Beyond Bulls & Bears


Notes from the Trading Desk – Europe

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.

The Digest

Last week equity markets remained volatile as investors focused on the Omicron variant headlines and rhetoric from central bankers. In particular, commentary from the Federal Reserve (Fed) was a key talking point as Chair Jerome Powell suggested the pace of Fed tapering could be accelerated. In that context, indices started off December with a distinctly unfestive performance, with the MSCI World Index down 1.5%, the European Stoxx 600 Index down 0.3%, the S&P 500 Index down 1.2% and the MSCI Asia Pacific Index down1%.1

Omicron Concerns Weigh on Sentiment

Last week equity markets were at the mercy of the next Omicron variant headline as investor sentiment wavered around the potential impact of the new variant on global economies and markets.

Whilst there has been a lot of noise around the new variant, we are still waiting for full clarity on the severity of illness, vaccine efficacy and the likelihood of reinfection. However, cases continued to rise sharply in South Africa and further cases are appearing globally. As a result, some travel restrictions are returning, and the newsflow around variant concerns was enough for some economist to cut their global gross domestic product (GDP) forecasts.

It is important to remember that nerves were already frayed last week over COVID-19 as cases rose sharply in some places, namely Austria and Germany. Some countries have already added restrictions on travel and recreation, and last week saw further negative COVID-19 headlines from Germany weigh on sentiment as the government announced tighter restrictions on unvaccinated people. Chancellor Angela Merkel said “the situation is very serious. The number of infections has stabilised but at far too high a level.”2

How the current situation impacts economic activity will be key, as early mobility numbers show declines in retail footfall in affected countries and flight bookings have decreased.

Central Bank Policy in Focus

December will be an interesting month for central banks as soaring inflation puts pressure on them to act. However, the waters are muddied significantly by the arrival of Omicron and the potential for disruption to economic activity.

Looking ahead this month, we have a number of central bank meetings on the calendar. The Bank of Canada and Reserve Bank of Australia meet this week, whilst the Federal Reserve, meeting and the Bank of England (BoE) and the European Central Bank (ECB) hold policy meetings next week.

ECB: Nobody thought that the ECB was moving any time soon, but President Christine Lagarde said last Friday that an interest rate rise in 2022 was very unlikely. She also confirmed that net purchases under its €1.85 trillion Pandemic Emergency Purchase Programme (PEPP) will likely expire on schedule at the end of March 20211. She also said the central bank may unveil short-term measures at December’s policy meeting due to heightened uncertainty, providing some clarity without making long-term commitments. So, it looks like the 16 December meeting may be a non-event, with eyes being focused on the 3 February and 10 March 2022 meetings, when we might see the bank scaling up its standard Asset Purchase Programme (APP) to make it more flexible upon the end of PEPP net purchases.

Despite European Union (EU) inflation hitting a record level of 4.9% (last week’s Consumer Prices Index (CPI) data), Lagarde feels this is peaking and will start to pare back in 2022.

Fed: Probably of more significance last week were Fed Chair Powell’s remarks suggesting that the term “transitory” should no longer be used, which added to expectations that the first US rate hike could be sooner than anticipated. He went on to say the Fed can consider wrapping up taper a few months sooner and must ensure higher inflation doesn’t become entrenched.3 That said, the November jobs data (released on Friday) did not look especially inflationary, besides the headline unemployment rate, with the Institute of Supply Management (ISM) data this week also on the softer side.

In this context, we have seen a sharp flattening of the US Treasury yield curve in recent weeks, with the curve now at levels similar to March 2020.

With Powell’s hawkish pivot, market expectations of rate hikes have risen, and expectations are for interest rates to hit 1.25% by the end of 2023.4

BoE: An interest rate increase was very much expected at the last monetary policy meeting on 4 November, but did not transpire, and we saw UK banks decline. Comments last Friday from traditionally hawkish BoE member Mike Saunders surprised markets somewhat as he stated there were “advantages” to waiting for more information on Omicron before acting on rates.5

With that, the British pound traded lower, gilts edged higher, and expectations of a rate rise on 16 December waned. Based on trading in interest rate futures, investors now see a 25% chance that the BoE will lift the base rate from 0.10% to 0.25%.6 Before he spoke, the probability stood at 50%, having already fallen significantly since the emergence of Omicron a week ago.

However, looking further ahead, Saunders said interest rates were likely to rise from their present historic lows over the coming months: “If the economy develops as I expect, then some additional tightening, on top of such a move, probably will be needed fairly soon.”

The Week in Review


European equities ended the week essentially unchanged, but mildly negative. However, that doesn’t tell the story of what was a volatile trading period, as markets nerves were brittle and we were very much at the mercy of the next COVID-19 headline.

