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.
Whilst there was no real change to overall market themes last week, there were a few developments for investors to be very mindful of. The Bank of England (BoE) and, surprisingly, the European Central Bank (ECB), added to the recently more hawkish rhetoric from the Federal Reserve (Fed). Those comments weighed on equities with the STOXX Europe 600 Index closing down 0.7%. Bond yields in Europe also gapped higher on the back of the announcements. US equity markets did manage to finish higher last week, with corporate earnings taking centre stage there. The S&P 500 Index closed the week up 1.5%. Meanwhile, it was quiet over in Asia with a number of market closed for the Chinese New Year. The MSCI Asia Pacific Index did manage to close up 2.8% on reduced volume.
BoE Rate Hike and an ECB hawkish surprise
Last Thursday, we got the interest rate decision from the BoE, and the UK central bank raised rates by 25 basis points (bps) to 50 bps, which was pretty much in line with market expectations. This marked the first back-to-back hikes for the BoE since 2004, and notably, four out of the nine committee members voted for a 50 bps hike to 75 bps, which was viewed as a hawkish signal. As a result of this rate rise, UK Sterling began to climb whilst government bond yields pushed higher.
With regards to other changes from the BoE announcement, the committee unanimously voted to start shrinking the bank’s balance sheet immediately by no longer reinvesting the proceeds of Gilts, allowing more than £200 billion to run off by 2025. Note, the bank’s balance sheet currently stands at £895 billion. Also, the bank announced it would be offloading its entire stock of corporate bonds by the end of 2023, totalling £20 billion. It also raised its forecast for peak inflation to 7.25% in April vs. the previous forecast of 6%.
Interestingly, during the press conference following the announcement, Governor Andrew Bailey came across as somewhat dovish, saying that it is a mistake to assume BoE rates are on an inevitable long march up. This seemed contradictory to the message the bank was sending with the actual rate increase, which meant that the initial spike in bank stocks were short-lived. However, investors did look through Bailey’s comments into the end of the week and the banks steadied to close the week generally higher.
Money markets are now pricing in an implied rate hike of 39 bps in March and up through 1% in May, despite Governor Bailey’s comments last Thursday that he favoured moving interest rates gradually instead of delivering an unexpected shock to get inflation under control.
The ECB also announced shortly after the BoE. There was speculation prior to the policy meeting as to whether ECB President Christine Lagarde would stick to her dovish stance, despite a surge in inflation data, or whether she’d reverse engines and endorse market rate-hike expectations. The Eurozone Consumer Prices Index (CPI) number last Thursday came in at a record 5.1%.
Ultimately, the ECB left the main refinancing rate unchanged at -0.5%, upholding the December policy decision. There were no changes to the Pandemic Emergency Purchase Programme or Asset Purchase Programme. However, in the press conference, Lagarde did not stick by her December statement that the ECB would be very unlikely to raise rates in 2022 although she acknowledged that the risks to the inflation outlook were tilted to the upside. This was a new statement which the markets took as hawkish. Lagarde also refrained twice from repeating her December view that interest rates will not be raised in 2022. She did note, however, that any more advanced discussions are being left until the March meeting, when the central bank will have the benefit of having the economic projections. Importantly, Lagarde did note that the ECB will observe the sequencing (i.e,. asset purchases should end first) and that this process will be gradual.
Money markets are now pricing in about 50 bps of tightening for December, suggesting the deposit rate will be lifted to zero from -0.5% at present.
In the United States, Fedspeak and macro data did nothing to dissuade the market of the possibility of a 50 bps rate hike in March. Atlanta Fed Chief Raphael Bostic told the Financial Times that the Federal Open Market Committee (FOMC) could raise by 50 bps in March if needed to tame inflation but did not alter his own calls for three 25 bps hikes this year. Kansas City Fed President Esther George said she would prefer the Fed to be more aggressive in shrinking its balance sheet. In addition, the January US employment report, released on Friday, was also hawkish. Nonfarm payrolls came in at 467,000, which was higher than anticipated. Also, the December reading was revised upward to 510,000, which some observers think raises the possibility of a 50 bps rate hike in March. Money markets are currently predicting that fed funds rate will breach the 1% mark in July this year, potentially even getting up to 1.5% by December.
Signs of stress in European credit
European government bond yields gapped higher on the back of the central bank announcements. The hawkish rhetoric drove selling in the credit market. The German 10-year bund yield was up 25 bps and returned to positive territory for the first time since May 2019. The Italian 10-year was up 39.4 bps and the equivalent French government bond was up 27.7 bps. In the United States, the 10-year Treasury yield popped 13.9 bps. Also, it is worth noting that the US three-year note is currently yielding about the same as the S&P 500 and the five-year note is comfortably exceeding the S&P Dividend Yield. Also, the market value of negative yielding debt fell by 50% in the last week.
European credit default swaps had been widening through January, but the ECB announcement on Thursday saw an aggressive move wider. This is key to monitor going forward, particularly as the ECB winds down many of its pandemic support programmes in March. The central bank had been seen as a backstop buyer for credit issuance due to the pandemic purchasing programme, so nerves are growing in the credit space for the landscape as we progress through the first quarter.
