Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what their 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.
Global equities closed last week higher overall, with dovish central bank announcements aiding sentiment. The S&P 500 Index closed the week up 2.0%, the European Stoxx 600 Index was up 1.7%, whilst the MSCI Asia Pacific lagged, up 0.7%. A dovish tone from several central banks helped support equity markets, alongside positive news on a Pfizer COVID-19 treatment. Earnings season continues to be supportive, with more companies beating than missing on earnings metrics.
Central Banks Take Dovish Path for Now
Last week, investors awaited announcements from the Reserve Bank of Australia (RBA), the Federal Reserve (Fed) and the Bank of England (BoE). Expectations were for a more hawkish outcome than we actually saw in the end. The European Central Bank (ECB) also doubled down on its dovish commentary from the previous week.
Fed: Wednesday’s Fed meeting saw Chair Jerome Powell confirm the tapering down of its US$120 billion a month asset purchasing programme at a pace of US$15 billion a month (US$10 billion US Treasuries/US $5 billion mortgage-backed securities). After months of careful choreography by the Fed, this news was in line with expectations. The quantitative easing programme (QE) will thus end with a final taper in mid-June 2022. Note, the Fed said it is “prepared to adjust the pace of purchases if warranted” but the market view is it would be unlikely to adjust the pace.
There were no hawkish surprises regarding the likely path of interest rates. The policy meeting statement softened the transitory inflation language to reflect heightened uncertainty, but the Fed still expects supply-chain pressures from the pandemic and reopening to ease and inflation to moderate. Powell reiterated the distinction between tapering and tightening. He also stated the Fed can be patient on labour market recovery but acknowledged maximum employment could be reached by mid-2022.
Despite the Fed’s comments that inflation will moderate, the markets’ measures of inflation (inflation breakevens) are near their highest in 15 years, and the market is currently pricing in two 25 basis point (bps) rate hikes by the end of 2022.
BoE: The markets had priced a 60% chance of a small increase in interest rates out of Thursday’s policy meeting, but in the end, the BoE held firm and returned a dovish result, voting 7-2 to keep rates on hold at 10 bps. BoE Governor Bailey said the BOE wanted to gather more information about the effects on the labour market of the recent end to the furlough scheme.
Regarding the market’s surprise at the result, Bailey commented to media that market pricing was “overdone”. QE was unchanged as expected. So, with the odds of two quick rate hikes now nil, consensus has now moved to February for a 15 bps hike, although many highlight that December cannot be off the table. Regarding future rates, Bailey said: “Let me assure you, we won’t bottle it,” and the BOE “will have to act” to curb inflation, which some forecasters see hitting 5% by April.
In terms of the market impact, UK yields initially experienced their biggest drop since the European Union (EU) referendum vote in 2016. The British pound declined sharply too (seeing its worst weekly performance since August) and the UK banks vs. UK housebuilders spread (which had rallied about 20%-25% since the hawkish commentary in September) reversed about 5% on the day. Bank stocks sold off sharply on the announcement, but they recovered pretty much all that ground on Friday thanks to some decent bank earnings, along with Pfizer news and the bullish US employment report.
Market pricing of implied policy is for UK interest rates at 0.34% in three months’ time, 0.62% in six months and 0.92% in 12 months. That compares with the implied policy as of two days ago of 0.50% in three months, 0.80% in six months, and 1.20% in 12 months, showing a material drop off in forward rate expectations post-BoE meeting.
Further central bank commentary: We also had the RBA abandon bond yield curve control, as it said it was put in place before the pandemic and now is no longer needed. However, the RBA left rates on hold, sending a dovish signal to the market. In addition, we had ECB President Christine Lagarde continue the dovish rhetoric, saying that she does not see a rate hike in 2022 (vs. the market pricing in ~23 bps of hikes by December 2022).
It was not all dovish action from central banks, with the Czech central bank lifting interest rates by 125 bps to 2%, as it aims to return price growth to a 2% target in 12-18 months and anchor inflation expectations.
The overall dovishness saw pressure on global bond yields, with yields on US Treasuries, British Gilts and German Bunds all falling. This could further galvanise the “TINA” (there is no alternative) argument to equities for those seeking yield.
Week in Review
European equities traded higher overall and made fresh all-time highs last week, helped by dovish central bank meetings and positive COVID-19 news flow. The Stoxx 600 Index closed the week up 1.7%. In terms of specific country indexes, the UK FTSE and the Spanish IBEX continue to underperform, up 0.9% and 0.8% respectively last week. The year-to-date winners continued their strength, with the Italian FTSE MIB up 3.4% and the French CAC 40 Index up 3.1%. As discussed, focus for most of the week was on the central bank announcements coming from the Fed and the BoE.
