Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what their 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.
Equity markets in the United States and Europe paused for breath last week as familiar themes dominated. US Federal Reserve (Fed) Chair Jerome Powell’s testimony at Congress was in focus and concerns over the COVID-19 Delta variant remained front and centre. Corporate earnings were also a talking point. Asian markets fared better following the recent reserve requirement ratio (RRR) cut in China. On the week, the MSCI World Index was down 0.9% the S&P 500 Index down 1%, the Eurostoxx 600 Index was down 0.6% and the MSCI Asia Pacific Index was up 1.4%.
COVID-19 Update: Freedom Day in the UK – Waning Optimism?
The spread of the more transmittable Delta variant has increasingly become a focus for investors, particularly in Europe. The United Kingdom has recorded around 50,000 new daily cases for the last three days and cases in the eurozone are trending higher again. Testing levels in the United Kingdom have so far exceeded Europe, so the true number of new cases in Europe may even be higher. Crucially, hospitalisation rates remain low and with that, UK Prime Minister Boris Johnson is pushing ahead with today’s “Freedom Day” and the end of social distancing rules (England only). There is some unease from experts. UK Chief Medical Officer Chris Witty said hospitalisations could “get scary” given cases are expected to hit 100,000 a day in August.
UK “Pingdemic”: High-frequency economic activity data doesn’t show any slowdown from the Delta wave, but with over 500,000 people in the United Kingdom being “pinged” by the National Health Service app last week to self-isolate (10 days), this could change in the coming weeks. We are seeing many reports of economic impact; for example, automaker Nissan had to suspend production at its manufacturing plant in Sunderland at times due to high numbers of staff self-isolating. This issue gained greater scrutiny over the weekend as UK Health Secretary Sajid Javid tested positive and both Boris Johnson and Chancellor Rishi Sunak initially tried to avoid self-isolation before public uproar prompted a u-turn. The economic impact of this will be something to watch for.
As we have said before, we feel if the UK economy can stay open through all this, it sets an important precedent to other regions. If restrictions have to be reimposed, something the UK government has said it will not do, then clearly this would be a major blow for sentiment. There is recent European precedent for the reimposition of restrictions, however. As we mentioned last week, the Netherlands reversed easing of hospitality rules after two weeks due to soaring cases. In addition, we just saw in a headline: “French minister says France cannot exclude re-imposition of COVID-19 curfews as cases rise”. This is particularly toxic for the travel and leisure industry.
One article in the Financial Times this past weekend dubbed today “Surrender Day” rather than Freedom Day, although the coming weeks will tell us the reality.
Powell Sticks to Dovish Stance
An interesting week for Fedspeak last week as Chair Jerome Powell testified at Congress. He stuck to the narrative that inflation is transitory, and we should not read too much into individual macro data points or forecasts.
He also said that the recent pricing pressures are a “shock going through the system associated with the reopening of the economy and it’s driven inflation well above 2%, and of course we’re not comfortable with that.” Again, he reiterated that much of the price increase are in specific parts of the economy, such as used cars, and expects those to be transitory, while also acknowledging that other things might see price increase that take their place.
However, he did state last Thursday that the uptick in inflation has been larger than many expected, and that while Fed policymakers have the tools to address it, they need to understand if it will pass through quickly, and whether they need to act.
US inflation data last week was higher than expected. The month-on-month (m/m) Consumer Price Index (CPI) came in at 0.9%, and year-on-year (y/y) CPI came in at 5.4%, the highest reading since 1991. However, much of the drivers were transitory factors, such as used cars, so the debate over inflation rages on.
Bank of America (BofA) Fund Managers Survey
Some interesting data points from this month’s BofA Fund Manager survey. In terms of the macro picture, global growth expectations from respondents appears to have peaked, but only 3% see a bear market in the next six months. On Fed policy, a clear majority of respondents feel inflation is transitory (70%), and 70% think the Fed will signal tapering plans by September. From a European perspective, we think the survey suggests European equities are still in vogue. Allocation to eurozone equites increased to net 45% overweight of respondents, the highest since January 2018. In addition, it was the third month respondents were overweight UK equities, after being underweight for seven years (albeit small).
Week in Review
European equities stumbled a little last week, ending down 0.6%. Fed commentary was a driver for sentiment as Powell stuck to his dovish narrative, but the spread of the Delta COVID-19 variant in Europe was also a factor. This was clear to see in European country and sector performance. Tourism-exposed Spanish and Portuguese equities slumped whist defensive Swiss equities outperformed. In term of sectors, travel and leisure was the was worst-performing on the week.
Looking at broader sector performance, it felt like the reflation/value trade paused for breath, with media and food and beverage stocks outperforming. The laggards were oil and the travel and leisure industry, both down. Reflation/value spaces lagged, with resources, automobiles and banks all down last week.
There was some respite for travel and leisure, with the airliners perking up on hopes that US President Joe Biden may allow Europeans to visit the United States soon. We just had comments from Biden indicating his COVID-19 advisers are considering lifting travel prohibitions from Europe. Biden has said a decision about lifting the ban is in process, and he expects an answer in the coming days, following his recent meeting with German Chancellor Angela Merkel.
