Notes from the Trading Desk

European markets faded last week as concerns over the impact of trade wars on global growth weighed on sentiment. However, US markets continued their grind higher as a dovish US Federal Reserve (US Fed) boosted equities. The Asia Pacific (APAC) region didn’t fare so well, with China the underperformer. Weaker Chinese macro was a culprit, despite resumption of trade talks between China and the United States.

The Digest

Central Banks’ Dovish Slant Takes Centre Stage

US Fed

During testimony on Capitol Hill last week, Fed Chair Jerome Powell left little doubt about the central bank’s intentions to ease interest rates.

Powell noted that since the last Federal Open Market Committee (FOMC) meeting in June: “Uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the US economic outlook.”

He added: “Monetary policy hasn’t been as accommodative as we thought.”

Importantly, Powell also clarified that the previous week’s stronger June nonfarm payrolls number had not changed the Fed’s views.  Powell did temper expectations of a larger 50 basis point (bps) cut, however, saying the economy was in “good shape”. Despite this, market expectations for a 50 bps cut, which had receded to 0%, spiked to 21.5% last week (based on CME Group Fed Funds futures). With a cut fully priced in, expectations of a 25 bps cut therefore stands at 78.5%.

The minutes from the June FOMC meeting also included details with a clear bias toward cutting rates soon. The ongoing trade spat with China was featured as one reason for cutting rates, with inflation and the labour market also cited.

Fed voting member James Bullard said he would argue for a 25 bps cut at this month’s meeting, but insisted the situation did not call for a 50 bps cut.

US equities enjoyed a relief rally following the dovish message last week. Markets hit new record highs after continuing to rally on Friday, even after a key monthly US inflation reading, the consumer price index, had topped expectations.

Bonds sold off aggressively, leading to the sharpest steepening of the yield curve in three years. It seems that following Powell’s testimony we have moved back towards a “good news is good” and “bad news is bad” backdrop.

The strong June employment report the previous week had spooked some investors initially as they speculated that the Fed may be less inclined to ease.

The Fed’s willingness to ease despite stronger employment and inflation data suggests some “overheating” of the economy. The dovishness appears positive for equities and negative for bonds (particularly at the longer duration), explaining last week’s moves. The US 10-year Treasury yield rose 8 bps and the German 10-year bund yield was up 15 bps on the week.

The next FOMC meeting is on July 31 and will be eagerly anticipated. It feels as though the markets will only be satisfied now with a cut of at least 25 bps.

US corporate earnings season gets underway this week, with banks the first to report. That should give us another indicator of how the economy is faring. The big focus, in our view, will be how bank operations can cope with potentially lower interest rates.

European Central Bank

The European Central Bank’s (ECB) latest minutes were also on the dovish side, showing widespread support for preparations for further easing from the central bank’s governing members. They discussed several potential measures, including the possibility of further extending and strengthening the forward guidance, restarting quantitative easing (QE ) and cutting interest rates.

However, this dovishness wasn’t enough to combat the weakness in European equities tied to concerns over a slowdown in global trade.

Second-quarter earnings season kicked off last week. and we continued to see the impact of trade concerns. In particular, Germany was hit by a number of heavyweight profit warnings.

Alongside the dreary earnings backdrop, the European Commission cut its 2020 gross domestic product (GDP) forecast to 1.4% from 1.5%, and also lowered its inflation outlook to 1.3% for 2019 and 2020.

It will be interesting to see if this theme of trade-related impacts continues as earnings season picks up pace.

Crude Oil Commentary

Oil prices were stronger last week on a combination of supportive US inventory reports, continued tensions in the Middle East and storms in the Gulf of Mexico.

An American Petroleum Institute (API) report on Tuesday was bullish, showing a drop of 8.13 million barrels the previous week. A US Department of Energy (DOE) report on Wednesday showing a 9.5 million-barrel drawdown, which was more than expected, sending oil prices to their highest levels since May.

Geopolitical turmoil in the Middle East intensified last week after Iranian vessels attempted to block a UK oil tanker in the Persian Gulf. It reportedly took the intervention of a UK military vessel to ward off the Iranians on this occasion and allow continued passage.

Finally, tropical storm Barry—briefly a Category 1 hurricane—was another support factor for oil prices as it approached the Gulf of Mexico. A number of refiners shut down operations in preparation, with 73% of US Gulf of Mexico production closed.

While all three drivers pointed towards weaker supply, in our view, the lack of improvement in the global macro picture on the demand side should not be ignored. New data this week showed the Chinese economy at its slowest rate of growth in 27 years.

Also, in 2019, oil industry bodies have been reducing their annual oil demand forecasts in the face of weaker economic data from the first half of 2019. We expect underlying commodity prices and their impact on equities to remain a focus for us over the summer as the picture continues to evolve.

Last Week

Europe

European equities traded lower on a week where central banks remained the key focus again. Markets were looking towards US Fed Chair Powell’s testimony on Wednesday and the ECB’s June policy meeting release through the first half of the week, seeking any further signal for upcoming rate changes. German equities underperformed and Greek equities also lagged on the back of election results in the country last weekend. The centre-right New Democracy party won with nearly 40% of the vote, showing Greece is moving away from the populist Syriza towards more mainstream pro-Europeans.

