Notes from the Trading Desk – Europe

The Digest

Sentiment across global equity markets was broadly risk-on last week, with COVID-19 vaccine hopes driving moves higher midweek. This helped the STOXX Europe Index 600 close the week up 1.6%, whilst the S&P 500 Index gained 1.2%.¹ The MSCI Asia Pacific was the underperformer, closing the week flat, as  weakness in Mainland China and Hong Kong was a drag.

Results published in the New England Journal of Medicine showed that a potential vaccine (mRNA-1273), produced antibodies in all patients tested within an initial safety trial.² The UK press also came out with a positive report on the potential for Oxford University and AstraZeneca’s vaccine. Outside of this, it was fairly quiet on the macro front.

In Europe, the focus fell on European Union (EU) Recovery Fund negotiations.

EU Summit: Is an Agreement on the Horizon?

The latest EU summit began last Friday and has continued through the weekend into the start of this week (despite being scheduled to end on Saturday) with deep ideological differences forcing the continuation. Equity volumes were subdued on Friday of last week as investors waited to see the outcome of the talks. Member states are working towards an agreement on the €750 billion recovery fund and €1 trillion budget. As we would expect with the EU, things are never smooth, and there have been a number of headlines about discord within the group. Germany, France and Italy are all behind the plan as it stands (which is clearly positive), whilst the so-called “frugal four” (Austria, Netherlands, Denmark, and Sweden) have been dragging their feet; they are pushing for downsizing of the fund, a different allocation of grants and loans and more conditionality.

Ahead of the meeting, German Chancellor Angela Merkel warned the four that Germany (backed by Italy) would vehemently oppose any sizable cuts to the plans and that continued opposition puts the recovery (and potentially even the single market) at risk—strong words from Merkel, clearly assigning blame if agreement cannot be reached.

The headlines over the weekend suggested that divisions remain, with a marathon round of negotiations breaking up in the early hours of Monday and to resume later in the afternoon. Finland joined the initial frugal four over the weekend in suggesting a reduced €350 billion in grants (vs. loans), whilst Germany and France were sticking with their demands for €400 billion.

However, there are reports this morning that the hardliners are willing to accept €390 billion in grants (vs. an initial €500 billion) alongside suggestions that this is what European Commission President Charles Michel is planning to propose. This does sound like it could be a workable compromise, although Dutch Prime Minister Mark Rutte warned that discussion could still fall apart despite this progress.

Ahead of the event, investment-bank analysts thought there was a small chance of agreement at the summit, but that it was likely too early and another extraordinary summit may be needed (something Merkel also echoed at the beginning of the week). This would likely take place at the end of the month.

The euro pushed on in early trade today, after making four-month highs last week. The currency has moved towards testing year-to-date highs, suggesting that investors see an agreement likely to be  reached and that risks are skewed heavily towards the downside should one not materialise. Chances of an agreement not being reached this month do seem low, especially given the message of solidarity tied up within the joint recovery fund and the implications for the long- term health of the euro area should member states not manage to come together.

There were a couple of snippets on investor sentiment around this in last week’s Bank of America Merrill Lynch Fund Manager Survey as eight out of 10 participants think the European Recovery fund is positive for European assets, again suggesting that risks are heavily skewed to the downside if nothing is agreed upon.

We’d also note that although it marks a step forward, the recovery fund would amount to increasing jointly guaranteed debt from 7.5% of total eurozone sovereign debt to just over 14% in 2024.¹ Not as significant as some of the excitement suggests?

Week in Review

Europe

After struggling earlier in the week, European equities got a boost on Wednesday after a UK journalist reported positive news was forthcoming on initial trials of a vaccine at Oxford University. Data to be released this week from the university are expected to show the initial trials of the vaccine seem to be producing the correct antibodies and T-cells required to fight the virus. This headline also came on the back of positive vaccine data from Moderna in the United States. With this positive news in the COVID-19 fight, the STOXX Europe Index 600 rallied to close Wednesday higher.

Airlines outperformed as part of the aforementioned move, with travel and leisure the leading sector on the day. Looking at other sectors, chemicals outperformed, with a number of positive pre-announcements in the space. Real estate was the underperformer as landlords have struggled to collect rent in the current climate. Technology was the other sector in the red, in sympathy with the pause for breath seen in the big US technology names.

Hopes for an agreement on the EU Recovery Fund also helped, pushing the euro to four-month highs.