Week in Review
European equities sold off once again on Friday to close the week lower, with the STOXX Europe 600 Index down 0.7%. It’s been three months since we had a Friday where European stock markets closed up on the day. Central bank announcements were the key focus last Thursday, with both the ECB and the BoE announcing their interest rate decisions. Corporate earnings have also been a clear focus for investors over the last few weeks; thus far, 24% of European companies expected to report have done so. Of the STOXX 600 companies reporting, 69% have beaten on earnings per share (EPS) estimates, and revenue has likewise exceeded analysts’ expectations.
Volatility remains high within European stock markets and sector performance divergence was notable again last week. Looking at sectors, banks outperformed on the week, helped by the higher interest-rate environment as macro-driven buyers continue to buy the sector. Oil and gas stocks had another strong showing last week, with oil prices creeping up towards US$100 per barrel. At the other end, retail stocks really struggled last week amid weak European retail sales data, and chemical stocks were also lower as a group, given their highly cyclical nature. Automobiles were also particularly weak last Friday following some disappointing earnings and negative corporate headlines in the space. Despite the volatility, inflows into European equities were significant last week.
On the geopolitical front, there was no significant change last week in the Russia-Ukraine situation. The United States gave the green light to move more troops to Europe and dispatch soldiers already stationed on the continent further east, seeking to send a stronger military message, alongside diplomatic efforts. Russia immediately responded by saying that this move is “destructive”. Various discussions continue with US President Joe Biden and French President Emmanuel Macron, who spoke last Wednesday night about Russia’s military buildup and “affirmed their support for Ukraine’s sovereignty and territorial integrity”. Although China hasn’t recognised Russia President Vladimir Putin’s 2014 annexation of Crimea and has urged all sides to show restraint in the present crisis over Ukraine, Foreign Minister Wang Yi told US Secretary of State Antony Blinken in a phone call last week that Russia’s “legitimate security concerns should be taken seriously and addressed”. It is worth noting that the Russian equity market has been steady and is up about 10% from its recent lows.
US equities recovered further ground last week, with the S&P 500 Index up 1.5%, the Nasdaq up 1.6% and the Russell 2000 Index up 1.7%. The week was not without drama though. Corporate earnings created some memorable moves and last Friday’s better-than-expected January nonfarm payrolls data was also a key talking point. It is worth noting that the S& P500 Index recovered back up above a key psychological level, its 200-day moving average.
Corporate earnings took centre stage last week as a number of technology heavyweights reported. Last Thursday, Meta Platforms (Facebook) closed down 26% post-earnings release. With that, it lost US$251 billion in market cap, marking the most market cap lost by a single security on a single day in the history of the stock market. The following day Amazon traded up 13.5%, and this move marks the most market cap gained (US $191 billion) by a single security on a single day in the history of the stock market.
Energy markets remain a focus with West Texas Intermediate crude oil up6.3% last week, extending its run to a seventh straight weekly gain, and logged its highest close since September 2014 as the US winter storm hit production and helped drive demand. There was also an OPEC+ meeting last week, where, as expected, they agreed to raise production by 400,000 barrels per day in March. With that move in crude oil, it was not surprising to see energy the strongest sector last week. Communication services was the worst-performing space as Meta weighed on the sector.
In terms of macro data, the main event was Friday’s January employment report, which was stronger than expected. Jobs added came in at 467,000 and the prior month’s data saw a significant upward revision to 510,000 jobs added (from 199,000 initially reported). Biden said this data demonstrated “America’s job machine is stronger than ever”.
Despite the recent recovery in equities, it is interesting to see the CNN Fear & Greed index still comfortably in “Fear” territory, suggesting nerves remain over the outlook for equities.
Looking ahead, the CPI inflation data this Thursday will be in focus, along with corporate earnings reports, including Disney, Twitter, Peloton, and Uber.
It was a quiet week in Asia with the Chinese Lunar New Year holiday shutting mainland China’s markets all week, with Hong Kong only open for a half day on Monday. That being said, the overall region had a decent move up 2.76%, albeit on reduced volumes.
For the markets that were open last week, Japan had a decent week, up 2.7% on the back of press speculation that the government is going to ease the ban on foreigners into Japan, together with reassuring comments from the Bank of Japan saying that it had no plans to modify its supportive policy.
Australia’s benchmark index closed the week up 1.89% as the Reserve Bank of Australia (RBA) exited from its quantitative easing (QE) policies, although policymakers emphasised that this did not mean that rate hikes were imminent.
In South Korea, core inflation accelerated further to 3.0%, keeping pressure on the Bank of Korea to further hike rates at its 24 February meeting as it battles to keep price rises to its 2% target. After suffering heavy outflows in the last two weeks of January, foreign buyers returned to South Korea’s market when the market reopened on Thursday, and it managed to close the week up 3.26%.
China’s equity markets closed higher today after reopening from the holiday break, mainly catching up after Hong Kong’s strong performance on Friday.
The Week Ahead
Monday 7 February: Germany Industrial Production (IP)
Thursday 10 February: US Jobless claims and CPI
Friday 11 February: UK gross domestic product (GDP) and trade balance
Monday 7 February:
- Germany IP (fell 4.1% vs expectation of -3.6%)
- US consumer credit
- China composite and services Purchasing Managers’ Index (PMI) (51.4 vs 50.5 exp)
Tuesday 8 February:
- France trade and current account (CA) balance
- Spain industrial output
- US trade balance
Wednesday 9 February:
- Italy IP
- Germany trade and CA balance
- Japan machine tool orders
Thursday 10 February:
- US jobless claims and CPI
- China money supply
Friday 11 February:
- UK GDP and trade balance
- Germany CPI
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