Notes from the Trading Desk – Europe

The Digest

Global equities closed generally higher last week with limited market catalysts at play. The MSCI World Index closed the week up 1%, while the S&P 500 Index closed the week up 0.6%, the STOXX Europe 600 Index was down 0.1%, and the MSCI Asia Pacific Index outperformed, up 3.9%.¹

There were very few developments in recent market themes; however, a couple late catalysts were noted on Friday. First, there was an announcement that current Japanese Prime Minister Yoshihide Suga will resign. We also had a large non-farm payrolls miss in the US monthly employment report; an increase of 725,000 payrolls was anticipated in August, but we only saw a rise of 235,000, which likely rules out a September taper from the US Federal Reserve (Fed). The small increase in COVID-19 cases seem to have impacted the US jobs report, as well as the latest Chinese Purchasing Managers’ Index (PMI) data.

Equities in Europe treaded water ahead of the European Central Bank (ECB) meeting this week, where any hints of tapering will be closely observed. Focus over the next few weeks will gradually build toward the German election on 26 September. According to Bank of America’s Flow Show report, last week saw the largest outflow of cash funds in seven weeks (US$23 billion). Meanwhile, US$19.2 billion went into global equity funds, US$12.7 billion into bonds and US$0.5 billion into gold. Within the report, Bank of America noted that European equities saw their largest outflow in six weeks (US$0.6 billion).

Focus on Central Bank Tapering

The monthly US employment report has always been keenly watched, not simply as a gauge of economic growth, but as an indication of monetary policy alterations. At the Jackson Hole Symposium in late August, Fed Chair Jerome Powell delivered a speech which was largely in line with market expectations for some kind of tapering announcement before year end and for the tapering to start in the fourth quarter 2021 or early first quarter 2022.

Job growth is a key input in the debate around when tapering will likely occur, and Powell said there had “been clear progress toward maximum employment”, but he also noted that the unemployment rate understates the amount of slack in the labor market, with job vacancies at all-time highs.

As noted, last week’s August US employment report showed an increase of 235,000 in nonfarm payrolls, which was a disappointment. The unemployment rate did fall from 5.4% to 5.2%, however. The latest increase in COVID-19 cases around the United States appears to be the driver behind the weakness.

Looking ahead, European equity markets will closely watch the ECB meeting this Thursday, with a potential tapering of bond purchases the key focus. There are expectations for a reduction in pace of bond buying within the pandemic emergency purchase programme (PEPP). There is roughly €500 billion left and a monthly spend of around €80 billion, with expiration planned for March 2022.

Some economists expect a small reduction to €70 billion per month; however, others are looking for something more significant, potentially down to €50-60 billion per month. The ECB only bought about €62 billion in bonds in August, so some argue that this tapering has already started.

Better-than-expected economic data, upward revisions and the potential that recent inflationary indications may be more enduring are all factors behind expectations winding down bond purchases. The ECB has been notably dovish in recent meetings, so it will need to be careful not to signal an extreme u-turn on Thursday. Communication will be key.

German Election

Polls remain close in Germany ahead of the election on 26 September with the CDU/CSU² (22% support) actually lagging the Social Democratic Party (SPD) (23%). The CDU/CSU have seen declines in support over the last five weeks. A win for the SPD would represent a shift to the left for German politics. The Greens also remain close behind, with around 18% support.

There are a number of potential outcomes, but the most likely will be some form of coalition between SPD/Greens/Free Democratic Party (FDP) or CDU/Greens/FDP. Whatever the outcome, it seems likely the Greens will be involved, so focus on renewable/sustainability stocks is a market talking point and that space traded well last week, up nearly 3%. An SPD-led government is more likely to result in more tax and spend policy vs. a CDU/CSU-led government.

Some of the other key policies the market is watching out for will be corporation tax, making the European Recovery Fund bonds a more permanent structure (Eurobonds) and fiscal spending.

Whatever happens, current German Chancellor Angela Merkel will be stepping down at this election, so from a broader European perspective, it will be interesting to see how the election affects the dynamics within the eurozone. Several reports have noted that there is unlikely to be a dramatic policy shift, rather a fairly fragile coalition with a relatively weak Chancellor.

Week in Review

Europe

European equities showed some relative resilience again last week following their mid-August weakness, with the STOXX Europe 600 Index closing the week near flat, down nine basis-points (bps)³, even though equity markets did hit new all-time highs in dollar terms mid-week. Country index performance divergence was fairly muted. In terms of themes, focus is on the ECB meeting this week. After that, attention will turn to the German election on 26 September.

Eurozone inflation registered its highest level since 2011 in August, up 3% year-on-year, vs. 2.7% expected, and well above the ECB’s 2% target.

In terms of factors, momentum stocks outperformed value last week. Ongoing concerns around the spread of the Delta variant continue to linger, so “Stay-at-Home” stocks outperformed “Going Out” stocks. In terms of sectors, technology and luxury stocks saw mean reversion last week given an absence of further interventionist headlines out of China. As such, technology finished the week up 2.0%, whilst retail stocks overall were up 0.7%. In terms of the laggards, telecommunications underperformed, down 2.2% on the week, followed by real estate, down 1.8%.

United States

As the summer draws to a close, the S&P 500 Index edged on to new fresh all-times highs last week, with the main talking point Friday’s employment data and what that may mean for Fed thinking. Aside from that, it was quiet in terms of corporate news flow and market volumes, as the 6 September Labour Day holiday loomed large.

