Notes From the Trading Desk – Europe

Equity markets drifted lower last week as investors focused on further disappointing macro data from both the United States and Europe. In addition, nerves around the Brexit situation weighed on sentiment as the October 31 deadline looms large. It was a quieter week in Asia, with China closed for most of the week.

The Digest

Macro Meltdown?

Weak global macro was a major theme once again last week. A slowdown in global purchasing manager index (PMI) data was one of several disappointments.

The German composite PMI figure fell into contraction for the first time in six years, adding weight to recession fears for the powerhouse.

Eurozone inflation slid further below the European Central Bank’s (ECB) 2% target, coming in at 0.9% for September, its lowest monthly rate in three years. Factory activity also slumped at its fastest pace since 2012.

Early this week, we’ve seen additional weak data from Germany: Month-on-month factory order figures have dropped further than expected.

In the light of the disappointing German data, we’ve seen further pressure on German Chancellor Angela Merkel’s government to provide fiscal stimulus.

Merkel has publicly said that her government will stick by its “balanced budget” policy, but reports last week suggested that a number of measures have already been drafted as part of a two-phase plan. Pressure further increased last week as two prominent German economic institutes cut 2019 and 2020 gross domestic product growth forecasts.

Looking at last week’s data from the United States, the discussion over whether a recession is approaching has increased as it felt like the global slump was finally seeping into the US economy. However, not all the signals from the United States are recessionary. The unemployment rate for September (unveiled on Friday) was at a 50-year low, and initial jobless claims, often an early barometer for recessionary risk, remain benign.

Market Reaction

Weaker macro weighed on sentiment, particularly on Wednesday as equity markets in Europe and the United States fell. It looked as though the equity market was finally registering some of the concerns about global growth that have been reflected in the bond market for some time.

Towards the end of Thursday there was a “bad news is good news” feel for the United States, however. The S&P 500 Index managed to reverse early losses on Thursday to close the day in positive territory.¹ 

The latest market data (based on Fed funds futures) saw the probability of a further US interest rate cut in October rise to 80%, up from just 40% at the start of week, pleasing dovish investors.

There also seems to have been a reluctance among investors to continue to sell equities ahead of Friday’s September employment report. In the end the non-farm payroll figure disappointed, but not nearly as much as some had feared.

Given this backdrop, European equities underperformed. However, there were other forces at play around Thursday’s selloff, including a move from the World Trade Organization (WTO) to allow the United States to impose tariffs on European Union products, beginning on October 18.

A desire to lock in some profits at the start of the fourth quarter likely also drove the stark selloff.

The first three quarters of the year were the best for equity markets since 1997. Given the dire performance seen in the fourth quarter of 2018, investors who have already seen their portfolios perform reasonably year-to-date may be unwilling to risk undoing any of that performance at this stage, leading to a lack of real buying.

The UK stood out, with the FTSE 100 Index selloff the worst in percentage terms since the day following the EU referendum in 2016.² 

Brexit Enters the End Game (Again)

Ahead of the October 31 deadline for the United Kingdom’s EU departure, UK Prime Minister Boris Johnson delivered his much-anticipated amendments to the Withdrawal Agreement to EU leaders.

The main focus was on the proposed alternative arrangements around to the Irish/Northern Irish border which removes the contentious so-called “backstop”.

Interestingly, Johnson finds himself in the opposite position to his predecessor Theresa May: his deal has the potential to gain the backing of Parliament, but apparently not from the approval of the EU.

Importantly, UK Government lawyers stated on Friday afternoon that they will comply with the so-called Benn Act which requires the prime minister to send a request for an extension to the EU should a deal not reached by October 19.

Sterling was relatively unmoved through last week as investors contemplate what the latest developments mean for the UK government’s chances of getting Brexit done.

The exporter-heavy FTSE 100 Index closed down on the week, but we think this probably has more to do with the broader macro move and a weaker dollar.

