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 saw some extreme moves in equity markets as investors digested several central bank announcements, most notably the Federal Reserve (Fed) meeting on Wednesday. Last Thursday saw a sharp selloff in global equities, as fears around central bank policy errors regarding a stagflation environment weighed on sentiment. The ongoing COVID-19 lockdown in China and the Russia-Ukrainian war heightened investor uncertainty. In that context, all markets traded lower last week, with the MSCI World Index down 1.2% (down 14% year-to-date), the STOXX Europe 600 Index down 4.5%, the S&P 500 Index down 0.2% and the MSCI Asia Pacific Index down 2.7%.
Central Banks in Focus
Fed: Last Wednesday’s announcement was largely in line with market expectations, as the Fed increased interest rates by 50 basis points (bps), taking the fed funds rate to 1% (as expected). The US central bank also set out plans to reduce its balance sheet. This was the first time it had raised rates by 50 bps since 2000, and the first time since 2006 rates were raised in back-to-back meetings. The Fed now aims to get back to its “neutral interest rate” between 2% and 3%, although Chair Jerome Powell said a neutral rate was “not something we can identify with any precision”.
Regarding the Fed’s US$9 trillion balance sheet, it announced quantitative tightening at US$47.5 billion runoff (marginally higher than consensus) starting on 1 June (marginally later than expected, likely offsetting the faster initial pace) rising to US$97.5 billion after three months (broadly in line with expectations).
Looking ahead, Powell said 50 bp rate increases would be “on the table for the next couple of meetings” but, when asked about a larger increase, he said the Federal Open Market Committee (FOMC) was not “actively considering” a 75 bp rate hike.
US markets initially focused on the comment to rule out future 75 bp hikes as dovish and, last Wednesday saw a knee-jerk 3% rally in the S&P 500 Index, only for it to reverse the following day as investors appeared to shift focus to the overall hawkish path ahead in a difficult economic context. On the economic outlook, the Fed feels that the US economy is strong enough to withstand the measures it is taking. However, US Treasury Secretary Janet Yellen said Powell would need to be “skillful and also lucky” to see the US economy have a soft landing.
Bank of England (BoE): Following on from the Fed rate increase last Wednesday, the BoE announced its interest-rate decision on Thursday. Consensus was for a 25 bp rate hike and the BoE didn’t disappoint, raising the benchmark rate by 25 bps to 1%—the fourth consecutive rate rise. Interestingly, six monetary policy committee members voted for 25 bps and the remaining three for 50 bps, giving the announcement a slightly hawkish feel (compared to the FOMC, which many thought had a slightly dovish feel to it). In the press release, there was some (depressing) commentary warning of growing recession risk, and the BoE also forecast inflation to hit 10% by the end of the year (the highest rate since 1982).
However, some have been questioning the BoE’s (very bearish) gross domestic product (GDP) projections, which are at odds with the Bloomberg consensus and, importantly, the United Kingdom’s own Office for Budget Responsibility (OBR). Maybe the BoE is being overly (or ”conservatively”) pessimistic, or maybe the market consensus is being overly optimistic. Either way, it seems there is a very rocky road ahead and we are at the mercy of geopolitical and pandemic developments.
European Central Bank (ECB): The focus will now turn to the next ECB meeting on 9 June. The change in rhetoric from ECB members has been notable, with a much more hawkish stance. Last week, Austrian Central Bank Governor and ECB Governing Council member Robert Holzmann said the ECB planned to discuss an interest-rate rise at its June meeting and will “probably do it.” The market now is factoring in three ECB rate hikes this year.
The Week in Review
Last week global equities made new year-to-date lows, so unsurprisingly it was a tough week for European equities. The STOXX Europe 600 Index declined 4.5% on the week. Clear headwinds included central banks raising rates into stagflation and a gloomy outlook from the BoE, causing growth and consumer stocks to buckle. Once again, the dispersion between sectors was extreme, with energy remaining one of the few hideouts, up 3.2% last week amid higher crude oil prices and positive earnings reports. Consumer products (particularly luxury goods) and real estate slumped.
It was another big week for corporate earnings, with the energy space the clear beneficiary of some good numbers (e.g., BP and Shell). In contrast, the market was unforgiving on any earnings misses, particularly so with consumer stocks (e.g., Adidas).
Once again, we saw outflows from European equities, continuing the streak.
In Ukraine, the Russian advance in the east made marginal gains, and with no mention of peace talks anymore, a long, drawn-out campaign into the summer seems probable. The impact of this on commodity and food prices is clear. Of note, fertilizer prices are now at all-time highs. In addition, the impact on supply chains was highlighted when German car manufacturer Volkswagen stated it had “sold out” of electric cars for 2022 after supply chain bottlenecks hit production.
Looking to other asset classes, European credit continues to show signs of stress amid fears over the region’s economic outlook. In addition, since 2020 the ECB has backstopped credit markets with its asset purchasing programme; as it is set to conclude in the second half of 2022, there are serious concerns over the impact of its disappearance from the market.
One of the big stories last week was the slump of the UK sterling, which fell 2.5% last week. The gloomy BoE message triggered the move, as downside risks to growth continue to rise even as the UK Consumer Prices Index (CPI) is expected to rise above 10%.
