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Notes from the Trading Desk – Franklin Templeton

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. As part of Templeton Global Equity Group, the European equity desk is manned by a team of professionals based in Edinburgh, Scotland, 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.

The Digest

Last week’s market performance was defined by one event, Federal Reserve (Fed) Chair Powell’s speech at the Jackson Hole Symposium on Friday. In the end, Powell struck a more hawkish stance than had been anticipated, and markets sold off sharply into the close. With that, the S&P 500 Index saw its worst daily performance (-3.3%) in 11 weeks.1 Last week, the MSCI World Index declined 3.3%, its worst weekly performance since June, the STOXX Europe 600 Index fell 2.6%, the S&P 500 Index fell 4% and the MSCI Asia Pacific was down 0.1% (Asian markets were closed by the time Powell spoke).

Powell strikes hawkish tone at Jackson Hole

Powell’s Jackson Hole speech was more hawkish in tone, with the message the Fed “must keep at it until the job is done”. Some had hope for further signs of a “pivot” to a more dovish stance, but this notion faded quickly. His message was clear: to achieve target inflation levels, the Fed’s restrictive policy must stay in place for as long as required, which could mean some “pain” for the US economy. However, the cost of not taking this course would be far worse, according to Powell: “Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy”.

Powell said there would “very likely be some softening of labour market conditions” and “some pain” for the US economy. However, he stressed a failure to act “would mean far greater pain”.

Following his speech, we saw a sharp selloff in US equities, with the technology sector hit hardest. The Nasdaq Composite Index fell 4% Friday and fell below support at its 100-day moving average.

In addition to Powell’s comments, several Fed speakers (Bullard, Harker and Bostic) were also quoted last week as saying that the Fed needs to move rates into restrictive territory to slow the US economy.

The market is now pricing in a further 159 basis points (bps) of interest-rate hikes this year, with rates peaking at around 3.85% next year.2 However, the market is actually predicting 31 bps of rate cuts by the end of 2023. Looking ahead, the US August employment report will be released on Friday of this week, and Powell speaks again on 8 September. The next Fed meeting is on 21 September, and the market is split on whether we see a 50 bps or 75 bps rate hike.

The US Treasury two-year yield has surged to 3.48%, the highest since 2007, while the 10-year yield rose to 3.13%, meaning there is a significant inversion in the yield curve, as investors see higher interest rates in the short term. The US dollar (DXY Index) continues to strengthen, up 0.6% last week and up 3.2% month to date, the highest since 2002.

As an aside, the conference also saw some hawkish European Central Bank (ECB) commentary. A number of speakers said the ECB needs to act forcefully and raise rates by at least 50 bps next month.

The week in review

United States

As stated, US markets sold off sharply on Friday after Powell struck a more hawkish stance than the markets had expected. Growth names underperformed in the move lower.

In terms of sectors, it was unsurprising to see energy stocks rally as West Texas Intermediate crude oil was higher on the week (+2.9%), with US inventories falling and suggestions of a Saudi-led OPEC+ production cut circling. Meanwhile, technology names were the worst-performing last week.

The CNN Fear and Greed index has moved from a “Greed” reading a couple of weeks ago to “Fear”, as the summer bear rally seems to be running out of steam.3

Last week’s US macro reports saw worse-than-expected Purchasing Managers Index (PMI) data, with the Services PMI at 44.1 and the manufacturing PMI coming in at 51.3.

Europe

Last week was another tough one for European equities, and the euro traded through parity versus the US dollar for much of the week given the gloomy economic backdrop. In addition, we saw a late selloff on Friday following Powell’s Jackson Hole speech. It is worth noting that volumes remained low.

Looking at indices across the region, Norway’s equity benchmark gained 1.3% and the FTSE 100 Index outperformed (albeit down 0.6%) given their energy weightings. On the flipside, Germany’s DAX Index was the laggard on the week, down 4%, and the German Midcap index (MDAX) performed even worse, declining 5.5%.

