Notes From the Trading Desk – EuropeOct 29, 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 the Trading Desk – Europe

It was a torrid week for global equity markets as some weak corporate earnings on both sides of the Atlantic unsettled investors. In addition, there was also a focus on global central banks’ paths to monetary policy normalisation and the removal of quantitative easing programmes, which have been a support for equity markets over the past 10 years. Against this backdrop, investor confidence was brittle at best and we saw sharp falls in markets in the United States, Europe and Asia.

The Digest

Markets Slump As Earnings Concerns Add To Existing Headwinds

Markets Slump As Earnings Concerns Add To Existing Headwinds

Last week’s equity market declines caught some investors off guard. No single “smoking gun” seemed apparent as the cause of the volatility. However, it’s important to remember that equity investors’ nerves were already frayed after US Federal Reserve (Fed) Chair Jerome Powell hinted earlier in the month that Fed policy was a long way from normalised. Those comments had caused US Treasury yields to widen.

In addition, a number of situations rumbling on behind the scenes are adding to a sense of uncertainty. These include the US/China trade spat, Brexit, concern over the Italian Budget and the global reaction to developments in Saudi Arabia.

Against that background, warning signs from some corporate heavyweights last week gave investors, already looking for an excuse, further impetus to take profits.

There was selling pressure across the board in equity markets. US markets underperformed European equities, giving back some of the outperformance so far this year.

The S&P 500 and Nasdaq Composite Indexes both moved into official correction territory, with a decline of 10% from recent highs, and gave up all gains for the year. The Eurostoxx 600 Index continued its miserable run of a fourth weekly decline out of the last five.

Earnings In Focus Last Week

Undoubtedly, weaker corporate earnings spooked investors last week. High-profile US tech stocks in particular posted disappointing numbers. Some tech companies did report positive earnings growth and sales, but these tended to be overlooked as the market focused on negative news.

We have often discussed the crowded positioning in the US tech sector, and selling pressure is extreme when prices move lower.

Concerns Over Monetary Policy Tightening:

Unsurprisingly, the Italian budget continued to dominate headlines last week, causing Italian equities to underperform broader markets. On Thursday, the Italy-Germany 10-year bond yield spread widened to its highest level since 2013. This rippled through peripheral bond markets on Friday.

Italy’s government approved a budget proposing a 2.4% deficit, which is three times higher than EU guidelines.

Amid last week’s equity market volatility, there was much debate about central banks’ monetary policy tightening trajectory and concern that the days of ample liquidity are drawing to a close.

Concerns Over Monetary Policy Tightening

We feel that one consequence of this reduction of liquidity could be a return to focusing on fundamentals, rather than a situation where all markets are lifted on the rising tide of cheap central bank liquidity.

Although this change in central bank policy should not be a surprise for anyone, it will likely prove to be a talking point as we start to see its impact on markets.

The US Fed shows no sign of changing its path of tightening. Last week US President Donald Trump said he “maybe regrets” nominating Fed Chair Powell. Trump added the Fed presented the “biggest risk” to markets.

Trump’s rhetoric didn’t seem to phase Fed speakers last week. Raphael Bostic, CEO of the Federal Reserve Bank of Atlanta, Robert Steven Kaplan, president and CEO of the Federal Reserve Bank of Dallas and Loretta Mester , CEO of the Federal Reserve Bank of Cleveland all reiterated their commitment to current rate-rising cycle.

Mester said the market move this month didn’t cause her to change her view that the US economy is “strong”. Robust US third-quarter gross domestic product (GDP) figures that came out on Friday would appear to support that.

In Europe, the European Central Bank (ECB) kept policy unchanged last week. It appears committed to concluding its asset-purchasing programme at the end of the year. That offers another reminder to markets that the days of ample central-bank-provided liquidity may be drawing to a close.

Looking Ahead…

It’s month-end this week, so we’d expect to see some positioning around that impacting markets. In addition, there is a further glut of earnings this week, including more prominent tech names that could drive market sentiment. The October US employment figures are due out on Friday.

As we progress through earnings, companies can come out of black-out periods and restart their corporate buybacks, which might lend some support to US equities in particular.

On November 6, voters in the United States go to the polls for mid-term elections. We’ll be looking out for any market volatility that may bring.

The upcoming G20 meeting between Chinese President Xi Yinping and President Trump could give equity markets a potential catalyst as well.

In Europe, we think Italian budget concerns and the Brexit negotiations could drive investor sentiment into the year-end alongside questions about the impact of the ECB’s asset-purchasing decision.

Last Week


European equity markets traded down last week. Focus was unsurprisingly on third-quarter corporate earnings.

The defensive sector rotation which we had seen in preceding weeks continued with only one sector—Personal and Household Goods—finishing higher on the week. The Technology sector was unsurprisingly the week’s laggard.

The head-to-head between the European Union (EU) and the Italian government over the latest Italian budget dominated newsflow at the start of last week in Europe.

Italy’s 2019 budget plan aimed to lift the domestic deficit to 2.4% next year from 1.8% in 2018. The EU had claimed such a move would be in direct breach of its fiscal rules.

On Tuesday, the EU formally rejected the draft budget and gave the Italian government three weeks to resubmit. This marked the first time a country’s budget has been rejected.

Italy’s Deputy Prime Minister Matteo Salvini initially claimed his government would not change the budget, stating: “Italians come first”.  The government’s other Deputy Prime Minister, Luigi di Maio, supported this stance on Thursday, saying Italy would not alter its 2019 budget deficit target.