Looking at European sectors, oil and gas stocks led the way, with the move in oil prices offering support. Health care was the obvious underperformer amid pricing proposals from US President Trump’s administration.

Americas

US equities were stronger last week, rallying into the end of the week. Major themes were Powell’s testimony to congress and trade concerns. Unsurprisingly, energy stocks led the way up with oil prices stronger. Similar to Europe, pharmaceutical stocks underperformed after a US government decision to scrap a proposal that would have eliminated rebates from government drug plans. The US dollar was also weaker on the back of the dovish central bank theme.

Asia

APAC equities were generally weaker last week, with mainland China the significant underperformer. Concerns over a slowdown in the economy persisted as both purchaser price index and export data came in below estimates. This is a theme that has continued into this week, with Monday’s release of second-quarter GDP data showing China’s growth rate hitting a 27-year low of 6.2%.

Despite this, there was some relief in early trading on Monday after the report came out that the trade spat with the United States had not impacted growth even more.

Trade negotiations between the United States and China resumed last week, but the atmosphere did not feel particularly optimistic as the two sides remain far apart on structural issues and don’t even seem to have a clear understanding about what their respective leaders agreed at last month’s G20 summit.

Japanese equities were a little sluggish in the face of a strengthening yen last week. Australian equities also fell on the week as disappointing macro weighed. Consumer confidence there unexpectedly fell to a two-year low in June even after two recent interest rate cuts and a A$158 billion tax rebate for low/middle income earners.

Week Ahead

Economic Data

• Europe: UK jobs report and eurozone and Italian trade balance on Tuesday; UK and eurozone consumer price index (CPI) and Italian industrial orders on Wednesday; UK retail sales on Thursday; and Italian current account balance and German PPIs on Friday.
• US: Industrial production, import prices and retail sales on Tuesday; US housing starts on Wednesday.
• Asia & Pacific: Chinese industrial production and GDP on Monday; Japanese trade balance on Thursday.

 Politics

• It’s a quiet week for scheduled political events, but clearly our focus will be on trade as well as geopolitical tensions in the Middle East.

• On Tuesday, the European Parliament votes on the next European Commission president. Nominee Ursula von der Leyen has promised parliament a bigger say in Brussels’ decision-making as she seeks confirmation for the top post in Brussels for the next five years.

 Monetary Policy

• The Fed’s Beige Book is due to be published on Wednesday, plus Fed speakers are on scheduled throughout the week.

Insight from Our Investment Professionals

Where Bricks Are Beating Clicks: Implications for Last-Mile Real Estate

Many observe the impacts of e-commerce growth as decimating commercial retail properties, leaving empty big-box warehouses and strip malls in its wake. While this may be true to a certain extent, it ignores the potential opportunity this new trend is creating in the industrial property sector. It seems that for every mall that closes, a distribution warehouse—or so-called last-mile logistics space—opens. Raymond Jacobs, Woon Pin Chong and Marc Weidner of Franklin Real Asset Advisors outline the opportunities they see, namely in new demand for logistics infrastructure. Read More.

A Strong June Pulled Emerging Markets Up in the Second Quarter

Trade issues continued to dominate headlines in June, with easing in US-China trade tensions providing a boost to emerging markets overall during the month. But Franklin Templeton Emerging Markets Equity cautions trade-related headwinds could persist. The team shares its latest emerging-market outlook and explains why the small-cap space looks attractive right now. Read More.

India’s Budget Moving in the Right Direction

India’s Finance Minister Nirmala Sitharaman recently unveiled the country’s new budget, which aims to give the economy a boost via tax cuts and other measures to stimulate foreign investment. Franklin Templeton Emerging Markets Equity Director of Portfolio Management Sukumar Rajah says the fiscal math looks credible and the targets seem achievable, with the assumption of improving Goods and Services Tax compliance. He says while there are likely to be some winners and losers from an investment standpoint, overall, the government seems to be moving in the right direction to spur economic growth. Read More.

Understanding the Climate Change Challenges Facing Consumer Goods Companies

As an active investment manager with a firm commitment to integrating environmental, social and governance analysis into its investment processes, Franklin Templeton recognises its responsibility to raise awareness of climate transition issues. Working alongside the Carbon Disclosure Project, Franklin Templeton recently co-hosted a roundtable event on consumer goods companies’ preparations for the low-carbon transition. Here, Julie Moret, Head of ESG at Franklin Templeton, reports back from the event. Read More.

For timely investing tidbits, follow us on Twitter @FTI_Global and on LinkedIn.

Important Legal Information

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of July 15, 2019, 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.

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.

What Are the Risks?

All investments involve risk, including 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.

Past performance is not an indicator or guarantee of future performance.

Links to External Sites

Franklin Templeton Investments is not responsible for the content of external websites.

The inclusion of a link to an external website should not be understood to be an endorsement of that website or the site’s owners (or their products/services).

Links can take you to third-party sites/media with information and services not reviewed or endorsed by us. We urge you to review the privacy, security, terms of use, and other policies of each site you visit as we have no control over, and assume no responsibility or liability for them.

___________________________