Notes from the Trading Desk – EuropeAug 24, 2018

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.


Focus remained on emerging markets last week as the Turkish government took measures to stabilise the country’s currency. Elsewhere, tragic events in Genoa, Italy, highlighted the strained relationship with Italy’s new government and the European Union (EU), and led to a dip in sentiment towards Italian assets.


The Digest: Emerging-Market Headwinds Weigh

The ongoing spat between Turkey and the United States remained a talking point last week.

However, the Turkish lira recovered some lost ground against the US dollar. European equity markets stabilised mid-week after Turkey took further measures to restrict investors from shorting the lira.


Meanwhile, Qatar pledged to invest US$15 billion in Turkey. However, uncertainty looks set to continue as the US-Turkey spat over a detained pastor carries on. And, the credit ratings agencies have recognised the uncertainty, cutting Turkey’s credit rating on Friday (August 17) based on a volatile Turkish lira and a wide current-account deficit.

The events in Turkey appear to be a catalyst for some de-risking across emerging markets. For example, Argentinian and South African equity markets moved lower as the MSCI EM Index1 entered bear market territory.

The US dollar’s continued strengthening last week (thanks to the robust US economy) exacerbated cautious sentiment towards emerging markets.

As a number of emerging-market economies have high dollar-denominated debt, such as Turkey, South Korea and Argentina, the strengthening dollar could prove a headwind for government financing. This concern comes on the back of negative sentiment from the ongoing US-China trade confrontation.

Investor Sentiment Towards Italy Falters


Italian assets underperformed last week following the collapse of a motorway bridge in Genoa. The Italian government pointed the finger at EU fiscal limits and infrastructure companies.

Following the tragic events in Genoa, Deputy Prime Ministers Matteo Salvini and Luigi di Maio were quick to shift focus to EU-enforced spending constraints. The Italian government cited the tragedy as an example of why Italy should be free to spend more money on upgrading infrastructure irrespective of EU limits.

Remember, the Italian government is made up of a coalition of two Eurosceptic parties: the League, led by Salvini, and Five Star, led by Di Maio.

Italy has been a notable laggard in the eurozone with regards to public investment in infrastructure. Italian debt is already under heavy credit-agency scrutiny, which makes the Italian government’s comments lambasting spending constraints all the more relative.

Finally, Italy’s 10-year bond yield touched above 3.2%, close to the highest level seen since the current government took power in June.

Greece Bailout Programme Finally Over

On Monday (August 20), Greece emerged from the three-year eurozone bailout programme. While it’s a sign of progress, the economy has grown only slowly in recent years and is still 25% smaller than when the crisis began.

After years of austerity, we think things are unlikely to improve dramatically on the street—public debt was 191% of gross domestic product (GDP)2 in 2018 and unemployment remains close to 20%. 3 EU observers will likely continue to monitor Greek fiscal policy to ensure it remains disciplined. Given some of the possible doomsday scenarios Greece faced in 2015 during the “Grexit” crisis, we think the bailout process has been fairly orderly, and somewhat encouraging for the future.


Last Week: Europe

In Europe, equities sold off for the third consecutive week last week as global trade fears and political turmoil in Turkey weighed on sentiment. This risk-off sentiment led to defensive-type areas performing better, such as food and beverage, personal household goods and utilities. On the other hand, basic resources significantly underperformed as commodities were broadly weaker on the back of a strong US dollar and concerns over global growth.

In macro data releases, eurozone GDP rose 0.4% in the second quarter. Germany led, showing growth at 0.5%. Annualised GDP growth in Europe was significantly higher, at 2.3%, against the previous reading of 1.6%.

Meanwhile, the eurozone trade balance came in well ahead of consensus, with a surplus of €22.5 billion above the €18 billion expected. Also, the final print for July eurozone inflation growth came in line with expectations at -0.3%. This gave 2.1% growth on the year and kept inflation above the European Central Bank (ECB) target of 2%.

Americas

US equity markets fared better than their European counterparts. Defensive sectors lead the way higher, namely food and staples, tech hardware and telecommunications. Energy stocks dipped due to weakness in crude oil, while software and semiconductor stocks were also weaker. Oil faced its longest run of weekly declines in three years. Concerns over global oil demand in the wake of the Turkish crisis added to trade-war tensions between the United States and China.

Monday, August 20

  • German July Producer Price Index Link

Tuesday, August 21

  • Reserve Bank of Australia Monetary Policy Meeting Minutes Published Link

Wednesday, August 22

  • Holiday in Singapore and India
  • US Fed Monetary Policy Meeting Minutes Published Link

Thursday, August 23

  • US Fed’s Jackson Hole Economic Policy Symposium (August 23 – 25) Link
  • ECB Monetary Policy Meeting Minutes Published Link
  • New Zealand July Trade Balance Link

Friday, August 24

  • Japan July Consumer Price Index Link
  • German Second Quarter Gross Domestic Product Link
  • US July Goods Orders Link

Monday, August 27

  • Holiday in the UK

There was a mixed bag of macro data for the United States. July retail sales came in ahead of expectations, rising 0.5%, while industrial production edged up 0.1% last month.

Asia     

Last Friday, stocks in the Asia-Pacific region fell to an 11-month low, with China feeling the brunt of the fall. This weakness came despite markets being buoyed part-way through the week following reports of US-China low-level trade talks restarting on Wednesday (August 22). However, the relief was short-lived, as US President Donald Trump said no trade deal would be reached if Beijing did not bring more to the negotiating table.

Alongside this, weaker than expected Chinese macro data weighed on sentiment. Industrial production and retail sales disappointed, doing nothing to abate investor concerns about the Chinese economy. There were also concerns about the technology space, with regulators freezing gaming licences as part of a government shake-up.

The Chinese yuan also suffered, though the currency recovered some ground towards the end of the week after intervention from the People’s Bank of China (PBOC) on Thursday (August 16), caused it to surge the most since January 2017.

Interestingly, the PBOC’s second-quarter monetary policy report said it would not use the yuan as a tool to cope with external issues, including trade tensions. This assertion is a contrast to recent speculation that the central bank would depreciate the currency to soften the blow of trade tariffs.

Japanese equities were little changed on the week, with earlier gains in the Nikkei erased towards the end of the week. Risk-off sentiment saw the traditional safe-haven currency of the Japanese yen up 0.53% by the end of the week. Australia was a bright spot amid decent earnings and strength in the banks.


Week Ahead:

Economic Data

  • In the eurozone, we’ll see eurozone consumer confidence, as well as German producer price index.
  • Initial jobless claims in the United States will be the focus in macro data releases.
  • In Japan, we’ll see inflation figures released.

Politics

  • The next round of US-EU trade talks is set to begin on Monday (August 20).
  • On Tuesday, we’ll see EU’s Chief Negotiator Michel Barnier and UK Brexit Secretary Dominic Raab meet for Brexit talks in Brussels.

Monetary Policy

  • This week, we’ll see minutes from the US Federal Reserve (US Fed) monetary policy meeting. Although the real focus will fall on the annual Jackson Hole central bankers’ meeting on Thursday, with US Federal Reserve Chair Jerome Powell set to headline.
  • We’ll also see ECB minutes released on Thursday. the meeting itself was very quiet, and we expect little market-moving statements in this release.

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1. The MSCI Emerging Markets Index captures large- and mid-cap representation across 24 emerging-markets countries. Indexes are unmanaged and one cannot directly invest in them. They do not reflect any fees, expenses or sales charges.

2. Source: OECD, 2018.

3. Ibid.