This week sees the UK negotiators in Europe, in a final attempt to thrash out an agreement ahead of the EU summit on October 17.

Europe

European equities traded lower and closed last week down, with all major indices and sectors lower.

Dismal global macro data was a cause for concern, as discussed. Also weighing on equities was confirmation that the United States would be allowed to enforce tariffs on €7.5 billion worth of EU products following a WTO ruling.

The announced tariffs were less than had been feared, but the move still weighed on sentiment as the EU hinted towards potential retaliation.

The United States and EU are set to meet for trade talks next Monday (October 14). With this, those sectors more sensitive to growth outlook and tariffs were the worst performers. Defensive sectors outperformed cyclicals.

Italian Prime Minister Giuseppe Conte looks ready to test the EU’s tolerance as he delivers Italy’s 2020 budget. The document was approved by the cabinet on Monday last week and falls short of the EU’s debt reduction targets, failing to reduce Italy’s deficit.

The tone between the EU and Italian government remains friendly at present, and relations have certainly improved with the new government in place. However, this will be something to keep an eye on.

Portugal held a general election on Sunday and as polls had predicted, Socialist Prime Minister Antonio Costa will remain in power for a second term. The market impact has been muted, given that there will be little change and this was expected.

Americas

US equities were lower last week, with weaker data earlier in the week knocking sentiment. Markets did recover ground later in the week as the September employment data—while mixed—was not as bad as some commentators had feared. Furthermore, with the mixed macro data, hopes of further US Federal Reserve interest-rate cuts have risen sharply, underpinning equity market performance.

Last week saw energy names lag as crude oil prices fell following news Saudi Arabia was getting production back on track.

There was a lot of US Fedspeak last week. New York Fed President John Williams said that outlook for the US economy is a mixed picture. He added there were a number of crosscurrents leading to slower growth. This Wednesday, the minutes from the last Fed policy meeting are due for release and may give an interesting perspective on the splits within the Fed over the rate path ahead.

With China closed last week, newsflow on the trade tensions was limited, but we expect this will change in the coming week as Chinese delegates are in Washington for fresh talks. Chinese Vice Premier Liu He will lead the talks.

Asia   

Asian equities were worse-off in a quieter week with Chinese markets closed from Tuesday onwards as the country celebrated Golden Week last week.

Hong Kong equities continue to be under pressure amid another week of demonstrations.

Japanese equities were one of the key laggards in the region, albeit on low volume. Japanese data of late has also been poor with consumer confidence now at an eight-year low. Also with 54% of exports going to China and the rest of Asia, the economic slowdown there continues to bite.

Australian equities underperformed last week, despite the Reserve Bank of Australia (RBA) lowering interest rates once again this year to 0.75%, which was in-line with consensus expectations. RBA Governor Philip Lowe did state that he would be willing to reduce rates again if conditions warranted it.

Week Ahead

We expect rhetoric from the US/China trade talks and UK/EU Brexit talks to be drivers for markets this week. Given the macro backdrop, Wednesday’s Fed minutes release will garner more interest than usual in our view.

Economic Data

• Data releases in Europe this week: French Trade Balance and Italian Retail Sales on Tuesday; German Trade Balance, Italian Industrial Production, UK GDP and Trade Balance on Thursday; and German and Spanish consumer price index (CPI) on Friday.
• In the United States: purchasing price index data (PPI) on Tuesday; CPIs on Thursday
• In Asia and Pacific: Chinese PMIs on Tuesday; Japanese PPIs on Thursday.

Politics

• Brexit headlines will likely continue to dominate as EU leaders establish whether or not Boris Johnson’s Brexit deal is agreeable.
• US trade talks with Chinese Vice Premier Liu He to begin on Monday.

Monetary Policy

• A series of ECB and Fed (including Chair Jerome Powell) speakers on Tuesday.
• Federal Open Market Committee (FOMC) minutes on Wednesday.

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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 guarantee of future results.
2. Ibid.