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.
Last week proved a bruising experience for global financial markets as several central banks raised interest rates and indicated the policy path ahead appears to be one of further tightening. From a European perspective, the failure of the European Central Bank (ECB) to address concerns over widening peripheral spreads at its 9 June meeting also weighed on sentiment. An emergency meeting was called on Wednesday to address this. We saw de-risking across asset classes on the prospect of aggressive central bank policy tightening into worsening economic conditions, with the MSCI World Index closing the week down 5.9%, the STOXX Europe 600 Index down 4.6%, the S&P 500 Index down 5.8%, and the MSCI Asia Pacific Index also down 5.6%.
All about the (central) banks…
The flurry of central bank announcements were the focus last week, with the Federal Reserve (Fed), Bank of England (BoE), Bank of Japan (BoJ) and the Swiss National Bank (SNB) all releasing interest-rate decisions. As if that wasn’t enough, we had an emergency ECB meeting to add to the mix.
Fed: Last Wednesday, the Fed raised rates by 75 basis points (bps)—the largest rate hike since 1994—to a target range of 1.5% to 1.75%, and committed to continue to tighten aggressively. Fed Chair Jerome Powell signalled that the Committee would likely decide between 50 bps and 75 bps at the July meeting. It would take a significant and convincing slowdown in realised headline inflation for the US central bank to feel comfortable that inflation was heading back towards its target. For the most part, the Fed meetings were in line with expectations. Market expectations are that the Fed will raise rates by 75 bps again in July. Beyond, it is thought that the Fed will slow to 50 bp increases in September and November, before slowing again to a measured pace of 25 bp increments in December.
The Fed’s commentary on growth and inflation was similar to the May statement. It noted that economic activity “appears to have picked up” following the first-quarter gross domestic product (GDP) decline, and it no longer mentioned “highly uncertain” effects of the Ukraine-Russia war. On the negative side, the statement omitted the “strong” household spending and business investment characterisation used in May.
BoE: The market was pricing in a 25 bps increase, from 1% to 1.25%, which would have been the fifth consecutive increase. As it turned out, the members voted six to three to raise by 25 bps, exactly in line with expectations, but they hinted that they would be prepared to make larger moves in the future if required, stating the UK central bank “would be particularly alert to indications of more persistent inflationary pressures and would, if necessary, act forcefully in response”.
Chief Economist Huw Pill said officials were focused on the persistence of inflationary pressure, lifting expectations that prices would keep rising. He was also looking for signs that those pressures are seeping into wage settlements. The remarks set out the reasons that may prompt the BoE to speed up its efforts to rein in inflation, which it expects to leap over 11% later this year. All eyes therefore will be on the next rate announcement on 4 August.
SNB: Perhaps more interestingly, the bank unexpectedly raised rates for the first time since 2007, lifting its policy rate by 50 bps to -25 bps, and said that more tightening may be needed.
This surprise decision was driven by a shift in inflation outlook, which the SNB now sees at 2.8% this year, 1.9% in 2023 and 1.6% in 2024. That’s considerably higher than in March when they predicted 2.1% this year and 0.9% in both 2023 and 2024.
The announcement caught the market off guard, leading European markets lower to close the day down 2.4%. In addition, the Swiss franc took a big leg up vs. both the euro and the US dollar; it was the biggest move in the Swiss franc since the 2015 intervention.
ECB: Last week also saw an emergency meeting on Wednesday of the ECB’s Governing Council to address the perception that it failed to provide sufficient detail last Thursday on how it plans on managing the excessive blow-out in peripheral spreads, or “fragmentation” in ECB speak. After the ECB announcement last week, the market was disappointed at the lack of any new detail on this subject.
The message after the emergency meeting was that there will be flexibility on Pandemic Emergency Purchase Programme (PEPP) reinvestment and the ECB vowed to accelerate the design of its new “anti-fragmentation” tool. Indeed, we are hearing that it is very keen for the design of this new tool to be signed off ahead of the next policy meeting/rate announcement on 21 July.
BoJ: The bank bucked the trend and stuck to its ultra-dovish stance. It kept interest rates unchanged at -0.1%, and conveyed willingness to step in to support the bond markets.