European Economic Affairs Commissioner Pierre Moscovici said he was open to a constructive dialogue with Italy over its budget plans.

In Germany over the weekend, there were further weak regional election results for Chancellor Angela Merkel. Merkel and her governing party allies lost significant support in a state election, while the Greens’ share of the vote doubled.

Merkel’s centre-right CDU party and the centre-left SPD were each 10% down on the previous election in Hesse state.

SPD leader Andrea Nahles said the federal government’s poor performance had “significantly” contributed to the disappointing result.

Look Out For... (October 29 - November 5):

Monday, October 29

  • UK Autumn Budget Link

Tuesday, October 30

  • French Third-Quarter Gross Domestic Product Link
  • Eurozone Third-Quarter GDP Link
  • Spanish October Consumer Price Index Link
  • German October CPI Link
  • German October Unemployment Rate Link

Wednesday, October 31

  • Australia September CPI Link
  • French October CPI Link
  • Italian October CPI Link
  • Eurozone October CPI Link
  • Eurozone September Unemployment Rate Link
  • Spanish Third-Quarter GDP Link
  • Canadian August GDP Link
  • China October Manufacturing Purchasing Managers’ Index Link
  • Bank of Japan Interest Rate Decision Link

Thursday, November 1

  • Bank of England Interest Rate Decision Link
  • Australia Third-Quarter Trade Balance Link
  • US Third-Quarter Non-Farm Productivity Link

Friday, November 2

  • Holiday in Brazil and Sweden
  • US October Employment Report Link
  • Canada October Unemployment Rate Link
  • Australia Third-Quarter Producer Price Index Link

Monday, November 5

  • Japan September Household Spending Link

The far-right AfD will enter the regional assembly for the first time, having secured about 12% of the vote. This development comes two weeks after a poor showing from Merkel and her allies in the Bavarian elections where they lost significant support.

In UK politics, Prime Minister Theresa May was under increased pressure as the Brexit saga rumbled on without any significant progress.

May’s Cabinet met on Tuesday, but cancelled a follow-up meeting planned for Thursday after a row. Due to the extent of the divisions and the lack of support for May’s Brexit plan, many people expressed doubt that it could get through Parliament. As a result, “no-deal” preparations have been ramped up in the United Kingdom and across the EU. The lack of progress weighed on the pound for the majority of the week.

Finally, in terms of economic data, that slowdown in euro-area growth was compounded, with eurozone October flash manufacturing purchasing managers index (PMI) data at 26-month low, while services PMI hit a 24-month low. There is an export-led slowdown as expectations of future growth are at the lowest level in nearly four years.


US stock markets also finished broadly lower last week with the focus again primarily on third-quarter earnings. Markets were optimistic going into the latest earnings season, hoping that positive corporate releases would negate the effects of a list of global geopolitical concerns. However, those third-quarter reports have not been strong enough, it would seem.

Investor attention seemed to have moved temporarily away from US-China trade war rhetoric. However a report at the start of the week suggested President Trump saw the confrontation with China as being the “beginning of the beginning.”

It was also reported in US media that China was struggling to make progress on a trade deal, while the United States was also becoming frustrated at the length of time it was taking China to propose progressive trade policies, mainly focused around technology.

On Wednesday, the US Fed released its Beige Book which showed the economy growing at a modest-to-moderate pace. The release made reference to the tighter labour markets, higher input costs and business uncertainty caused by macroeconomic concerns.

Manufacturers reported higher costs for raw materials and shipping, causing them to raise prices for finished goods. Employment expanded and overall wage growth expanded modestly to moderately across the United States.


Equities in Asia closed down last week as weak corporate earnings and seemingly ever-present geopolitical risks caused investors to move into traditional safe-havens.

Japanese equities posted their largest weekly loss in more than eight months and a fourth straight week of losses as concerns grow over corporate earnings. Meanwhile the yen strengthened further, supported by the global risk-off sentiment.

At the start of the week, Chinese equities surged, after President Xi vowed “unwavering” support for the private sector. In addition, a central bank advisor hinted at another round of tax reductions after stating that tax cuts could exceed the equivalent of 1% of GDP.

Shinzo Abe became the first Japanese prime minister to pay an official visit to China since 2011 as the two countries sought to make improvements in their often-precarious relationship.

While China remains mired in a trade war with the United States, both Japan and China reiterated their support for free trade and called for a 16-nation regional Asia-Pacific trade deal to be concluded.

The two nations signed 50 cooperation agreements, including having their central banks sign a three-year credit swap agreement, allowing for the exchange of $30 billion worth of each others’ domestic currencies.

Economic data was quiet but looked mostly better this week. Japanese October Flash Manufacturing PMI was the highest since April 2018 as a pickup was registered in most components. New export orders made a welcome return to expansion territory for the first time since May despite several respondents highlighting problems arising from global trade tensions.

Week Ahead


  • US midterm elections loom large on November 6.

Economic Data

  • GDP data for the Eurozone, France and Italy are due out on Tuesday.
  • Japanese Industrial production data is due on Wednesday
  • US monthly payroll data is due on Friday.

Monetary Policy

  • A Bank of Japan (BoJ) rate decision is due on Wednesday. Markets are pricing in a 5% chance of a rate rise.
  • Bank of England interest rate decision is due on Thursday. Markets are pricing in a 2% chance of a rate rise.

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This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of October 22, 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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