with the United States, totalling $34.1 billion in September.

Chinese exports accelerated, while imports fell. It’s believed the strong showing is a result of exporters rushing to deliver before further US tariffs take hold, a falling domestic currency and an increase in shipments to the EU and Japan.

Week Ahead


  • Wednesday sees UK Prime Minister Theresa May attend the Brexit summit between the United Kingdom and 27 other nations.
  • Also on Wednesday, members of the World Trade Organization (WTO) procurement team meet in Geneva to decide if the United Kingdom may re-join the alliance after leaving the EU.

Economic Data

  • European earnings season gets underway this week. The United States kicked off last week, and is now well underway.
  • Europe: Tuesday sees the release of UK labour market data, as well as the German ZEW survey and a final estimate of Italy’s inflation. On Wednesday we get the final readings of inflation data for euro-area and the United Kingdom. On Thursday, we get retail sales data for the United Kingdom.
  • US: On Tuesday, we get industrial production, which is likely to have weakened. Tuesday’s Job Openings and Turnover Survey will put the August payrolls number into context. On Wednesday we get housing starts, which are likely to show the impact of Hurricane Florence, and on Friday we get existing home sales.
  • Asia: We get inflation data from China on Tuesday and trade balance data from Japan on Thursday. Also on Thursday we will see employment data from Australia. On Friday we get inflation data from Japan and September activity data from China, which will be scrutinised for any signs of a slowdown.

Monetary Policy

  • The minutes from the latest Federal Open Market Committee (FOMC) meeting are released on Wednesday.

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This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of October 15, 2018, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton Investments. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security.

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1.The Chicago Board Options Exchange (CBOE) Volatility Index is constructed from the implied volatilities of a wide range of S&P 500 Index options, and shows the market’s expectation of 30-day volatility. It is widely used to measure market risk. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not a guarantee of future performance.