On the recent yen weakness, Governor Haruhiko Kuroda said: “It is desirable for the foreign exchange rates to reflect economic fundamentals and to move in a stable manner. The recent sharp depreciation of the yen is negative for the economy.”
Prime Minister Fumio Kishida backed it, saying monetary easing should remain on track for now given the negative effect a change would have on smaller firms. Central bank policy “should be judged comprehensively by taking into account the trends of the economy as a whole”, he said.
Further evidence inflationary pressure is UK consumer behaviour
Last week, the BoE said inflation will hit 11% later in the year. Meanwhile, UK gross domestic product (GDP) data came in in worse than expected, and we also saw some high-profile profit warnings from UK retailers, raising questions over health of the UK consumer.
Online fashion retailer ASOS declined 32% after revising down its fiscal year guidance, citing higher return rates as a reason for the poor performance and drawing a link between the cost-of-living crisis and consumer purchase behaviour.
Halfords declined 30% last week after warning inflationary pressure is hurting consumer demand.
In addition, Tesco noted it is seeing some early indications of changing customer behaviour as a result of the inflationary environment.
The week in review
European equities took out their year-to-date (YTD) lows last week as investors fretted over growth and whether we are heading towards a global recession. The STOXX Europe 600 Index closed the week down 4.6%, its worst weekly performance since March. Central bank meetings were the clear focus, with fears over widening peripheral spreads in Europe weighing on sentiment as investors took the view the ECB messaging was too vague on this issue. The shock from the SNB decision also spooked investors, prompting a sharp selloff into the end of the week.
All sectors closed last week lower in Europe. The YTD outperformers lagged on the week with the selloff in commodity prices, led by a downturn in oil and gas and basis resources amid profit taking. In terms of outperformers, insurers and banks closed last week with mild losses, the latter helped by higher rates and mergers and acquisitions (M&A) news in the space. European equity funds saw their 18th week of outflows, shedding another US$1 billion.
Macro data continued to disappoint investors last week. UK April GDP was weaker than expected, falling 0.3% on the month. Manufacturing fell 1.0% month-on month (m/m) despite a surge in automobile production in April, while services output fell 0.3% m/m. UK industrial production (IP) was also down 0.6% m/m. These data points have simply added to the rise in recession risks this week and support the recent downgrades to economic growth we’ve seen.
Yet, economists note the eurozone and the United Kingdom can still likely count on some “shock absorbers”, including COVID-19-related excess consumer savings and more room for a rebound in consumer spending, and the return to the more normal tourist season. In addition, demand for labour likely means that companies will do their utmost to hold on to their workforce.
The S&P 500 Index closed last week down 5.8%, hitting a new 52-week low on Friday. The hawkish tone from global central banks drove risk-off sentiment last week. The latest Fed announcement was the clear focus for US equity markets, with the central bank hiking rates by 75 bps and suggesting there is more to come, as discussed.
Risk assets were sold and we saw the retail-driven cryptocurrency market implode further, with Bitcoin down another 11% by the end of the day Friday, dipping below US$20,000 for the first time since December 2020. The S&P entered bear market territory on Monday, the 20th bear market in the past 140 years. On another technical note, the percentage of S&P 500 members trading above their 50-daily moving average sank below 5% last week; similar examples of terrible market breadth have preceded a rebound in stock markets. Also, Bank of America’s Bull and Bear indicator hit 0.0 last week, meaning positioning is peak bearish and indicating a buy signal. Despite the weakness last week, US equities saw their sixth consecutive week of inflows, with month-end and quarter-end expected to provide an inflow tailwind this week. Last week’s inflow totalled US$14.8 billion.
Oil prices sold off last week, ending the week down 9.2%. With that, US energy stocks were down as much as 17.2% on the week, breaking below the 100-daily moving average for the first time this year. There were a number of factors feeding into this move: i) According to the latest Bank of America Fund Manager Survey, long oil/commodities is the most crowded trade, with 67% of investors believing oil will provide the best returns in 2022; ii) President Biden will visit Saudi Arabia next month with investors maybe viewing it as an attempt to smooth out relations and help limit the impact of the war in Ukraine on oil prices; iii) China has been ramping up purchases of Russian oil at low prices; iv) Global recession fears could imply that there will soon be reduced demand for fuel; v) Following strong outperformance, investors may be beginning to take some profits in some of these year-to-date winners; and, finally, vi) The Biden Administration could still push for a windfall tax on US energy companies. Commodity prices in general were down last week, with iron ore prices getting hit 14% driven by the continued slowdown in China and hawkish central banks fuelling a drop in demand. Iron ore has now wiped out all of its 2022 gains and traded 32% below its early April highs.
