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23/03/2021
Notes from the Trading Desk - Franklin Templeton

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.

The Digest

Global equities were mixed last week, with the STOXX 600 Index closing the week up a muted 0.1%, whilst US markets underperformed (S&P 500 Index down -0.8%), despite a dovish tone from the US Federal Reserve (Fed) on Wednesday. The MSCI APAC Index closed up 0.35%, with mixed regional performance. Wednesday’s Federal Open Market Committee (FOMC) meeting and rising COVID-19 cases in continental Europe were key areas of focus.

The Fed: Dovish Signals

Overall, the takeaways from the FOMC meeting were dovish, with the Fed keeping its median interest-rate projections unchanged despite a strong outlook for the labour market, growth and inflation. A few participants raised their rate expectations for 2022 and 2023, likely skewed towards regional bank presidents, but Chair Jerome Powell was clear that he would ‘not read too much’ into this. Powell was also reluctant to discuss the possibility for future tightening, and noted that ‘a strong bulk of the committee’ kept their rate projections at zero, which was actually an 11-7 split.

In terms of inflation forecasts, 11 out of 18 participants saw inflation at 2.1% or above in 2023. With only seven members predicting one or more interest-rate hikes, a decent portion of the Fed (likely including the leadership) would seemingly prefer to let the economy run hot despite also expecting inflation to run above their target. This detail tilts us further towards the dovish side. Of course, this is all about forecasts, not actual data points, so if we do begin to see more evidence of a cyclical rebound, we are also likely to see upgrades to individual forecasts and a corresponding move in the Fed’s ‘dot plot’ projections of expected hikes.

The market reaction was positive on the day of the meeting, with the S&P 500 Index closing on Wednesday near new all-time highs as cyclical and value stocks rallied in the United States, whilst defensive names underperformed. The Dow Jones Industrial Average also made a new record high, trading above 33,000 for the first time. The CBOE VIX (volatility index) had a knee-jerk move higher, but then settled at its lowest level since the pandemic hit markets.

The US dollar moved lower following the release, alongside US Treasury yields, which also helped commodities. These moves were not sustained, however, with some choppy trading around rebalancing flows towards the end of the week and US yields ultimately continuing their recent rally.

Europe’s ‘Third Wave’

Talk of a third wave of new COVID-19 cases increased across the European Union (EU) last week, with France reimposing lockdown in Paris, and German health officials stating cases are accelerating ‘exponentially’. In France, new daily cases increased to above 30,000 (a 20% increase), while Germany saw new daily cases rising to 17,5000 on Friday. Central European countries are also seeing sharp rises, with an increase of 38% in new cases week-over-week in Poland. These increases are due to more infectious new variants taking hold and highlight the pitfalls for European economies coming out of lockdown. The German health minister said it was unlikely that Germany would be looking at easing lockdown measures and if anything, it was more likely to tighten them.

Europe’s Vaccine Confusion

In the context of the ‘third wave’, it is important to keep an eye on the ongoing confusion over the EU vaccination programme, as further delays risk delaying the reopening of the economy.

This week we saw 16 EU nations pause the use of the AstraZeneca vaccine due to concerns over a handful of clotting cases. Subsequently, the World Health Organisation (WHO) and the European Medicine Agency (EMA) confirmed they saw no association with an increase in overall risk of blood clots. Many countries are now restarting the use of AZN vaccine, but it will have further delayed the already slow vaccine rollout and undermined public confidence. This could lead to damaging delays to the restarting EU economies. We would also note that a US AZN trial just concluded, with results showing 79% efficacy against COVID-19, 100% efficacy against severe or critical disease, and no increased risk of blood clots.

Alongside this flip-flopping on the AZN vaccine, the politisation of the global vaccine rollout continues to ramp up. Last week, EU President Ursula von der Leyen stepped up the rhetoric about Astra vaccines being exported from the EU, stating: ‘If the situation does not change, we will have to reflect on how to make exports to vaccine-producing countries dependent on their level of openness’.

Over the weekend, the UK press has focused on asking what EU are doing with an alleged 14 million Astra vaccines sitting in storage, pointing the finger at French President Emmanuel Macron and other leaders for creating uncertainty over the vaccine. The EU has said that it will review all requests to export AstraZeneca vaccines to the UK ‘very severely’ and will likely reject them until the drug-maker fulfils its delivery obligations to the bloc, accusing London of hoarding supplies.

We can expect further vaccine-related headlines this week, with the EU heads set to decide at a summit on Thursday whether to make good on their threat to block exports of 1 million doses produced at a Dutch factory. The post-Brexit political impact of all of this has the potential to be far- reaching and long-lasting.

UK Picture More Promising

In contrast, the picture for the UK economy looks more encouraging. New cases remain far below January highs and hospital numbers continue to fall sharply. Crucially, the vaccination programme continues at pace, and hopes of reopening in April remain high. UK consumer confidence is its highest level since the start of the crisis. On the back of this, stocks tied to UK re-opening outperformed similar EU stocks last week, a trend we have seen a number of times on relative vaccine rollout success.