Looking at central bank action in Europe, there were hawkish comments from another Bank of England (BoE) member, and a UK parliamentary committee also pushed the BoE to explain its super- accommodative policy. On Thursday of last week, Economist Michael Saunders joined Deputy Governor Dave Ramsden in noting that both growth and inflation in the UK economy have exceeded the central bank’s latest forecasts in May. Ramsden said last Wednesday he could “envisage those conditions for considering tightening being met somewhat sooner than I had previously thought”. In addition, The House of Lords economic affairs committee, which includes former BoE Governor Mervyn King, said last Friday that the BoE had failed to justify its flagship quantitative easing (QE) policy.
Major US indices were lower across the board last week, with the S&P 500 Index down 1% as cyclicals underperformed defensives. With this, the small/midcaps also underperformed; the Russell 2000 Index was down over 5% last week. The utilities were the clear outperformer, followed by consumer staples and real estate investment trusts (REITS), all part of the cyclical/defensive rotation.
On the macro front, the US consumer outlook was disappointing despite a rebound in retail sales in June. Rising inflation has dented optimism, with US CPI jumping to a 13-year high of +5.4% y/y in June. Powell did try to address this, as discussed. Interestingly, US Treasuries rallied despite the strong inflation print, as the typical negative correlation between inflation and bond prices has broken down, especially when it comes to longer-dated debt. The US 10-year fell sharply, down 6.9 basis points7 on the week. Updated data from the Commodity Futures Trading Commission (CFTC) showed a large fall in the level of short positions in US 10-year Treasury Futures, suggesting there was some covering going on here.
Political tensions remain in focus after the US government issued a “business advisory” last Friday, focused on warning US companies of the risk of doing business in Hong Kong. The advisory warned of a number of risks related to data security and the national security law imposed by Beijing on China last year, as well as a new Chinese law allowing sanctions to be imposed on anyone who aids other nations in implementing sanctions against China. Biden also imposed new sanctions on seven senior Chinese officials working in Hong Kong.
The APAC region outperformed last week, with the Hang Seng Index the clear winner, up 2.4%. All major indices saw gains on the week, with Australia’s market up 1% even as COVID-19–related lockdowns in Sydney and Melbourne were being tightened. There were other worrying developments on the pandemic front. Indonesia became a new epicentre for the region as the country’s daily cases surpassed India’s. Cases in Malaysia and Singapore reached record highs, and Singapore saw the most daily infections since April 2020. Thailand reported an average of 7600 cases after reopening Phuket to tourists, more than the total cases seen in the entire of 2020. Tokyo is particular focus given the decision to go ahead with the Olympic Games, which begin this Friday. Tokyo saw the highest number of cases since January last week and organisers have said that 55 people taking part in the games in various capacities have tested positive since 1 July. Public opposition to the games remains high in Tokyo.
Looking at macro data China’s second quarter gross domestic product (GDP) saw a modest recovery at +1.3% quarter-on-quarter, higher than expectations and up from a revised +0.4% in the first quarter. Retail sales rose 12.1% in June, but this is compared with 12.4% in May and 17.7% in April, and highlights an uneven economic recovery, with consumer demand still weak. Chinese Premier Li Keqiang reiterated the government’s plans to refrain from “flood-like” stimulus measures, with any loosening of policy threatening to undercut policies introduced last year to reduce leverage and protect against bond defaults.
In other news, last week China launched its emissions trading system (ETS), adding to a big week for carbon markets around the world. On Wednesday, the European Commission announced major reforms to the European Union (EU) ETS and confirmed plans to introduce a carbon border adjustment mechanism (CBAM). CBSM is a tool to impose fees on carbon emissions linked to imported goods in order to level the playing field between overseas companies and those paying for their carbon under the EU ETS. The same day, the United States hinted that it would follow suit with a CBAM as part of its US$3.5 trillion budget plan. Continuing on the sustainability theme, the Bank of Japan announced that it would offer zero-interest loans to banks investing in emissions reduction.
Finally, the Reserve Bank of New Zealand announced that it would end its quantitative easing programme this month, citing more persistent inflationary pressure. This was evident in the June inflation print, which came in at 3.3%, above the central bank’s target band.
The Week Ahead
Corporate earnings will dominate newsflow in Europe and the United States this week. Another focus will be the European Central Bank (ECB) meeting on Thursday.
Events: ECB (Thursday), ECB decision on lifting bank dividend caps (Friday); US second-quarter technology earnings (all week)
US Data: National Association of Home Builders (NAHB) housing index (Monday); housing data (Tuesday & Thursday); leading index (Thursday); jobless claims (Thursday); flash Purchasing Managers’ Index (PMI) (Friday)
Europe Data: Euro-area consumer confidence (Thursday); France business confidence (Thursday); Euro- area & UK flash PMI (Friday); UK retail sales & consumer confidence (Friday)
Asia Data: Japan CPI (Tuesday); China loan prime rate (Tuesday)
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