Last was a quiet week on the  macro data front, but we did see eurozone industrial production for May come in ahead of expectations. Whilst this is backward looking data, seeing the  reading +12.4% month-on-month does suggest we are seeing a reasonably solid rebound. It’s also worth noting that the Citi economic surprise index is continuing to move higher, now at just -7 and almost back to pre-pandemic levels.⁴

European Central Bank (ECB): No Change, Lagarde Reassures

We also heard from the ECB last week, but there was little of interest and no change in policy. The focus fell on the press conference, where ECB President Christine Lagarde pushed back against commentary from ECB board members that the central bank “doesn’t necessarily need to use the full Pandemic Emergency Purchase Programme (PEPP) envelope”. Lagarde said that the ECB will use the full PEPP package unless there are significant upside surprises.

She also highlighted the importance of “flexibility” in the PEPP programme and whilst convergence to the capital key will take place “at some stage”, the ECB will not let this get in the way of its policy objective. On economic outlook, Lagarde highlighted the sharp recovery in May/June data, signaling that the contraction in this year’s second quarter should be broadly in line with the central forecast.

United States

In the United States last week, we saw both the S&P 500 Index and the Dow Jones Industrial Average (DJIA) edge higher, as the aforementioned positive news on  potential COVID-19 vaccines boosted sentiment midweek.

Another interesting dynamic last week was the underperformance of technology stocks. For the first time since 2018, on a weekly basis the Nasdaq closed in negative territory while the S&P 500 and DJIA gained on the week. This is a timely reminder that with so much concentration risk in the tech juggernauts, it is important to keep a close eye on upcoming earnings. Microsoft will report quarterly earnings this week and 30 July is a huge day as we get earnings from Amazon, Apple and Google.

Last week the United States saw an average of over 63,000 new COVID-19 cases a day, with Florida, Texas and California among the worst hit.⁵ However, markets for now seem to be shrugging off the surges.

In terms of macro data, both June retail sales (excluding automobiles and gasoline) and industrial production stood out as better than expected.

Asia Pacific (APAC)

Equities in the APAC region put in a mixed performance last week, with both Hong Kong  and Mainland China  underperforming. Other markets managed to gain, including the Japanese Nikkei Index. The selloff in China came despite better macro data, with second quarter 2020 gross domestic product (GDP) rising 3.2%. The main market selloff came after reports midweek that China may slow its fiscal stimulus in the second half of the year as the economy grows and as government revenues come under pressure.

Last week the UK banned Chinese telecoms company Huawei as a long-term supplier for 5G networks over security concerns, which likely didn’t help sentiment. US/China tensions also remain an overhang, with headlines last week stating the United States may ban visas for Chinese Communist Party Members.

Meanwhile, the Bank of Japan meeting was largely uneventful, with no change as expected.

One final thing to note is that over the weekend the United Kingdom signalled that it would join allies in suspending its extradition treaty with Hong Kong. An update will be provided on arrangements this week.

Week Ahead

Although many market participants are taking summer holidays, there is still a lot of noise expected this week as quarterly earnings in United States and Europe continue to be a focus. In terms of macro data, Global Flash purchasing managers indexes (PMIs) for July will be the main talking point on Friday. News on the EU COVID-19 bailout will be a key driver for the region. Brexit talks also resume this week.

Market holidays: None this week.

Calendar:

Monday 20 July

• Economic/Political: US Secretary of State Mike Pompeo meets UK Prime Minister Boris Johnson and British Foreign Secretary Dominic Raab; EU-UK Brexit talks resume.
• Data: Germany producer price index (PPI), Italy current account balance, eurozone ECB Current Account; Japan June consumer price index (CPI); Reserve Bank of Australia meeting minutes.

Tuesday 21 July  

• Data: Chicago Fed National Activity Index.

Wednesday 22 July    

• Data: US existing home sales (June); South Korea GDP (second quarter).

Thursday 23 July 

• Economic/Political: Central Bank of the Republic of Turkey Meeting; Bank of England’s Jonathan Haskel speaks.
• Data: Germany consumer confidence, Norway unemployment rate and industrial confidence, France business and manufacturing confidence, Sweden unemployment rate, eurozone consumer confidence, UK consumer confidence.

Friday 24 July

• Economic/Political: Russia central bank meeting; Greece sovereign debt to be rated by Fitch.
• Data: UK retail sales (excluding autos and fuel), Spain PPI, France manufacturing PMI, Germany manufacturing PMI, Italy consumer and manufacturing confidence, eurozone manufacturing PMI, UK manufacturing PMI; US Markit PMI (July), new home sales month-on-month.

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1. Indices are unmanaged and one cannot directly invest in an index. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.

2. Source: New England Journal of Medicine, “An mRNA Vaccine against SARS-CoV-2 — Preliminary Report”, 14 July 2020.

3. Sources: Eurostat, European Commission, Bloomberg, Berenberg, as at May 2020. There is no assurance that any estimate, forecast or projection will be realised.

4. Indices are unmanaged and one cannot directly invest in an index. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.

5. Source: Financial Times, analysis of COVID Tracking Project data, summarised by US Census regions, 10-16 July 2020.