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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. 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

Last week was quieter in terms of newsflow and volumes as we had a few different holidays throughout the week to contend with, notably in the United States, United Kingdom and China. May month-end did see elevated volumes thanks to a MSCI reweighting. Aside from that, a cautious interview with JPMorgan CEO Jamie Dimon was one of the few highlights. Market performance lacked direction, and most markets drifted lower, with the MSCI World Index down 0.8%, the S&P 500 Index down 1.2%, the STOXX Europe 600 Index down 0.9% and the MSCI Asia Pacific Index up 1.3%.

European Central Bank (ECB) in focus this week

All eyes are on this Thursday’s ECB meeting after last week’s Eurozone Consumer Price Index (CPI) data came ahead of expectations at 8.1%, putting further pressure on the ECB to rein in inflation. Market consensus is that the ECB will terminate the net asset purchase programme in June and start raising interest rates in July (the policy rate is currently at -0.5%). The key will be President Christine Lagarde’s press conference and any clues around the likelihood of a 50-basis-point (bp) interest rate increase in July instead of 25 bps. The market is pricing in nearly 1.25% of rate hikes by the year end; as the ECB is behind the Bank of England (BoE) and the Federal Reserve (Fed), there is pressure is on Lagarde to outline the path ahead.

With the ECB’s €20 billion-per-month asset purchasing programme winding down, the impact on European bond yields will be closely watched. Since 2014, the ECB has bought €4.9 trillion of bonds, more than half of the €8.8 trillion assets making up the ECB balance sheet.

Italian bond yields will be of particular interest given the high debt levels and volatility. The Italian 10-year yield (3.37% as of this writing) is at levels last seen in 2018. In addition, the spread between German and Italian 10-year government bonds is now at its highest levels since 2020, comfortably over 2%. With that in mind, the ECB’s Governing Council is reported to be working on proposals to create a new bond-buying programme in order to tackle any extreme moves in debt market. The pressure on peripheral yields will be a key dynamic to watch as the ECB embarks on policy tightening.

The week in review

Europe

Equities traded down 0.9% on a very quiet week for markets in Europe. With US markets closed last Monday, UK markets closed last Thursday and Friday, and Asian holidays through the week, volumes were significantly lower (aside from the month-end MSCI rebalance). Market-moving newsflow has also been scarce, with most of Europe now focused on this week’s ECB policy meeting and announcement (9 June).

There were a few data-point misses in Europe last week, with the Eurozone Services Purchasing Managers’ Index (PMI), French industrial output, German trade surplus and Italian PMIs all weaker than expected. Importantly, earlier in the week, the latest Eurozone CPI report showed inflation had risen to 8.1%. Unfortunately, the week brought an acceleration again in European equity fund outflows—while in contrast, US equity funds saw inflows.

Last week, the European Union (EU) agreed a deal to partially ban the import of Russian oil and products, with concessions for Hungary. The EU reached consensus on measures that would affect Russian oil and petroleum products, around two-thirds of the ~4 million barrels per day of Russian exports. Specific details of the agreement are still being finalised, but the plan is reportedly to bring the ban on oil into effect within six months and on refined products within eight months. Hungary and other landlocked European nations will still receive oil via the Druzhba, which is world’s longest oil pipeline, transporting ~700,000 barrels per day.

However, the bulk of oil via Druzhba flows to Poland and Germany, both of which have already committed to halting Russian crude oil purchases. The EU agreement, combined with measures imposed by individual countries and companies, will eventually cut off ~90% of Russian exports. One key question is whether the EU will also impose restrictions on the provision of insurance and related services to ships transporting Russian crude oil, greatly restricting Russia’s ability to redirect crude previously destined for Europe to buyers in India, China and elsewhere.

United States

US equities traded lower last week as investors continue to fret over the growth of the economy. The S&P 500 Index traded down 1.2%, after snapping seven weeks of losses the previous week. It was a holiday-shortened week, with US markets closed last Monday for Memorial Day. Sector performance was mixed. Energy was the outperformer amid higher oil prices, as OPEC+ production hikes underwhelmed the market, and the EU agreed to a partial ban on Russian oil. In addition, Shanghai’s recent easing of COVID-19 lockdown restrictions was seen as likely to boost demand. At the other end, health care stocks lagged last week.

The key market themes we have seen recently continued to persist, with inflation at stubbornly high levels. Yet, last week, the Beige Book seemed to hint that inflation was moderating slightly, with price increases in some districts appearing to abate. With companies passing on costs on to customers, the report noted consumer pushback, as some either made smaller-volume purchases or purchased less expensive brands.

In terms of interest rate hikes, market expectations are still for 50 bp hikes in June and July, with September acting as an important pivot point. Atlanta President Bostic said that a 25 bp or 50 bp hike should remain an option in September if inflation is too high, but admitted it would “make sense” to pause, depending on the economy. On the other hand, Governor Waller supported 50 bps hikes for “several” meetings and agreed with market pricing of around 2.5% total rate increases this year, which would be consistent with 25 bps hikes from September onward, bringing the year-end rate above his neutral estimate of 2%-2.25%.