Week in Review

Europe

European equities were little changed on the week overall, but within that there was some choppy sector and country dispersion. In terms of factors, value outperformed momentum, no doubt helped by the Fed and outperformance in the European autos. The energy sector (oil and gas) was the notable outlier as oil had its worst week in five months, and long positions were unwound. The sector closed last week down 4.8%. The winner last week was the autos, as solid earnings and US retail impact offered a boost. The sector finished up 5.3%, which is the widest dispersion in two months between top and bottom sectors on the week.

Regional performance reflected sector weightings once again this week with Germany’s DAX Index outperforming, up 0.8%, on the strength in autos. Spain’s IBEX lagged, down 1.8% amid strong sector biases towards oil and gas and the financials. Other basket themes included the stay-at-home theme, down 2.3%, as investors trimmed some profits here again.

European cyclicals came under pressure vs. defensives, with the COVID-19 backdrop weighing on sentiment. Last week was the first week of underperformance for the EU cyclicals vs. defensives in seven weeks, as weakness in underlying commodities also added bearishness. Finally, there was a continuation of the weakness in European renewables, with the basket down 4.8% on the week.

Finally, it is worth noting the Dutch election took place this week and saw a market-friendly outcome, with Marke Rutte on course to win a fourth term and right-wing populists falling to third place. The last Dutch election four years ago garnered a lot of attention over feared gains by anti-EU populists, so it is notable how this election passed by with so little attention.

United States

Last week was choppy for US equities, with the mid-week Fed meeting the main talking point (as discussed). With that, the S&P 500 Index ended the week down 0.8%, the Dow Jones Industrial Average down 0.5% and the Russell 2000 Index down 2.8%. As in recent weeks, moves in Treasury yields were a key driver, and the US 10-year yield continued its rally, up 9.6 basis points (bps) to 1.72%. The 10-year yield has now risen for seven straight weeks.

Another notable mover last week was West Texas Intermediate (WTI) crude oil, down 6.4% on a continued rise in US inventories and demand concerns coming from fresh EU lockdowns. With that, the energy sector was a clear loser, while telecommunications services and health care were the best-performing sectors.

Interestingly, reports show global equities continued to attract record asset flows, with investors showing a preference for the US equities over European equities given economic recovery/reopening concerns.

The US economy’s reopening prospects remain good as new COVID-19 fell to a four-month low and President Joe Biden wants all US states to offer vaccines to all adults beginning May 1. However, these positive trends will likely feed into fears over inflationary pressures and how this may impact the Fed’s thinking.

There was further noise around the potential for fresh retail investing, as stimulus cheques were sent out last week to individuals in the United States. Younger and higher-income investors in particular seem more likely to investing more in the market with these new funds, according to a Financial Times poll.

Asia

Asian markets saw lacklustre performance last week, with the MSCI Asia Pacific up 0.3% last week. Equity markets in Hong Kong and Japan closed higher, while Shanghai’s benchmark ended the week lower. In terms of themes, central bank action was a major focus in Asia too last week, with a two-day Bank of Japan (BoJ) meeting concluding on Friday. The BoJ kept interest rates unchanged as expected, but did widen the band at which it allows long-term interest rates to move around its target, one of several measures to make its policy more sustainable amid a prolonged battle to boost inflation.

In addition, it removed its explicit guidance to buy exchange-traded funds (ETFs) at an annual pace of roughly ¥6 trillion (US$55 billion), which gives it more flexibility. BoJ Governor Haruhiko Kuroda confirmed that these changes are to aid the deployment of monetary stimulus rather than any sign of tightening.

Japan was also in focus as Prime Minister Yoshihide Suga said the state of emergency for Tokyo area will end. However, this positive was offset by news that the Tokyo Olympics will take place without overseas spectators.

Elsewhere, any notion of a thaw in US/China relations in the wake of the new US administration can be put to one side after a frosty summit in the US state of Alaska.

The Week Ahead

The chaotic vaccine rollout programme in the region seems likel to dominate the European Council summit in Brussels this week. In the United States, we have a slew of Fed speakers, which will be of interest given last week’s meeting. Notably on Tuesday, the Fed’s Powell and Treasury Secretary Janet Yellen are scheduled to make their first joint appearance before the US House Financial Services committee to testify on Fed and Treasury pandemic policies.

It’s also a busy week for European central bank speakers, and the German cabinet is set to sign off a 2022 budget plan on Wednesday.

Tuesday 23 March:            

UK employment report

Wednesday 24 March:      

UK consumer price index inflation (year-over-year)
Euro-area Flash Composite Purchasing Managers Index (PMI); March UK Flash Composite PMI; Markit US PMIs

Thursday 25 March:          

US gross domestic product (quarter-over-quarter)

Friday 26 March:             

UK retail sales (month-over-month)
Germany IFO Survey

 



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