European government bond yields continue to sharply widen, with the German 10-year bund going from negative territory in March, up to 1.13%. Peripheral yields have also widened, with the spread between 10-year BTPs and bunds crossing 200 bps. This will be a concern for authorities in Italy, as its economy is heavily exposed to Russian energy imports.
Macro data for the region was mixed last week. Eurozone Purchasing Managers’ Index (PMI) manufacturing data was a little better than estimated at 55.5, but new orders had the lowest reading since June 2020. German year-over-year March factory orders also dropped far more than expected. The consumer has also been under pressure, with retail sales in Germany falling unexpectedly in March.
The S&P 500 Index closed last week down 0.2% to record its fifth consecutive weekly loss, its worst run since 2011. The tech-heavy Nasdaq Index also fell 1.3%, now with five straight weeks of >1% declines. Risk-off sentiment was clear when we look at fund flow data, which showed continued US equity outflows. Focus for the week was on the Fed announcement, which initially sparked a rally in equity markets with a couple of dovish signals. The deterioration in macro datapoints was cited as the reason behind the subsequent selloff in global equities, as data out of China and Europe disappointed. Despite the dramatic moves last week, there was no sharp rise in the VIX Index, which closed at 30.19.
Meanwhile, the April US employment report was roughly in line with expectations, with 428,000 jobs added. However, there were a couple of misses within the report. There was a decline in household employment and labour-force participation, which raised concerns on the future growth of the jobs market.
US equities were very mixed at a sector level last week. Energy closed the week with strong gains helped by the rally in oil prices on the prospect of a European Union (EU) embargo on Russian oil, as well good earnings. Utilities and communication services also fared relatively well last week. At the other end, real estate investment trusts (REITs) underperformed, closing the week lower with interest rates on the rise and as US Treasury yields moved higher. Consumer discretionary stocks were also weak, with retailers under pressure. The Goldman Sachs Non-Profitable Technology Index traded down on the week as well.
Meanwhile, earnings season remained in full force, with nearly 90% of the S&P’s market cap having reported first-quarter earnings. So far, we are seeing more companies beating expectations than missing. Value and growth stocks are delivering similar revenue growth as in the first quarter; however, value stocks are delivering stronger earnings-per-share (EPS) growth. Within the United States, more globally oriented companies are delivering faster earnings growth than their more domestically oriented peers.
In terms of credit markets, the US 10-year Treasury bond crossed 3%, rising to levels last seen in November 2018. Global credit markets remain under pressure, driven by fears of slowing economic growth, faster inflation and subsequent interest rate rises. Last week was the fifth consecutive week of losses for credit markets, the longest losing streak in more than three months.
Although markets in China and Japan were closed for most of last week amid holidays, the week was marked by declines.
China’s market reopened on Thursday and declined on Friday. The government’s strict zero-COVID policy continues to hit economic growth, jobs and the entire supply chain. As a guide to how impactful the restrictions have been, spending over China’s five-day Labour Day holiday plummeted 43% from a year earlier to CNY 64.7 billion, or roughly US$9.8 billion. This follows the Caixin and official purchasing managers’ surveys, which showed manufacturing and services contracted at a significant rate in April.
US-China relations continue to be stretched, as US regulators added more than 80 companies to an expanding list of firms that face possible expulsion from American exchanges because of Beijing’s refusal to allow access to the businesses’ financial audits. Also, investors continue to be wary of possible sanctions on China over their tacit support of Russia, with Chinese regulators holding emergency meetings with domestic and foreign banks to discuss how they could protect the country’s overseas assets from US-led sanctions.
Later in the week, the market sold off as the government reaffirmed its commitment to a zero-COVID strategy, and amid the Fed’s rate hike and bearish BoE outlook.
Yields on Chinese government bonds declined after the People’s Bank of China said it would use incremental policy tools to support steady economic growth and stabilize employment and prices. The CNY weakened slightly against the US dollar from the prior week as corporates rushed to hedge after the currency slumped 4% in April, its steepest monthly drop since foreign exchange reforms in 1994.
Japan’s market closed the week up 0.58% despite the holidays and the volatility induced by the Fed’s decision to implement the first 50 bps raise since 2000. The yield on the 10-year government bond rose to 0.24%, from 0.21% at the end of the previous week. The yen finished the period slightly weaker, at around JPY130.51 vs. the US dollar, continuing to hover at a two-decade low.
Elsewhere, in Australia the Reserve Bank of Australia raised rates by 25 bps to 35 bps last Tuesday, and short-dated bonds traded off hard as a result.
The Week Ahead
In Europe, focus ahead will be on the German ZEW economics expectations survey, the UK Sterling and Eurozone Industrial Production (IP) reports. Rhetoric from the ECB will continue to be a focal point ahead of its June meeting. Elsewhere, US and Chinese Inflation data on Wednesday will be closely watched.
In terms of politics, commentary around the proposed EU ban on Russian oil imports will be important to track, given the potential economic impact.
Monday 9 May
- UK BRC sales LFL
- French trade balance
Tuesday 10 May
- Germany ZEW Expectations Survey
- Italian IP
Wednesday 11 May
- German CPI
- US CPI
- China CPI
Thursday 12 May
- UK GDP
- UK imports and exports
- US Producer Price Index (PPI)
Friday 13 May
- French CPI
- Spanish CPI
- Euro area Industrial Production
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