Notes from the Trading Desk—Europe

The Digest

Global equities put in another resilient performance last week with the MSCI World Index closing up 2.4%.¹ Markets reversed losses arising from the US Federal Open Market Committee (FOMC) announcements the prior week as volatility declined; the CBOE VIX was down 25% on the week, with the V2X in Europe down 20%.² The reflation trade appeared to be re-emerging and the cyclicals did well, as commodity prices pushed higher, too. As a result, growth outperformed value, whilst cyclicals outperformed defensives. There was focus again on the central banks last week, with the Bank of England (BoE) keeping interest rates on hold and commenting that it sees inflation as transitory. We also had the European Central Bank (ECB) reiterating it is in no rush to adjust policy, either. Macro data was in focus with European Purchasing Managers Indices (PMIs) strong.

European PMIs gather pace: The European economy is recovering fast from the COVID-19 recession. The relaxation in COVID-related restrictions has resulted in sharp growth in both services and manufacturing. In the eurozone, the flash Composite PMI rose to a 180-month high of 59.2 in June and also above the reading of 57.1 in May. In the United Kingdom, the composite figure did edge down in June but still remains high at 61.7, indicating strong growth.

Looking at the specific sectors, manufacturing growth is exceptionally strong. The eurozone figure for June came in at a near-record of 63.1. This is despite supply constraints affecting many manufacturers as a result of shortages of critical inputs. Whilst this holds back production for now, when this bottleneck is eased it is likely that production will simply shift into the future as demand remains. The eurozone services index grew to a 41-month high of 58.0. Again, as restrictions ease, the services sector begins to benefit from that mobility. This will continue to grow as the vaccination programme progresses and restrictions ease further.

COVID-19 cases spike in the United Kingdom: The number of COVID-19 cases in the United Kingdom has risen dramatically over the course of last week. We saw the travel and leisure space come under pressure last week, whilst a lot of uncertainty remains regarding international travel to and from the United Kingdom. With a high vaccination rate, the United Kingdom has become the test case for whether mass vaccination can bring an end to the cycle of surges in serious illness arising from the virus and subsequent economic shutdowns. The data so far look encouraging. The key driver behind the rising cases appears to be the highly contagious Delta variant first identified in India. The spread of the virus appears to be impacting a younger demographic than the previous two waves. As a result, and given the success of the vaccination programme thus far, new hospital admissions are increasing much less than recorded infections and by much less than during the winter wave.

Also, some seven weeks since recorded infections started to pick up pace and whilst hospital admissions rise gradually, there has been no significant increase in the number of deaths yet. During the wave from August last year, COVID-related deaths rose c.8 per day to 115 per day by the second week of October. In the three days to 23 June, the United Kingdom averaged 21 deaths. Whilst this represents a small increase to the previous week, we are far from the trajectory witnessed last year. Higher-risk groups within society appear to be benefitting greatly from the vaccination programme, which should also serve the economy well as the country proceeds through this latest wave.

Week in Review

Europe

European equities showed resilience again last week to trade higher overall. The Stoxx Europe 600 Index closed the week up 1.2%, paring most of the losses from the previous Friday when European stocks lost 1.6% post-FOMC meeting. Away from the Federal Reserve, focus in Europe is on the improving macro picture. As noted, spiking COVID-19 cases in the United Kingdom offer some cause for concern. Elsewhere, the Bank of England kept interest rates and its asset purchasing programme unchanged. Despite stronger sterling and the sharp increase in COVID-19 cases in the United Kingdom, the UK FTSE Index outperformed last week, up 1.7%, whilst the Spanish IBEX lagged, up just 0.5%, not helped by its sector composition with the utilities struggling as the defensives were under pressure.³

Cyclicals outperformed last week, helped by better PMIs out of Europe and as US President Joe Biden reached a tentative bipartisan deal with senators for a $US579 billion infrastructure plan. As a result, basic resources stocks led the way, also supported by a weaker US dollar. Oil and gas stocks and industrial goods and services were also better off. It was the defensives which lagged on the week with utilities the most obvious laggard. Meanwhile, telecommunications and health care finished roughly flat.

Thursday saw the BoE vote to keep interest rates (0.1%) and its asset purchasing programme unchanged. The 8-1 vote was in-line with expectations. The central bank stated that whilst inflation could surge to over 3% in the coming months, inflationary pressures would be “transitory” and would settle closer to its 2% target. (We would note that, the May consumer price index [CPI]) was 2.1%). The Monetary Policy Committee said inflation expectations were “well anchored” at 2%. On the recent delay to ending all lockdown measures the BoE noted that the direct economic implications of the delays in the final stages of COVID-19 restrictions are likely to be relatively small.