The US 10-year Treasury yield edged up 4 bps to 1.33% and, interestingly, we have not seen a weekly move over 10 bps in the last six months.

Elsewhere, Hurricane Ida impacted US crude production which is still halted in some states. With that, WTI traded up 0.8% at US$69.29 a barrel.

Defensives outperformed last week with health care and the staples leading as some viewed the disappointing employment report as an indication that Fed tapering is likely to be pushed further out. On the downside, the financials declined amid the prospect of lower yields for longer and energy weakened on some concerns over Hurricane Ida’s impact.

The spread of the Delta variant continues to weigh on sentiment, with August data showing COVID-19 hospitalisations are at record levels in 10 US states. There were signs that concerns over the Delta variant continue to weigh on other macro data, as US consumer confidence declined to 113.8, missing expectations, and the Chicago August Purchasing Managers Index (PMI) was also weaker than anticipated.

In terms of Fed speak, it was notable that Atlanta Fed President Raphael Bostic said “we’re going to let the economy continue to run until we see signs of inflation”, before moving on interest rates, reiterating the point that rates are unlikely to increase any time soon.

There were also concerns raised over US President Joe Biden’s US$3.5 trillion social spending plan from within his own party last week. Senior Democrats remain confident of getting critics onside, but the progress of this bill will be important to monitor in coming weeks.

Asia and Pacific

Asian equities were broadly higher last week, with the MSCI Asia Pacific Index closing the week up 3.9%. Japanese equities were the region’s outperformers, receiving a shot in the arm on Friday with news that Prime Minister Suga will resign over his handling of the pandemic. Japan’s Nikkei Index closed the week up 5.4%, hitting a 30-year high as Suga’s resignation fueled hopes of added stimulus. Suga was expected to run in the upcoming presidential election but cancelled those plans, stating that he couldn’t handle the pressures of an election campaign alongside the COVID-19 response.

Stimulus hopes boosted Chinese technology stocks, which have been weak recently. The government announced measures for small businesses to boost the economy, which fed into hopes of further support more generally to help tech stocks. The market was also on the lookout for further regulatory measures by the government and Beijing did tighten online gaming service rules for teenagers and minors, announcing it would strengthen inspections of online game providers and limit teenagers to three hours most weeks.

There were a few notable macroeconomic datapoints out of Asia last week. The Chinese PMIs were an early focus for markets, given the recent misses. Last week, the non-manufacturing PMI missed expectations, coming in at 47.5, the first contraction since March 2020. The main driver behind the miss was the weak services sector. The manufacturing PMI also missed expectations, coming in at 50.1. Overall, the composite PMI report notably weakened to 48.9 from 52.4 previous.

Elsewhere, Japanese industrial production (IP) fell 1.5% month-on-month in July, which was not as bad as feared. Employment data also looked better in Japan, with the unemployment rate falling to 2.8% vs 2.9% previous. Total employment rose sharply in seasonally adjusted terms.

Finally, a technical recession is expected in Australia following the economic slowdown there; economists are now expecting a quarterly contraction in the third quarter of 3%-4%, with the report due out on Wednesday of this week.

Week Ahead

Holidays 

• Monday 6 September: US Labour Day

Key Events

• Tuesday 7 September: China trade balance, eurozone gross domestic product (GDP), Germany IP (month-on-month) Germany ZEW Survey
• Thursday 9 September: ECB main refinancing rate, ECB deposit facility rate, China Consumer Price Index (CPI) and producer price index (PPI)
• Friday 10 September: UK monthly GDP (month-on-month), France IP (month-on-month)

Monday 6 September      

• Informal meeting of the EU economy and finance ministers
• UK (August) new car registrations
• Germany (July) factory orders
• Labor Day holiday in the United States and Canada. Markets will be closed
• US President Biden will likely decide this week whether to renominate Fed Chair Jerome Powell to a second term
• US federal emergency unemployment benefits and other aid expire today

Tuesday 7 September     

• Germany IP
• Eurozone (second quarter final) GDP
• China trade balance, imports, exports

Wednesday 8 September    

• France (July) trade balance
• Italy (July) retail sales
• US (July) JOLTS
• Fed’s John Williams, Robert Kaplan speak
• US Fed releases Beige book
• US Mortgage Bankers Association (MBA) mortgage applications (September)
• Japan gross domestic product (GDP)

Thursday 9 September     

• ECB interest-rate decision
• ECB President Christine Lagarde briefing
• Germany (July) trade balance
• UK (August) Royal Institution of Chartered Surveyors (RICS) house prices
• US initial jobless claims (September), continuing claims (August)
• Fed’s Mary Daly speaks
• China CPI and PPI

Friday 10 September       

• UK monthly GDP
• UK (July) IP, (July) trade balance
• France (July) IP
• Italy (July) IP
• Informal meeting of EU economic and financial affairs ministers (through 11 September)
• Key speakers: ECB’s Olli Rehn
• US (August) PPI
• US wholesale inventories (July), wholesale trade sales (July)

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1. 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 results.

2. CDU/CSU, unofficially is the union parties’ political alliance of two political parties in Germany: the Christian Democratic Union of Germany (CDU) and the Christian Social Union in Bavaria (CSU).

3. One basis point is equal to 0.01%