It was an interesting end to the week for the reopening trade. Pfizer announced that its COVID-19 pill reduced hospitalisations and deaths in high-risk patients by 89%, a result that has the potential to upend how the disease caused by the coronavirus is treated and alter the course of the pandemic. The Goldman Sachs Going Out basket closed last week up 5.6%. Airlines, banks and autos all rallied on the news. Notably, European airlines saw a big intraday swing.
In terms of sectors, technology outperformed in Europe, closing the week higher. As noted, central banks were less hawkish than feared, which brought government bond yields lower—good news for tech stocks. The Industrials were also strong, as were the autos, both up on the week. Basic resources struggled last week, down 2.8%. Steel prices in China have come down further, reaching their lowest levels since March 2021. Energy stocks were also weak, driven by weakness in the wind space.
Now more than halfway through the corporate earnings calendar, it has been a good earnings season, with more companies beating than missing on many metrics. So far, financials have been the winning sector, with telecoms losing. We expect 94 companies of the Stoxx 600 Index to report earnings this week.
Finally, it is worth keeping one eye on rising COVID-19 cases in Europe; for example, Germany has seen new cases surge in recent weeks.
US equities marched on to fresh all-time highs last week as the Fed stuck to its recent messaging and we had positive COVID-19 drug news from Pfizer. In addition, sentiment was helped by more the robust consumer and corporate demand backdrop highlighted in third-quarter earnings. The S&P 500 Index ended the week up 2%, hitting new record highs for seven straight days. and the S&P 500 Index has gained 16 out of the past 18 sessions—the last time that occurred was 2017, and before that May 1990. The Russell 2000 small cap index put in an impressive performance too, gaining 6% last week.
Looking at sector performance, consumer discretionary and technology stocks were leaders, while the defensive pharmaceuticals were lower, along with banks (tightening bond yields). Markets reacted well to the Pfizer COVID-19 pill, with the US “Go Outside” basket surging.
On Friday, the US House of Representatives approved a US$1.2 trillion Infrastructure bill, which would increase total spending US$550 billion on public works, new climate resilience initiatives and improve high-speed internet access. Meanwhile, it is expected they will vote on the larger “Build Back Better Act” on the week of 15 November.
Macro data last week was encouraging. The US October employment data offered support to the markets, with nonfarm payrolls up a better-than-expected 531,000, putting full employment on track to be achieved ~mid-2022. In addition, ISM data also beat expectations, with the manufacturing reading at 60.8 and services at 66.7.
Finally, a word of caution. With markets at all-time highs, it is worth noting the CNN Fear & Greed Index is comfortably in “Extreme Greed” territory, suggesting sentiment/markets don’t stay at such highly positive levels for long as we tend to see a pull back from extreme ratings.
Asian equities were more mixed last week, with the MSCI Asia Pacific Index gaining 0.7%. Hong Kong’s equity market lagged, recording seven consecutive down days, stabilising briefly on Thursday. Once again, it was technology names leading the way lower amid China’s demand for security review before overseas data use. The Shanghai Index was also lower as China’s COVID-19 outbreak continues to prove a headwind for investors. In addition, Chinese autos were weak after Great Wall Motors reported weak third-quarter earnings results and Chinese steel names traded sharply lower amid a drop in iron ore prices.
Japanese equities performed well after the surprise LDP election win, with the focus now shifting to Prime Minister Kishida’s potential fiscal package/supplementary budget (expected in early November).
Over the weekend, China exports beat expectations again. Nominal exports rose a further 4.3% month over month on a seasonally adjusted basis, keeping year-over-year (YoY) growth elevated at 27.1%. Nominal import growth rebounded to 20.6% YoY. With this, China saw a record trade surplus in October.
A much quieter week ahead from a central bank and macro data perspective. We do have a number of inflation data points to watch out for and expect any commentary from central bankers to garner a lot of attention. In Europe and the United States, we are getting towards the end of corporate earnings season. Focus will also turn to upcoming “Singles Day” on 11 November in China (the largest retail event globally) and of course Black Friday in the United States near the end of the month. Expect mentions of the seasonality market performance and the potential for a “Santa Rally” to be heard soon.
Monday 8 November:
- Switzerland Unemployment Rate
- Norway Industrial Production
Tuesday 9 November:
- Germany ZEW Survey
- Germany Trade & Current Account Balance
- France Trade & Current Account Balance
- US – Small Business Optimism, Producer Price Index
Wednesday 10 November:
- Germany Consumer Price Index (CPI)
- Italy Industrial Production
- US – Mortgage Applications; CPI, Hourly/Weekly Earnings, Jobless Claims, and Continuing Claims; Consumer Comfort; Inventories and Trade Sales; Budget Statement
- China CPI
Thursday 11 November:
- UK GDP & Trade Balance
- UK Manufacturing & Industrial Production
- Eurozone EU Commission Economic Forecasts
Friday 12 November:
- Spain CPI
- Eurozone Industrial Production
- The COP26 climate summit ends in Glasgow
- US – JOLTS Job Openings and Univ. of Michigan data
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