Looking at sectors, energy was the clear outperformer and health care has also been strong. Chemicals and industrials remained weak as energy prices rose, while financials had a poor week and could not find a bid. Consumer-related sectors—particularly retail—performed poorly last week.

Once again, energy prices and the cost of living was front and centre. Gas prices continue to surge higher—European gas prices are up about 77% in August (and +385% year-to-date).4 Gas prices will remain in focus this week as Nord Stream 1 is scheduled to shut down for three days of maintenance work on 31 August. German gas reserves are above 80%, but the cost-of-living issue is front and centre across the region given soaring prices. Energy prices in France have also soared as nuclear output remains below average levels.

Today, the European Union (EU) called an emergency meeting of energy ministers to discuss bloc-wide solutions to the spike in power prices.

In France, President Emmanuel Macron has been preparing the public for a tough winter, stating the French public must be ready to pay “the price of liberty” and said they are at the “beginning of the end of what seemed like an age of abundance…the end of an abundance of raw materials and water. The end of cost-free credit”.

In the United Kingdom, the energy regulator announced a new price cap that will see the UK residential bill price cap rise from £1,971 to £3,549 from 1 October, (and given recent gas price surge, potentially to £4,700 in January and £5,800 in the second quarter). There are some predictions that more than half of UK households risk being pushed into energy poverty this winter if there is no further intervention from the government. With that, pressure is mounting on Prime Minister Boris Johnson’s successor to take more action to help the public with energy costs. Liz Truss is likely to be announced as the new prime minister on 5 September.

Inflation is seen remaining high into 2023, and the market now sees UK interest rates at 3.75% in May 2023, 2% higher than current levels. In this environment, the British pound lost ground versus the US dollar and UK gilt yields continue to soar, with the 10-year up 8% last week to 2.6%.

European equities continue to see outflows, with last week marking the region’s 28th consecutive week of outflows.

There is some good news though. While it hasn’t been mentioned much, one headwind does appear to have eased—the Rhine water levels rose sharply last week, and water levels at key bottleneck Kaub look a lot healthier.

Asia

Last week was mixed for Asian equities, with the broader MSCI Asia benchmark down 0.11%, while  Japan’s market declined 1% and on the flip side, Hong Kong’s market outperformed, up 2%.

Japan’s market sold off last week on the back of some weaker factory and PMI data early in the week and ahead of Powell’s speech on Friday.

On Thursday, Bank of Japan (BoJ) board member Nakamura reiterated the BoJ’s commitment to easing and warned that tightening policy now would significantly suppress private sector activity. While Governor Kuroda seems unlikely to pivot towards normalization until his term ends in April, there is still some thought markets could challenge the BoJ if inflation remains above its 2% stability target. Japanese government bonds sold off and the yen closed the week broadly flat.

Amidst the decline in China’s mainland equity market last week, the government stepped in to help markets.

To help revive the economy, the Peoples Bank of China cut two key interest rates last week—the five-year loan prime rate and one-year loan prime rate.

The government also outlined a 19-point policy package, committing more funds to infrastructure development and further liquidity for local governments.

Towards the end of the week, the Wall Street Journal reported that United States and China are nearing an agreement to allow US accounting regulators to travel to Hong Kong to inspect audit records of US-listed Chinese companies.5 Chinese ADRs surged overnight on Thursday, and the positive sentiment carried over to Hong Kong/China markets, a reversal after the selling over the past few weeks.

Elsewhere, a heat wave in China fuelled concerns that Sichuan power outages could spread, affecting production of commodities and keeping inflation elevated.

Hong Kong’s equity market fared better last week, with most of the gains coming on Thursday and Friday as the tech sector rallied on the news about US-listed Chinese companies will open their books to US regulators, meaning that these companies will not be delisted in the United States. Despite recent geopolitical tensions, the agreement could lead to thawing of relations, and there is hope progress could be made in several other areas of mutual concern.

Hong Kong reported over 9,700 cases of COVID-19, the highest number in five months, amid fears that recent relaxation measures could be reversed. The government said that it might consider suspending full-day teaching in person.