One of the more notable themes last week was the rather downbeat commentary from corporate CEOs. Elon Musk announced that Tesla would be cutting 10% of its staff and applying a global hiring freeze. He stated in an internal email that he had a “super bad feeling” about the economy. Earlier in the week, JP Morgan CEO Jamie Dimon said that a hurricane was bearing down on the economy. He noted there were “big storm clouds” coming and encouraged attendees at the financial services conference to “brace yourself”. His comments got some traction in the market on Wednesday, triggering a 2% selloff. However, there was some more upbeat commentary from companies, too. American Express CEO Stephen Squeri said he did not expect a recession and did not expect defaults to rise to pre-pandemic levels in 2022.

There were a few notable data reports last week in the United States. The May employment was the highlight, with nonfarm payrolls coming in at +390,000, ahead of expectations. The unemployment rate came in at 3.6% (slightly higher than expected) and the labour force participation was up a touch to 62.3%. Despite the robustness of the report last week, there is a view, alongside the announcement from Elon Musk regarding Tesla trimming its staff, that the US labour market could be about to turn as companies worry about future growth.

May’s ISM Manufacturing survey was also out last week. The report showed demand remained strong and inflation was not waning; 94% of ISM manufacturing industries reported paying increased prices for raw materials. The story told by the panelists’ commentary was still one of broken supply chains and shortages.

Asia-Pacific

Last week finished on a positive note for Asian markets, with the MSCI Asia Pacific Index up 1.27% and Japan’s benchmark index up 3.66%, the best regional performer.

Japanese equities rallied as strict border controls there were eased, and China decided to allow segments of the economy to reopen. The daily number of visitors allowed to arrive in Japan was increased to 20,000 (vs.10,000 prior) and, from 10 June, tourists will be allowed back, albeit under somewhat strict rules. Bank of Japan (BoJ) Deputy Governor Masazumi Wakatabe reiterated the bank’s commitment to monetary easing, if required, stating that it is necessary for the BoJ to persistently continue with monetary easing and to not rule out taking additional easing measures without hesitation. This statement helped market sentiment.

China’s markets had a better week, albeit shortened by the Tuen Ng Festival holiday last Friday, closing the week up 2.1%. Better PMI data offered support, along with Beijing’s unveiling a raft of support measures to cushion an economic slowdown the country’s zero-COVID policy triggered. In addition, COVID-19 restrictions eased in Beijing last week, with public transport reopening and entertainment venues opening on a limited capacity.

On the macro front, the Caixin/Markit Manufacturing PMI rose to a stronger-than-expected 48.1 in May from 46.0 in April, when it hit its lowest level in 26 months. The latest Caixin/Markit reading reflected a similar improvement in the official manufacturing PMI in May, which also beat forecasts and signalled that the worst of the country’s lockdown-related disruptions was over.

Finally, earlier in the week we saw some interesting intelligence from Bloomberg, which reported global funds have turned net buyers of China stocks.

Hong Kong’s equity benchmark was up 1.9% in a holiday shortened week. Sentiment improved on Shanghai’s gradual exit from lockdown, while details of Beijing’s new stimulus measures added to the optimism. Reopening names performed well amid an easing of COVID restrictions in Bejing and Shanghai.

South Korean equities closed the week up 1.2% in an election week; it was pretty much a clean sweep for the ruling party. Index-provider MSCI’s month-end rebalance helped drive foreign money into the KOSPI, as investors turned to risk-on mode after US macro data showed moderation in inflation pressure and firmer US dollar/South Korean won. Additionally, China’s reopening helped investors gain confidence in the market and China-related plays.

The week ahead

Expect a quiet start to the week for European markets, with several markets closed for Whit Monday. As discussed above, the main event in the region is Thursday’s ECB meeting. In terms of macro data, German Industrial Production (IP) should shed light on the impact from supply chain disruption.

Market holiday on Monday 6 June for several countries: Austria, Denmark, Hungary, Norway, Sweden, Switzerland.

Elsewhere, Friday will see inflation data from a number of major economies with the United States, China and Japan all releasing CPI or Producer Price Index (PPI) data.

Monday 6 June

  • Chinese Caixin PMI composite and service
  • Euro area: Sentix investor confidence

Tuesday 7 June

  • RBA rate decision (survey +0.25 bps to 0.6%)
  • US trade balance
  • Germany factory orders
  • Spain IP
  • UK PMI services/PMI composite output

Wednesday 8 June

  • Japan GDP
  • Germany IP
  • Italy retail sales
  • Euro area: GDP (first quarter final)

Thursday 9 June

  • Chinese trade balance
  • UK RICS house price balance
  • ECB deposit facility rate/end of net asset purchases

Friday 10 June

  • US CPI
  • China CPI and PPI
  • Japan PPI
  • University of Michigan Sentiment survey
  • Italy IP


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 23 May 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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