Notes from the Trading Desk – Europe

The Digest

Global equities were mixed last week as investors looked towards the Federal Reserve’s (Fed’s) annual economic symposium at Jackson Hole in the US state of Wyoming. Chairman Jerome Powell, members of the Federal Open Market Committee (FOMC) and economists were meeting at a resort, whilst markets awaited any commentary which would allude to future interest-rate changes.

US-China trade wars also rumble on, with both China and the United States announcing retaliatory tariffs. In Europe, the focus was on Brexit and the rhetoric from Prime Minister Boris Johnson’s counterparties around the likelihood of him being able to renegotiate a new Brexit deal.

Also, Italian politics remained at the forefront after Prime Minister Giuseppe Conte resigned and fresh elections look likely. Trading volumes were poor all week in the equity markets, which ended mixed last week across the globe. The MSCI Asia Pacific Index was up 1.1%, while the Eurostoxx 600 Index was up 0.5% and the S&P 500 Index was down 1% amid a downturn on Friday during the North American trading day.¹ 

Macron and Merkel Offer Glimmer of Hope

As we know, market sentiment around UK assets has been increasingly cautious in recent months, thanks to the heightened likelihood of a no-deal Brexit. Last week, there was some respite, however, with sterling getting a small boost and domestically-exposed stocks benefitting.

It is all relative, of course, but last week we saw some more positive comments from French President Emmanuel Macron and German Chancellor Angela Merkel as they stepped away from the blanket European Union (EU) refusal to look again at the withdrawal agreement. Macron said that amendments to the agreement (and nature of the contentious Northern Irish backstop) were possible, although he did add that the backstop itself was indispensable.

Macron urged Boris Johnson to set out his proposed alternatives as soon as possible. He said he would like visibility on the UK government’s proposals within a month, echoing language Merkel used as she had highlighted how little time there was before the UK’s planned exit date of October 31.

Johnson returned to London on Thursday evening and ordered his UK ministers to draw up a new Irish border policy, hoping to avoid the UK’s departure at the end of October without a deal.

The Group of Seven (G7) summit commenced over the weekend, with the big Brexit moment being a sit-down meeting between Johnson and EU Council President Donald Tusk on Sunday. In the lead-up to the meeting, both men had called each other “Mr. No Deal”.

Tusk noted he was “willing to listen” but was not willing to co-operate in preparing for a no-deal exit. Johnson has said the UK will no longer legally owe the £39bn divorce bill should the country leave the EU without a deal, with many UK media outlets suggesting the bill could be less than £10bn. We expect further details about this meeting to come out in the coming days.

Overseas Investors Go Bargain Hunting

Despite the small pop towards the end of last week, the pound remains subdued. An emerging theme, despite the uncertainty, is the attractiveness of UK companies as merger-and-acquisition targets for overseas investors amidst the weaker currency and subdued equity markets.

This year overseas investors have made a string of notable acquisitions. These include Inmarsat, Merlin Entertainment, Cobham Greene King and Peppa Pig creators Entertainment One. It remains to be seen who will be bid for next, although the window for bargain hunting is at danger of closing at any point should a Brexit deal be announced.

What Next?

• UK Parliament is currently on recess, returning on September 3.
• The UK opposition party, Labour, confirmed it would try to bring down the government in September with a no-confidence vote, while other cross-party members of parliament (MPs) are working on plans to stop a no-deal Brexit if Johnson loses a confidence vote.
• Johnson said he would hold a general election “days after” the UK leaves the EU on October 31 if he is forced to go to the polls (should a no-confidence vote succeed against his government).
• In addition, some politicians continue to push for a second referendum on EU membership and, with all the moving parts, this cannot be taken off the table.

Will Italy be Heading to the Polls?

Italian politics is, if nothing else, consistent.

The unlikely Five Star-Northern League coalition collapsed after a 14-month reign, as Conte resigned on Tuesday of last week following a challenge from Northern League’s Matteo Salvini.

Salvini is keen for fresh elections as he is riding high in the polls and sees this as an opportunity for his party to form a government on its own. However, the veteran President, Sergio Mattarella, will be keen to avoid fresh elections as Italy needs to submit budget plans to the European Commission by October 15. With that, he has spoken to all the main parties who are exploring fresh coalition possibilities.

A Five Star/Democratic Party (centre left) coalition is one possibility, but not easy as they have feuded bitterly in the past. The president has given parties a deadline of Tuesday, August 27 to come up with a potential government.

Last Week

Europe

European equities were muted last week on poor volume as investors looked towards the G7 meeting as well as the Fed symposium at the end of the week. Italian equities outperformed the other major indexes, whilst the UK’s FTSE 100 Index lagged and the pound strengthened.

There was a mixed feel to sectors, with Travel and Leisure the week’s outperformer, whilst the banks underperformed amid a lower-yield environment. Utilities and telecomms also lagged.

