Notes from the Trading Desk – Europe

The Digest

It was another strong week for global equities overall, with the S&P 500 Index closing the week up 1.3% at a new all-time high, whilst the STOXX Europe 600 Index closed the week up 0.8% and Asian equities were mixed, with the MSCI Asia Pacific Index closing last week down 1.5%, weighed down by the Hang Seng Index, which was down 2.9%.¹ Global equities rebounded through October, with the MSCI World Index closing the month up 5.6%.

Earnings have been a bullish driver in the last couple of weeks, as the latest round of quarterly reports have surprised to the upside overall. Outside of that, the European Central Bank (ECB) meeting was closely watched but had little market impact. Eyes were also on moves in bond markets, energy prices and the UK budget.

Central Bank Focus Last Week

At its policy meeting last week, the ECB elected to continue with its stimulus programme as it seeks to sustain the eurozone’s tentative recovery from the coronavirus pandemic amid pressure from supply shortages. The ECB’s 25-member governing council decided at its meeting to keep interest rates at historic lows and continue the bank’s monthly bond purchases at a “moderately lower” rate than in the second and third quarter (Q2 and Q3). Note, the €1.85tn (US$2.15 trillion) pandemic emergency bond-buying programme (PEPP) is the ECB’s main crisis-fighting tool, aimed at keeping borrowing costs low to stoke economic growth.

At the press conference, ECB President Christine Lagarde valiantly held the line when she said that the market’s pricing in a 20 basis points (bps)² in December 2022 isn’t supported by the ECB’s analysis. Less than 24 hours later, traders went even further, bringing forward that timing by two months to October 2022!

Lagarde acknowledged that faster inflation will stick around for longer than the ECB previously anticipated, but that it will ease through 2022. She stopped short of saying markets are wrong to bet on rate hikes next year, which reflected an agreement among Governing Council members that such a move could backfire. Therefore, we expect Council members will likely speak out over the next week or two to help reinforce their policy line.

The surge in global inflation has seen some central banks shift tack lately, but the ECB seems to be standing firm. Nonetheless, as noted, traders now expect the ECB to raise its deposit facility rate by 20 bps in October 2022. That would lift the rate to -0.3% and mark the bank’s first increase in more than a decade.

The runup to the next policy meeting in December will be interesting to say the least, against a backdrop of sceptical markets pricing in rate increases and reinforced by a selloff in the riskier sovereign bond markets (Greece, Italy and others).

Last week also saw the Bank of Canada accelerate its potential timing of interest rate hikes. The announcement was more hawkish than was expected, as the central bank brought forward guidance changing from the second half of 2022 to “sometime in the middle quarters of 2022”. It also removed “considerable” from its assessment of the level of slack, stating: “The Bank is closely watching inflation expectations and labour costs to ensure that the temporary forces pushing up prices do not become embedded in ongoing inflation.”³ So, a very similar theme to what we have spoken of in the last few weeks and a potential indicator of what we will see this week.

Central Bank Focus This Week

Central bank action continues this week, with the Reserve Bank of Australia (Tuesday), Federal Reserve (Wednesday), Norges Bank and Bank of England (Thursday) all meeting. The Fed is expected to announce the start of tapering, including key details on the pace, timing and composition of its plan to reduce asset purchases. Another key detail will be on any forward guidance on rate lift-off. Investors’ sentiment has changed notably through October on when we can expect a rate hike. Investors have started to price in an interest rate hike at the end of next year and potentially up to four hikes by September 2023.

The Reserve Bank of Australia announcement on Tuesday could potentially be market-moving. Q3 inflation was stronger than expected, which has increased attention on the yield-curve target, testing the bank’s resolve. Last week, investors started pricing in 75bps of hikes over the next 12 months. A rate hike would be unexpected at this meeting, so the meeting outcome could have a material impact on equity markets this week.