After a decent run of inflows into European equities, we did see a small pause for breath last week as the week’s inflow into Europe was the smallest in 10 weeks. However, given low initial allocations to European stocks, these flows may have room to continue over the coming months.

Looking at exchange traded fund (ETF) flows over the last month, there have been record inflows into US ETFs that track European markets. Within Europe, investors favoured EU value and EU banks ETFs, as well as the broader indices (Stoxx 50 & Stoxx 600 indices).

United States

The reflation trade was back on in the United States, with Treasury yields higher last week. The focus again was on Fedspeak with investors trying to get a grasp of what might be coming in terms of interest rate rises and when. President Biden’s announcement of a US $579 billion infrastructure package was supportive. It was a similar theme on sector moves in the United States, with the cyclicals outperforming. Energy stocks were strong, and also helped by rising West Texas Intermediate oil prices. Financials were also stronger amidst a steepening of the yield curve. Industrials were also up on the week. It was the defensives which lagged but still managed to finish higher.

Fedspeak last week was a little mixed; however, the focus for markets was on comments from Fed Chair Jerome Powell. He said that whilst a debate on tapering may be on the cards, the Fed was nowhere near raising interest rates. Powell also said that he still viewed inflationary pressures as “transitory,” and he has “a level of confidence” that prices will eventually come down. Meanwhile, St. Louis Fed President James Bullard said he was predicting a rate hike by the end of 2022 and reiterated his concerns that inflation “may surprise further to the upside”. Also, Dallas Fed President Robert Kaplan warned that the US economy may meet the Fed’s targets for tapering its asset purchases sooner that people think.

Asia and Pacific

Asian stocks rebounded well through last week after a sluggish start as the cyclical-heavy markets like Japan and Australia struggled as the prospect of less accommodative US monetary policy hit the global reflation trade. Asian stocks rose on Wednesday as Fed officials moved to clarify their stance, with Powell on Tuesday saying authorities would be patient in waiting to lift borrowing costs. Commodity stocks were among the top gainers in the MSCI Asia Pacific Index on Tuesday after Brent oil rose to US$75 a barrel for the first time in more than two years, adding to the ongoing rebound in raw materials prices.

Equity markets in China and Hong Kong outperformed last week, up 2.3% and 1.7% respectively. Crypto-related stocks tanked after the Peoples Bank of China told lenders and Alipay to avoid crypto transactions as the crackdown on miners continues. Shares of Chinese companies related to infant care rose on Monday after Dow Jones reported on Friday that officials are making plans to further loosen birth restrictions and transition towards policies that explicitly encourage childbirth. Chinese solar stocks were mixed on US plan to ban Xinjiang products—the United States will bar some solar products made in China’s Xinjiang region, people familiar said, in response to alleged human rights abuses. Factories in the area produce roughly half of the global supply of polysilicon.

Week ahead

Monday 28 June

• US Dallas Manufacturing Activity
• BoE’s Haldane speaks; ECB’s Weidmann and Guindos speak; Fed’s Williams speaks

Tuesday 29 June

• French Consumer Confidence; UK House Price Index, M4 Money Supply, Mortgage Applications; Germany CPI; Eurozone Economic Survey; US Consumer Confidence, House Price Index; Japan Jobless Rate, Retail Sales
• ECB’s Villeroy speaks, BoE’s Hauser speaks

Wednesday 30 June

• China NBS Manufacturing and non-Manufacturing PMI; French CPI; German Unemployment; Eurozone CPI; US Employment, Pending Home Sales, Japan Industrial Production, Vehicle Production, Housing Starts, Consumer Confidence; South Korea Industrial Production

Thursday 1 July

• Global Final Manufacturing PMI; China Caixin Manufacturing PMI; Italy Unemployment Rate; Eurozone Unemployment Rate; US Initial Jobless Claims, ISM Manufacturing Survey; Australian Trade Balance; South Korean Trade Balance

Friday 2 July

• US June Employment Report (Change in nonfarm payrolls and unemployment rate), Trade Balance, Factory Orders; German Retail Sales

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1. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.

2. The CBOE Market Volatility Index measures market expectations of near-term volatility conveyed by S&P 500 stock index option prices. The Euro Stoxx 50 Volatility Index (V2TX) measures implied volatility of near term EuroStoxx 50 options, which are traded on the Eurex exchange. Indices are unmanaged, and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future performance.

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