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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, financial markets saw selling across the board. European equities made new 52-week lows and US equities finished near similar lows. The STOXX Europe 600 Index closed the week down 4.4%, the S&P 500 Index was down 4.6%, whilst the MSCI Asia Pacific Index closed down 3.5%.

A series of central banks raised interest rates last week—more than 600 basis points (bps) of rate hikes globally. Geopolitical risks seemed to escalate once again last week with Russian President Vladimir Putin announcing a “partial mobilisation” and plans to hold “referendums” in the Russian-controlled regions of Ukraine.

The mini budget announcement in the United Kingdom garnered attention too, as Chancellor Kwarteng introduced the largest tax cuts in the country since 1972, with borrowing likely to be £60 billion higher than previously thought. We saw significant moves in foreign exchange markets, with the euro down 3.3% and sterling down 4.9% vs the US dollar. Japan intervened in the foreign exchange market for the first time since 1998 to stop the yen’s slide.

The CNN Fear and Greed Index is now down in “Extreme Fear” territory, down from “Neutral” sentiment just one month ago. Note: The last time the Index hit this level in June, we saw an aggressive bear squeeze in the following weeks.

All about the central banks

The Federal Reserve (Fed), the Bank of England (BoE), the Swiss National Bank (SNB), Norges Bank and the Riksbank all raised interest rates last week and paved the way for further hikes at upcoming meetings.

Fed

The Fed managed to out-hawk the market last week when it delivered a 75 bp hike. The hike itself was as expected; however, the “dot plot”—the Fed’s interest-rate trajectory—for this year is now 25 bps more hawkish than previously estimated. The year-end rate is now expected to be 4.375%, up from 4.125%, implying an additional 125 bps of tightening at the next two meetings. Recall a quarter ago, we were hearing about rate cut projections in 2023. Fed Chair Jerome Powell said that the chances of a soft landing are now diminished, adding that there is no “painless way” to get inflation back under control and reiterated the central bank anticipates ongoing rate hikes for now.

After the announcement on Wednesday, the S&P 500 Index sold off, pushing its drop from the January highs to over 20%. Several companies hit 52-week lows. The 2/10 Treasury yield curve is now inverted by over 50 bps, a level which has almost always signalled a recession and represents the deepest inversion since May 2000. The US real yield also pushed higher, up 24 bps to 1.319%, the highest level since 2010.

BoE

On Thursday, the BoE raised rates by 50 bps (vote split 3-5-1) to 2.25%. Three members voted to raise rates by 75 bps and one member by 25 bps. They also outlined plans for quantitative tightening. Over the next 12 months, the BoE plans to reduce its gilt holdings—through ceasing the reinvestment of maturing assets, as well as active sales—by £80 billion to £758 billion.

In terms of growth outlook, the central bank said the United Kingdom may already be in recession. It had previously expected to see growth in July/September, but now expects a -0.1% decline. It now expects inflation to peak at just under 11% in October, having previously forecast it would reach 13% next month. Following the government measures announced on Friday, the market sees an 80% chance of a 1% rate hike.

Riksbank, SNB, Norges

On Tuesday, Sweden’s Riksbank set the tone for the central banks last week with a 1% rate hike, which was higher than expected.  The hike moves the policy rate to 1.75%. The Riksbank only has one more meeting this year, so it has to move quicker than other banks. However, given the increasing pressure on Swedish mortgage holders, it is unlikely it can keep up that pace for long. It raised the terminal rate to 2.5%, implying 75 bps of more hikes in their view. The Swedish Krona finished last week down 4.5% vs. US dollar.

The SNB ended its negative rates policy by hiking rates by 75 bps to 0.5%. It also forecast inflation should reach 2% over the long term. Overall, the announcement was viewed as slightly dovish, as the futures market was pricing in 91 bps of rate hikes for Thursday and another 95 bps for December. SNB also introduced a tiered system for remunerating banks’ deposits at the SNB, and the Swiss franc has weakened on the back of that, closing the week down 1.7% vs. the US dollar.

Norges Bank hiked its benchmark rate by 50 bps to 2.25% as expected, citing signs that inflation will remain higher for longer than expected. Inflation is now seen to peak higher (above 6%) in the coming months, while past the next 12 months the inflation forecasts remain largely unchanged. It slashed its growth outlook on the back of “clear signs of cooling” in the economy as monetary policy is starting to have an effect, suggesting it may now return to quarter-point hikes going forward. The central bank does not expect to go higher than 3%, which could now be reached by the end of the winter. The Norwegian Krone finished the week down 3.8% vs. US dollar.

Europe

European equities broke lower again last week, smashing through year-to-date lows. Credit markets also got hit last week, with the XOVER Index hitting new highs. The focus was on the central banks, and messaging remained hawkish, increasing fears on global economic growth. An apparent escalation in geopolitical risks dampened investor sentiment further.