Las week was poor in Asia, with the MSCI Asia Pacific index closing down 5.63% and all major markets were deep in the red, apart from China. The overriding theme for the week was recession fear.
Japan’s equity benchmark index closed the week down 6.69% as the BoJ continued with its (divergent) dovish, low-rate policy (currently -0.1%) and its willingness to step in to support the bond markets. It reiterated its commitment to quantitative and qualitative monetary easing as it pursues its 2% price stability target. Ministry of Finance data showed a big jump in exports, highlighting the weaker yen and higher commodity prices which are fueling demand from overseas. The yen weakness continues to be in focus, as BoJ Governor Kuroda said this week that a recent rapid weakening of the yen is undesirable and negative for the economy in his first public comments since the currency reached its lowest level in 24 years.
China’s equity market was one of the best-performing, closing the week up 0.97% as the government approved 10 fixed asset investments worth CNY121 billion in May, representing more than sixfold jump from April. Sentiment also received a boost after data showed surprising growth in industrial production in May and from hopes of increased policy support following weak housing market data.
On the COVID-19 front, some easing of curbs in Beijing raised investor optimism, as mass testing has stopped reverting to more targeted and measured testing. Elsewhere, there was some positive economic news, with activity data for May better than expected. IP unexpectedly maintained growth, while retail sales fell by less than forecast. Fixed-asset investment held up slightly better than anticipated and the unemployment rate declined. US/China talks continued. Earlier last week, US national security adviser, Jake Sullivan, met with China’s top diplomat, Yang Jiechi, to discuss a range of security challenges facing the countries’ bilateral relationship.
Australia’s equity market closed down 6.6% as commodity weakness weighed on sentiment, and we saw wage inflation rising sharply, triggering a rapid increase in the country’s government bond yields. The yield on Australia’s three-year sovereign bond increased more than 50 bps, reaching a 10-year high during the week. In addition, the government and new Prime Minister Anthony Albanese continue to come under pressure due to rising electricity prices and blackouts across several states.
The week ahead
A quiet start to the week with a US bank holiday on 20 June, but focus will be squarely on central bank commentary this week. Notably, Powell is testifying twice this week and ECB President Christine Lagarde is talking at an event as well.
Looking to macro data ahead, UK inflation data on Wednesday will be closely watched. Flash Purchasing Managers’ Index (PMI) data across a number of countries later in the week will also be in focus.
The fallout from the French parliamentary election will be interesting to watch, with President Emmanuel Macron’s centrist party losing its majority due to gains for opposition on both the left and right.
Central Bank Speakers this week: Powell is scheduled to testify twice this week (on Wednesday and Thursday) joining a raft of Fed speak interspersed through the week (Bullard today, Barkin/Mester Tuesday, Barkin/Evans/Harker Wednesday, Bullard/Daly Friday).
ECB including Lagarde/Centeno/Muller Tuesday, Lane/Rehn Wednesday and Nagel/Villeroy on Thursday, and the BoE with Huw Pill Tuesday.
Monday 20 June
- Germany Producer Price Index (PPI)
- Eurozone construction output
- US Juneteenth (observed)/all markets closed
Tuesday 21 June
- ECB current account (CA)
- Italy current account balance
- US existing home sales
Wednesday 22 June
- UK Consumer Price Index (CPI) inflation
- Eurozone consumer confidence
Thursday 23 June
- Euro area flash composite PMI
- UK flash composite PMI
- UK public finances (PSNCR)
- France business and manufacturing confidence
- France S&P global manufacturing PMI
- Germany S&P Global/BME manufacturing PMI
- US jobless claims and CA
- US S&P/Markit manufacturing PMI
- US KC Fed manufacturing survey
- Japanese PMI
Friday 24 June
- UK retail sales (including automobile fuel)
- Spain GDP
- Italy consumer and manufacturing confidence
- Germany IFO business climate
- US new home sales
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