Turning to the Bank of England (BoE), traders are pricing in a 53% chance of a 15bps rate hike on Thursday. With inflation moving higher, and given recent hawkish commentary, it will be a close call. Note: we also get nationwide house price data on Wednesday, which could be another indicator ahead of the event. Some observers point to the extra stimulus in last week’s budget, which could act as a nudge to hike.  It seems like this week’s announcement is on a knife’s edge, but with traders pricing in a rate hike, there is room for disappointment. UK banks have already started to raise mortgage rates in anticipation of higher rates.

Finally, Norges Bank is likely to keep rates on hold at 0.25% on Thursday. It had previously hiked 25bps from zero at the September meeting. Again, traders are pricing in further hikes in December and through next year. Not much room for disappointment regards this one, but a rate hike a month earlier than expected would likely be taken as hawkish.

Week in Review

Europe

European equities moved higher again last week and are back near all-time highs. Corporate earnings were the key focus for markets for most of last week. There was very little market reaction to the ECB decision to keep interest rates unchanged. Whilst President Lagarde acknowledged inflation would be higher for even longer, she reiterated that inflation should be seen as temporary.

The UK equity market continued to be a laggard, with the FTSE +0.5% on the week. UK equities continue to struggle, with the FTSE 100 Index and FTSE 250 Index underperforming other major European indices. Recent energy prices surges and supply chain issues likely dampened sentiment, as investor outflows are notable this year.

Last week we saw a clear reversal in one of the themes from the previous week. The reopening trade was bought once again, with the Goldman Sachs Going Out basket up 2.1% as fears over the reintroduction of COVID-19 restrictions faded. The equivalent Stay at Home basket was down 5.7%. Food delivery names have been well-held through the pandemic, and they were particularly weak last week.

Investors favoured momentum over value again last week, with no change in the rate trajectory. Renewable stocks were higher ahead of the COP26 conference in Glasgow this month. In terms of sectors, autos continue to rebound. Insurers were also higher, while telecoms declined following some poor earnings in the space.

More than half of the companies in the Stoxx 600 Index reporting quarterly earnings have been positive—when looking at sales surprises, earnings surprises, sales growth and earnings growth there have been more beating expectations than missing them. Still a trend to watch, as 107 companies in the Stoxx 600 Index are reporting this week.

The latest UK budget was also a focal point last week as the government navigates the country out of the pandemic. Chancellor Rishi Sunak’s announced higher public spending, new tax cuts and a change in the taxation system for alcohol. He also announced a 0.4% fiscal boost to 2022 gross domestic product (GDP), fading to 0.3% in 2023. Sunak also stated that the UK economy was now forecast to grow 6.5% in 2021 (higher than the previous forecast of 4%), and 6% in 2022. It is likely that the Bank of England’s monetary policy committee members will look towards these growth forecasts for extra guidance on whether to hike this month.

In terms of macroeconomic data, eurozone GDP came in ahead of expectations. Q3 growth came in at 2.2%, higher than anticipated. Strong consumer spending underpinned the growth and more than offset poor output growth on the back of supply shortages. Households have built up excess savings through the pandemic, so these numbers show that consumers are willing to spend money when possible. However, some consumers may turn more cautious amid new waves of infection.

United States

US equity markets continued their grind higher, with the S&P 50) Index at fresh all-time highs last week Corporate earnings news continues to dominate the narrative, although investors are also keeping a firm focus on the Fed meeting this week (3 November).

There was a clear growth outperformance over value when we look at last week’s sector performance, with consumer discretionary and communications stocks higher and financials and energy lower.

Looking to corporate earnings, last week saw the five largest S&P 500 Index constituents report a mixed bag of earnings. Overall, performance was pretty resilient: for example, both Apple and Amazon disappointed on the earnings front, but both share prices rallied from intraday lows on Friday to temper losses. On the back of these moves, Microsoft overtook Apple to become the world’s largest company (by market capitalisation).