Macroeconomic data was poor in Europe last week, with the UK and Eurozone Purchasing Managers Indices (PMIs) disappointing on Friday. Eurozone Consumer Sentiment hit an all-time low, whilst UK Consumer Confidence came in at its worst level since 1974. Bank of America’s weekly “Flow Show” report showed that investor sentiment is back at “maximum bearishness”. From the same report we can see that it’s now 32 consecutive weeks of outflows for European equity funds, shedding another $2.8 billion this week.

Some sector moves have been brutal last week in Europe, with all sectors finishing lower. Real estate was the most notable underperformer amid the interest-rate hikes. Travel and leisure stocks were also hit hard, with the move attributed in part to rising Russia tensions. (Note: European airline stocks declined sharply when day Russia first invaded Ukraine, 24 February.) With growth fears and rates rising, construction and materials stocks struggled too. Unsurprisingly, defensive stocks outperformed on a risk-off week but still finished lower (food and beverage, utilities and personal and household goods). Given the escalation in geopolitical risks in Europe, defence stocks fared relatively better. UK stocks were particularly weak, with the FTSE 250 Index closing down 4.8% last week, weighed further by the government’s mini-budget announcement on Friday.

One positive is that European gas prices continue to fall as countries continue to build their winter stockpiles. Prices are still six times higher than normal for this time of year. A Bloomberg report stated that Europe’s gas storage sites are more than 87% full.

Italian elections

On Sunday, Italy held a snap election which follows the collapse of Mario Draghi’s government earlier in the summer. The election saw a far-right coalition including Giorgia Meloni’s Brothers of Italy party win a 43% majority, which is likely enough for a parliamentary majority. This win for the far right was expected, and it made up of the Brothers of Italy, Lega and Forza Italia. Meloni is likely to be announced as the new prime minister. She has said she would respect European Union (EU) fiscal rules and tried to strike a responsible tone during campaigning, but she has suggested the EU’s €200 billion recovery plan needs to be revised given soaring energy prices.

On the issue of Russia, there is a contrast amongst the likely coalition partners, with Meloni supportive of Ukraine but Lega and Forza Italia both sympathetic to Putin.

Italian equities have been a small outperformer recently, down 2.3% month-to-date vs. the STOXX Europe 600’s 6% decline, as uncertainty surrounding Italian politics appears to be easing. The Italian 10-year bond had hit 4.3%, levels last seen in 2013, as broader macro concerns around Europe’s outlook weigh on the market.

UK mini budget

On Friday, the new UK government give a mini budget statement where a wide range of tax cuts and fiscal stimulus were announced. Some of the measures announced had been expected, but many were a surprise, notably cuts to higher and basic rate taxation. In all, the government estimates that the changes will cost about an extra £12 billion this year, £37 billion next year and £38 billion the year after that.

Separately, Chancellor Kwarteng says the energy package will cost £60 billion for the six months from October. Kwarteng also set a target of 2.5% trend growth, a level not seen since before the 2008 financial crisis. These policies seem at odds with the BoE’s effort to rein in inflation. The BoE said on Thursday that signs of excess demand would force its move faster and after Friday’s news, and the market now sees 1.25% rate rise by November, suggesting we could even see an ad-hoc announcement.

The market did not take the announcement well. The reaction was swift, with sterling closing the day down 3.5% vs. US dollar. Sterling fell further to a new all-time low of $1.0327, with the market now speculating about a large intermeeting rate hike from the BoE in a panicked effort to stabilise markets.

The gilt market saw equally extreme moves. The yield on five-year bonds jumped as much as 51 basis points to 4.07%, representing the biggest daily increase since 1992 and its biggest weekly move on record.  UK Consumer Confidence data didn’t help the market’s mood, hitting its weakest level since 1974.

United States

US equity markets slumped last week as hawkish central bank commentary and global growth fears weighed on sentiment. The S&P 500 Index came within touching distance of year-to-date lows of 3666. Sector performance saw defensive names fair slightly better than other sectors, albeit still weak. Energy names were the worst performing sector as global growth concerns dragged down the price of oil.

In terms of corporate news, a profit warning from Ford saw the automaker fall 16% last week. Following the warning from FEDEX in the prior week, this news only added to investor unease ahead of the coming earnings season.

Looking at investor positioning, the negative tone was clear. More than 33 million US puts traded on Friday, the highest single day of put volume since data began to be collected roughly 30 years ago. In addition, the Financial Times reported that the last four weeks has seen record purchases of put option contracts, protection against falling markets.

Asia

Last week was similarly poor for Asian equities, with the MSCI AC Asia Pacific Index closing the week down 3.47%, mirroring the general sell off globally, following a series of rate hikes which has seen one of the largest number of central banks raising interest rates in a single week. Globally, 10 central banks raised interest rates by over 650 bps, and the Reserve Bank of India and Bank of Thailand are expected to follow this week. The bond selloff on Thursday was blamed on Asian central bank selling of Treasuries to raise dollars for currency market intervention; the US dollar strength has impacted Asian currencies with the KRW, CNY and INR all falling through key technical levels last week.