With that, the European Volatility Index remained at elevated levels.7 It also felt like moves were exaggerated as we navigated month end, but also as we approach the year end and investors grow nervous about protecting performance.

Looking to sector performance, despite a volatile week for crude oil, oil and gas stocks were higher. On the downside, telecommunications and technology stocks were lower.

Credit: Looking beyond equities, it is noteworthy that European credit spreads widened on the Omicron news and have remained at somewhat elevated levels. We see this as a good barometer for investor sentiment and something to keep an eye on.

United States

US equities declined for last week as Omicron concerns rattled nerves and as Powell stuck by his recent hawkish tilt. The pain was greatest in growth names (particularly technology) as investors factored in a faster Fed tightening cycle.

Volatility remains high—on Wednesday of last week, the S&P 500 Index saw its largest intraday swing since March. As in Europe, the US Volatility index remains elevated, with the VIX Index around the 30 level.8

Looking to Fed speak beyond Powell, Loretta Mester (a non-voter) said she is “very open” to scaling back asset purchases at a faster pace so the Fed can raise interest rates a couple of times next year if necessary. In addition, Mary Daly (also a non-voter) also said that the Fed may need to taper asset purchases more quickly.

Fund flows for the week to 1 December also carried a risk off tone, with investors moving largely to cash and US Treasuries.

It was also interesting to see retail investor favourites suffering in this risk-off climate, as crowded trades saw outflows. Given “buy the dip” has become a familiar mantra for some investors in recent times, it will be interesting to see if this behaviour continues into year end..

Asia Pacific

As with other regions, uncertainty over the Omicron variant and travel restrictions weighed on sentiment for Asian equities, with the MSCI Asia Pacific Index down last week. The Nikkei was hardest hit, as Japan banned foreign visitors once again.

South Korea was the best performing index in the region, rising on the back of a strong week for heavyweight Samsung.

In Hong Kong, the Macau gaming sector dragged the market lower.

In terms of macro data, China Purchasing Manager Index (PMI) prints were mixed; the Caixin PMI Composite came in at 51.2 vs. 51.5 prior while Caixin PMI Manufacturing came in at a weaker-than-expected at 49.9.

Week Ahead

Equity markets are off to a positive start this week in Europe as Dr Anthony Fauci, US President Joe Biden’s chief medical adviser, said early data on Omicron’s severity is encouraging, while a small South African study supported anecdotal evidence the variant causes only mild illness. No doubt we will be at the mercy of COVID headlines once again.

Key macro focus this week will be US Consumer Price Index (CPI) data Friday. China Trade data comes out on Tuesday and we have gross domestic product data from the European Union and United Kingdom towards the end of the week.

The Reserve Bank of Australia meets on Tuesday and the Bank of Canada meets on Wednesday. Note, the Fed is now in a blackout period ahead of the 15 December meeting so no comments are expected.

Monday 6 December     

  • Germany: factory orders (October), PMI construction (November)
  • Italy: retail sales (October)
  • UK: PMI construction (November)
  • BoE Deputy Governor Ben Broadbent speaks on the outlook for growth and monetary policy. He is considered a key swing voter ahead of the BoE’s interest rate decision on 16 December.

Tuesday 7 December    

  • Germany: ZEW Survey expectations/current situation (December), Industrial Production (IP) (October)
  • France: current account balance (October), trade balance (October)
  • US: non-farm productivity, unit labor costs, trade balance (October), consumer credit (October)

Wednesday 8 December

  • France: private sector payrolls, total payrolls
  • US: MBA mortgage applications, JOLTS job openings (October)

Thursday 9 December       

  • Germany: trade balance (October), current account balance (October), imports/exports (October)
  • UK: RICS house price balance
  • US: initial jobless claims, continuing claims, Langer Research Associates consumer comfort, wholesale trade sales (October), household change in net worth

Friday 10 December       

  • Germany: Consumer Price Index CPI (November)
  • Italy: IP (October)
  • UK: IP (October), manufacturing production (October), construction output (October), Index of services (October)

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

2. Source: Financial Times, “Germany moves towards mandatory vaccination and tightens Covid curbs”, 2 December 2021.

3. Source: Financial Times, “Transitioning away from ‘transitory’ inflation”, 1 December 2021.

4. Source: Bloomberg. There is no assurance that any estimate, forecast or projection will be realised.

5. Source: BBC, “December rate rise hangs in balance amid Omicron”, 4 December, 2021.

6. There is no assurance any estimate, forecast or projection will be realised.

7. 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.

8. The CBOE Market Volatility Index measures market expectations of near-term volatility conveyed by S&P 500 stock index option prices. 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.

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