Overall, earnings season has driven a strong rebound for US equities, with the S&P 500 Index up more than 5% since the earnings season began, its best start since 1999.⁴

Moves in global bond markets garnered much attention, and in the United States we saw a flattening of the curve in government bond yields. Concerns of stagflation persist—with that, we saw the US 20-year Treasury yield exceed the 30-year yield. Concerns that persistent high inflation will force a hawkish central bank response, which forces up shorter term yields, seems to be driving the inversion. Concerns over long-term growth prospects have also kept longer-term yields subdued.

The US Biden administration grinds slowly towards an infrastructure deal agreement. On Thursday, the White House unveiled the framework for an eventual US$1.75 trillion “Build Back Better” (BBB) social spending bill. This is well below the original US$3.5 trillion proposal and also below a compromise President Biden recently floated, but officials are “confident” this iteration will get the moderate Democrats on board who have been holding out support for the deal.

Looking at last week’s macro data, US GDP (annualised quarter-over-quarter) missed expectations, coming in at 2%.

Asia and Pacific

Last week was lacklustre week for Asian equities, with the MSCI Asia Pacific Index down 1.5%. The Hong Kong equity benchmark was down -2.9% and Chinese mainland stocks were down 1%. In China, we had property developer Modern Land defaulting, adding to the unease over that sector given the recent Evergrande situation. Furthermore, we saw the shares of another Chinese developer, Kaisa Group, fall after ratings agencies S&P and Fitch downgraded it on refinancing debt concerns. Fresh COVID restrictions in some regions were another headwind, with the latest outbreak spreading to 11 provinces and the capital of Beijing.

Looking at Chinese macro data, official Purchasing Managers’ Index (PMI) readings came in weaker than expected, with the Manufacturing PMI at 49.2 and Non-Manufacturing at 52.4. In addition, the Chinese Composite PMI came in at 50.8 vs. 51.7 prior. The suggestion is power shortages and surging commodity prices may have hampered manufacturing, along with ongoing COVID restrictions. That said, this morning we did see a better-than-expected reading on the Chinese Caixin PMI manufacturing index, which came in, at 50.6.

Japan’s Nikkei Index was essentially unchanged last week, treading water ahead of the general election this past weekend. The result was a surprise victory for the Liberal Democrats (LDP), led by Fumio Kishida, and they maintain their majority in the Diet’s lower house. The LDP won 261 seats in the 465-seat parliament, down from 276 but still giving them a majority. The LDP are seen as having more “market-friendly” policies, and this was evident in the market reaction, the Nikkei traded sharply higher today, closing up 2.6%.

The Week Ahead

Macro Highlights

Monday 1 November

• World leaders gather at the 26th UN Climate Change Conference of the Parties (COP26) in Glasgow, Scotland, through 12 November
• United Kingdom: Markit manufacturing PMI
• United States: construction spending, ISM manufacturing, Markit manufacturing PMI
• Eurozone: Markit manufacturing PMI (Spain, Italy, France, Germany, Eurozone)
• Asia: Caixin manufacturing PMI, Japan vehicle sales, Hong Kong GDP, South Korea trade balance

Tuesday 2 November

• Reserve Bank of Australia interest-rate announcement

Wednesday 3 November

• UK: nationwide house part exchange
• US: MBA mortgage applications, factory orders, durable goods orders
• Eurozone: Spain unemployment rate
• Federal Open Market Committee (FOMC) interest-rate decision and Fed chair news conference
• Asia: Caixin services and composite PMI

Thursday 4 November

• United Kingdom: BoE policy meeting
• United States: Initial jobless claims, trade balance
• Eurozone: Germany factory orders, Norway policy meeting

Friday 5 November

• Eurozone: industrial production (IP)
• United States: October employment report

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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. One basis point is equal to 0.01%.

3. Source: Reuters, “Bank of Canada head signals rates could rise as soon as April 2022”, 27 October 2021.

4. Source: Proactive Investors, “S&P’s Best Earnings Run since 1999 Meets Rebalance”, 27 October 2021.