Japan’s market closed a shortened week down only 1.5% last week—remarkably the outperformer in the region—highlighting even more the divergence in policy between the United States and Japan.

The government intervened in the foreign exchange market for the first time since 1998 to support the yen after it nearly hit 145 vs. the US dollar. The size of the intervention was not revealed, and came on the back of the Bank of Japan maintaining its dovish monetary policy, setting a short-term interest rate at -0.1% and purchasing JGBs to defend the 0.25% cap for 10-year JGB yields.

Prime Minister Kishida announced that the daily 50,000 cap of foreigners will be removed from 11 October, and that visitors will no longer need a visa to come to Japan. The coming week will see PMI data reported as well as retail sales and industrial production figures.

China’s market was another relative global outperformer, closing the week only -1.22%, as global growth slowdown fears affected sentiment. On Friday, the CNY fell to a near 28-month low and closed at 7.1284. The Peoples Bank of China, (PBOC) which sets a reference rate each trading day for the onshore CNY vs. US dollar, set the fixing at its lowest level since early Aug 2020. The onshore CNY can trade up to 2% on either side of the fixing. However, the central bank has set the fixing stronger than market expectations in every single session for almost a month, indicating China’s efforts to slow the pace of depreciation.

The Fed’s aggressive tightening has boosted the dollar at the expense of the CNY and other emerging market currencies this year. China’s surprise decision to lower key interest rates in August has also fueled the CNY’s slide.

The Asian Development Bank was the latest to downgrade its growth estimate for China to 3.3% this year from a prior 4.0% estimate. It also forecast that China’s economic growth would lag that of developing Asia for the first time in more than three decades. Beijing’s official growth target this year is about 5.5%, a level that many economists believe is unattainable.

The PBOC kept its benchmark lending rates unchanged at its monthly meeting, after unexpectedly cutting both rates in August. The yield gap between the benchmark US Treasury 10 year note and its Chinese equivalent widened to the highest since 2007.

Activity in Chinese markets is likely to slow ahead of next week’s Golden Week holiday.

Hong Kong’s equity market was the weakest of the major Asian markets, closing last week down 4.42%, despite the government’s abolishment of hotel quarantine for arrivals. Despite China’s continued zero-COVID strategy, Hong Kong has removed the requirement for pre-departure PCR tests, although arrivals still face restrictions for the first three days after arrival, as well as 12 tests (including four PCR tests) in the subsequent eight days. The Hang Seng Index fell below its 15 March lows. The Hong Kong property sector remains vulnerable after more interest rate rises were forecast and major banks raised their prime rates. Retail sales will be reported in Hong Kong in this week.

The week ahead

Holidays

Monday 26 September – Israel
Tuesday 27 September – Israel
Wednesday 28 September – Czech Republic
Friday 30 September – Canada

Macro week ahead highlights

The Italian election has garnered some attention, as Italians went to the polls on Sunday to elect their 70th government since the end of World War II. Elsewhere, European Central Bank officials will make multiple appearances over the course of a week that will be rounded off with various inflation prints across the region.

Key events

Monday 26 September – Eurozone OECD Publishes Interim Economic Outlook, Germany IFO Business Climate
Tuesday 27 September – Swedish Producer Price Index (PPI)
Wednesday 28 September – Germany, France, Sweden & Italy Consumer Confidence
Thursday 29 September – Spain & Germany Consumer Price Index (CPI), Italy PPI, US gross domestic product (GDP) & Jobless claims
Friday 30 September – UK GDP, Eurozone Unemployment Rate & CPI

Calendar

Monday 26 September

  • Spain PPI
  • Germany IFO Business Climate
  • Eurozone OECD Publishes Interim Economic Outlook
  • US Dallas Fed manufacturing survey

Tuesday 27 September

  • Sweden PPI & Trade Balance
  • US FHFA home prices
  • US Durable goods
  • US New home sales

Wednesday 28 September

  • Germany GfK Consumer Confidence
  • France Consumer Confidence
  • Italy Consumer & Manufacturing Confidence
  • US Merchandise trade balance
  • US Pending Home Sales Index

Thursday 29 September

  • Spain CPI
  • Italy PPI
  • UK Net Consumer Credit & Mortgage Approvals
  • Eurozone Economic Confidence
  • Germany CPI
  • US GDP & Jobless claims & Real consumption

Friday 30 September

  • UK CA Balance & GDP & Total Business Investment
  • France CPI & PPI & Consumer Spending
  • Germany Unemployment Change
  • Spain CA Balance
  • Italy Unemployment Rate
  • Eurozone Unemployment Rate & CPI
  • Italy CPI
  • US Personal income


Franklin Templeton Key risks & Disclaimers:

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 25 July 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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