The week started upbeat after a report the previous Friday noting Germany could increase fiscal spending by approximately €50bn should the country find itself facing an economic crisis. There was also a report in Der Spiegel which suggested Germany was willing to run a budget deficit should the economy enter a recession.

On Wednesday, investors rejected the world’s first 30-year bond (priced at -0.11%) as Germany failed to hit its €2bn target, with only €800m worth of demand.

In terms of data, eurozone Composite Purchasing Managers Indices (PMIs) came in ahead of estimates; however, manufacturing remained well in contraction. There was also a notable drop in economic confidence regarding the outlook for the next 12 months in Europe.

United States

US equities were on track for their first weekly gain in a month until Friday’s selloff, which came on the heels of a re-escalation in trade-war rhetoric.

Powell’s speech at Jackson Hole was the focus for the week, with market volumes very subdued in the lead-up to the event. Utilities stocks outperformed in the United States, whilst materials lagged on the week given a pullback in metals prices. The US dollar was also weaker.

The market’s decline on Friday came after China announced 5-10% tariffs on US$75 billion worth of US goods, which was in retaliation to the August 15^th announcement from the United States’ introduction of a further 10% tariff on US$300 billion of Chinese goods.

The new Chinese tariffs on US goods would commence in two batches, the first on September 1 and the second on December 15. Also, China announced it would restore the 25% tariff on US auto-related imports.

In response, the United States raised the existing 25% tariff on US$250 billion in Chinese goods to 30% and the 10% tariffs noted above to 15%. In a tweet, US President Donald Trump also encouraged US companies to start looking for alternatives to Chinese business.

The tit-for-tat nature of the trade war shows no signs of abating and August has seen a re-escalation.

Sticking to usual form, markets were seemingly given a shot in the arm as we began this week on a headline noting Trump had said China wanted to restart trade talks. As has been standard with these types of headlines, the proof will be in the pudding as all the signs from Friday suggest China, with no policy adjustments and a weak yuan, seem willing to ride this tit-for-tat situation out.

Trump is in attendance at the G7 summit in Biarritz this week, and we expect these headlines to continue in the coming days. Picking through the rhetoric in order to find any kind of substance will be the challenge facing investors. Trump is due to give a joint press conference with French President Macron on Monday.

Moving back to the Fed’s meeting at Jackson Hole, in Powell’s speech on Friday, he reiterated his previous dovish stance, saying that the Fed would act as appropriate to sustain the US economic expansion. The market did pare back expectations for a 50 basis point (bp) interest-rate cut in September, however, with economists now largely pricing in a 25bp cut.² 

Also, the FOMC notes from earlier in the week showed diverging opinions on potential rate cuts, with two members voting against a rate cut in July, whilst two members were seeking a 50bp cut to combat stubbornly low inflation.

In macro data, US manufacturing PMIs moved into contraction territory at 49.9. New orders and export sales slowed to their worst pace in 10 years. It was also reported that economic outlook for the next 12 months was also at its worst in a decade.

Asia Pacific

Last week was positive for Asian equity markets. However, we need to keep in mind that the news of fresh Chinese tariffs on US products and the subsequent series of angry Trump tweets all followed the close of the Asian markets last week.

Last week there was little macro data out and the protests in Hong Kong appeared to be peaceful, though there was more violence this weekend.

In Japan, the yen had weakened a little last week, which helped Japanese equities find some support. On Friday, we saw a July inflation figure came in below consensus estimates, with the consumer price index at 0.5% (year-over-year), lending weight to the view the Bank of Japan will likely continue with the ultra-easy monetary policy.

We would note that with the flare-up in trade-war tensions over the weekend, the yen has strengthened again, and is creeping towards levels versus the US dollar that we have not seen for some time. This is clearly thanks to the yen’s “safe haven” status among investors.

South Korean markets saw more muted gains last week as geopolitical tensions rose again when the Korean government announced it will not renew an intelligence-sharing pact with Japan.

Week Ahead

Politics

• At the start of the week, the focus is on the G7 summit. Trade wars, Brexit and Italian politics are at the forefront of investors’ minds so, in our view, any commentary around these will likely garner the most interest.

Monetary Policy

• We have speakers from the Fed (Friday), the European Central Bank and Bank of England (Tuesday)

Macro

• In Europe, we get a report on the German business climate on Monday, German gross domestic product (GDP) data on Tuesday; German and Italian consumer confidence on Wednesday; French GDP and eurozone consumer confidence on Thursday; eurozone CPIs and Italian GDP on Friday.
• In the United States, a report on durable goods orders comes out on Monday, and consumer confidence on Tuesday.
• In Asia, a Chinese industrial profits report is released on Tuesday, and Japan CPIs on Friday.

Holidays

Insight from Our Investment Professionals

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US Market Volatility and Sleepless Summertime Nights

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This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of August 26, 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.

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2.  A basis point is a unit of measurement. One basis point is equal to 0.01%.