The week ahead

It looks like a quieter start to this week in Europe as UK markets were closed for a bank holiday, leading to subdued volumes across the continent. This week, Consumer Price Index data from across Europe will be released, and should prove a key focus for markets. Looking to energy markets, Gazprom plans to halt flows of Russian gas through the Nord Stream pipeline for three days of maintenance. From a US perspective, the August employment report (including non-farm payroll data) on Friday is the highlight  ahead of the Labour day bank holiday there on 5 September.

Holidays            

Monday 29 August: United Kingdom

Key Events

Monday 29 August: Japan Unemployment Rate

Tuesday 30 August: Spain HICP Inflation (year-over-year [Y/Y]); Germany HICP Inflation (Y/Y)

Wednesday 31 August: France HICP Inflation (Y/Y); Italy HICP Inflation (Y/Y); Euro-Area CPI Inflation Estimate (Y/Y)

Thursday 1 September: UK Decision Maker Panel Survey; US Initial Jobless Claims

Friday 2 September: US Nonfarm Payrolls and Unemployment Rate

Monday 29 August

  • Japan Unemployment Rate

Tuesday 30 August

  • UK Nationwide House Price Survey
  • Spain HICP Inflation
  • Germany HICP Inflation
  • Hawkish ECB Governing Council members Robert Holzmann, Madis Muller and Pierre Wunsch speak along with arch dove Yannis Stournaras about “Inflation: Can Central Banks Cope?” at the Alpbach Forum in Austria.
  • US JOLTS Job Openings; FHFA House Price Index; Board Consumer Confidence
  • New York Fed President John Williams speaks with the Wall Street Journal about the US economic outlook.

Wed 31 August

  • France HICP Inflation, Gross Domestic Product (GDP)
  • Italy HICP Inflation
  • Euro-Area Flash CPI Inflation
  • Germany Unemployment Change
  • Russia’s Gazprom is set to halt gas flows through the key Nord Stream pipeline for three days of maintenance. The shutdown will occur just as Germany rushes to fill storage sites to at least 95% capacity by November and will likely further squeeze energy supplies.
  • Cleveland Fed President Loretta Mester discusses the outlook for the economy and monetary policy at an event hosted by the Dayton Area Chamber of Commerce. Atlanta Fed President Raphael Bostic speaks at the Georgia Fintech Academy about the role of fintech in promoting financial inclusion.
  • US Mortgage Applications; ADP Employment Change; MNI Chicago PMI.

Thursday 1 September 

  • UK Decision-Maker Panel Survey
  • UK S&P Global/CIPS UK Manufacturing PMI
  • S&P Global Spain Manufacturing PMI
  • S&P Global Italy Manufacturing PMI
  • S&P Global France Manufacturing PMI
  • S&P Global/BME Germany Manufacturing PMI
  • S&P Global Eurozone Manufacturing PMI
  • Italy GDP WDA
  • US Initial Jobless Claims; Nonfarm Productivity (Revision) and Unit Labour Costs; ISM Manufacturing

Friday 2 September

  • The UK leadership ballot closes in the evening, with the winner announced on 5 September. Liz Truss and Rishi Sunak have been engaged in a battle to succeed Boris Johnson as UK prime minister, with Truss favored to win in a recent Tory-members survey.
  • US August Nonfarm Payrolls and Unemployment Rate; Factory Orders; Durable Goods Orders.


Index:

1. Source: Bloomberg. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.

2. Source: Bloomberg, as of 29 August 2022. Based on Eurodollar spreads.

3. CNN’s Fear & Greed Index tracks seven indicators of investor sentiment. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.

4. Source: Bloomberg.

5. Source: Wall Street Journal, “U.S., China Near Deal to Allow Audit Inspection of N.Y.-Listed Chinese Companies,” 25 August 2022.


Franklin Templeton Disclaimer:

WHAT ARE THE RISKS?

All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.  Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

Past performance is not an indicator or guarantee of future performance. There is no assurance that any estimate, forecast or projection will be realised.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 29 August 2022, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. 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. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

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