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 saw some respite for global equities markets with a relief rally in many markets as we approach month and quarter-end. There were a range of catalysts for the moves, including an easing in rate-hike expectations as recession risk rises and some potential signs that some of the key drivers of inflation could be peaking. In addition, some argue markets are oversold following a sharp move lower and quarter-end positioning has lent support.

On the week, the MSCI World Index was up 5.4%, S&P 500 Index was up 6.4%, the STOXX Europe 600 Index was up 2.4%, and the MSCI Asia Pacific Index was up 1.5%.1

Market bounce: quarter-end squeeze or improved fundamentals?

Last week’s rally was a welcome relief for equity investors, but questions remain as to the reasons for the move.

Hopes rose that we could be approaching peak inflation thanks to declines in commodity prices, with the Bloomberg Commodity index down 4.3% last week. Notably, the price of copper fell 7% and iron ore 5%. In addition, some soft commodities have also declined this month, including corn, wheat and palm oil. Importantly, there were some possible signs in the macro data that inflationary pressures were easing, including the latest US Purchasing Managers Index (PMI) report. Furthermore, the University of Michigan Survey data for the end of June saw 5-10 year inflation expectations drop to 3.1% from 3.3%. It is too soon to say if this does mark peak inflation, but this dynamic is crucial to watch in the coming months.

On Friday, St. Louis Federal Reserve (Fed) Bank President James Bullard said worries over a US recession are overblown, also aiding the market bounce. That said, last week we also saw some economists up the odds of a recession. Those increasing recession fears have started to feed into interest-rate expectations, with markets now pricing in US rates at about 3.41% at the end of the year (down from about 3.57% at the end of last week).

It seems likely that the market bounce was also driven by some month- and quarter-end positioning from oversold levels. A similar trading pattern was seen at the end of the first quarter when markets rallied 11% ahead of quarter-end. Investor sentiment has also been extremely bearish in recent weeks. Last week saw some improvement, with the CNN Fear & Greed Index moving from “Extreme Fear” to “Fear”.2

With the move lower this quarter, European equity valuations are now close to pandemic lows.

Looking to other assets, cryptocurrencies seem to have stabilised, which may give some confidence for retail investors to step back into the market. That said, credit markets do not show the same improvement in sentiment. Investment-grade credit dramatically underperformed equities last week, something credit participants consistently highlighted as a reason not to believe the equity rally has legs.

European credit hasn’t reflected the same change in sentiment, with the ITRAXX XOVER Index still close to recent highs. Sovereign bond yields were healthier though, with the Italian 10-year bond yield falling back to 3.4% vs. 4.1% high previously.

European gas supply in focus

Gas prices in Europe have been a focus for markets, particularly the tightness of the European gas market after Russia significantly reduced its flow of gas to Europe. Overall flows of gas into Europe from Russia are down 55% from the start of 2022, with gas prices continuing to surge.3 An unexpected outage from Freeport LNG, one of the largest operators of liquefied natural gas export terminals in the United States, hasn’t helped.

Germany, which gets roughly 65% of its gas imports from Russia, began planning for potential shortages in winter. Reports at the start of the week suggested Germany is planning incentives for the industry to reduce consumption and is preparing to reopen more coal plants to reduce the reliance on gas. Other countries are also looking at alternatives, which are in short supply. Austria and the Netherlands announced they would be restarting the use of coal plants as an energy source, a move which resulted in a warning from European Commission President Ursula von der Leyen that countries must remain focused on their “massive investment in renewables”.4

On Wednesday, the Financial Times reported that the International Energy Agency (IEA) was advising governments to prepare for a complete severance of Russian gas this winter, urging governments to take measures to cut demand and keep ageing nuclear power stations open.5 Gas supplies via NordStream 1 have been reduced by 60% in the last 10 days. The head of the IEA, Fatih Birol, said Russia reducing gas supplies could be an attempt by the Kremlin to gain “leverage” during its war with Ukraine.

On Thursday, Germany triggered the second level of its gas emergency plan. German Economy Minister Robert Habeck called the cut to gas supplies by the Kremlin an “economic attack” and said  gas is “a scarce commodity” in Germany and that citizens are obliged to reduce gas consumption. The second “alarm stage” of a three-stage emergency plan signals that authorities see a high risk of long-term gas supply shortages. Rationing of gas supplies would kick in if Germany triggered level three of the emergency plan. The risks of course are further cuts on Russian deliveries and a colder-than-normal winter, whilst, in the current market, countries can’t fully rely on supply from alternative sources.

Interesting week for European macro data

It was a busy week in terms of macro data updates. European PMI data missed expectations, although still came in expansion territory, with the June preliminary composite figure coming in at 51.9 (a 16-month low and weaker than anticipated). Manufacturing output was down for the first time in two years.

UK inflation edged up again in May, hitting 9.1% year-on-year, and up from 9.0% in April. The print was in line with market expectations. Core inflation, which strips out some of the more volatile energy and food components, edged down to 5.9% from 6.2%. From here, it could be an uncertain path ahead, resulting in a severe squeeze for UK corporates.

In addition, last week saw UK Consumer Confidence data came in with the lowest reading on record, at -41.

The Week in Review

United States

US equities rebounded last week, recording their biggest one-day move since June 2020 on Friday to finish the week up 6.4%. It was a holiday-shortened week, with US equity markets closed on Monday for Juneteenth. Sentiment remains very bearish on a technical level, so bear-market squeezes such as last week’s are possible. Recession fears continue to plague sentiment; however, there was hope last week that we may be beyond peak inflation after the University of Michigan’s latest survey showed consumer inflation expectations eased from a 14-year high. Fed Chair Jerome Powell also hardened his resolve in the fight to cool inflation, but the markets’ US rate expectations eased last week. US equity funds saw their first outflow in seven weeks, and bond funds continued to see redemptions.

Energy—a huge year-to-date outperformer—was the only sector to finish lower last week. The sector closed the week lower, with West Texas Intermediate crude prices declining and fears of a recession raising questions of forthcoming demand. Over the last two weeks, the US energy sector has seen its third-worst drop over the last 40 years, beaten only by October 2008 and March 2020. Given the robust gains this year, it seemed primed for profit-taking at some stage. As we also noted last week, there are other factors weighing on the sector at the moment, such as China ramping up purchases of discounted Russian oil, overall Russian oil exports increasing month-on-month, and the potential for a windfall tax on US energy companies.

Macroeconomic data continues to be a focus for markets as investors seek a pullback in inflation levels. As noted, the University of Michigan consumer inflation expectations dropped to 3.1% in June from 3.3%, flagging the attention of Fed Chair Powell. Also, with recent moves in commodity markets potentially impacting the July Consumer Price Index (CPI) report, focus will continue to be on further signs we are past peak inflation. Also, last week, new home sales rebounded in May, partially retracing their fall in April. US PMIs were soft, however, with the preliminary manufacturing PMI coming in at 52.4. Services were lower as well at 51.6. The underlying details were poor, with output and new orders dropping into contractionary territory for the first time since the pandemic downturn.


European equity markets recovered ground last week thanks to a late squeeze higher on Friday led by some clear rotation into growth names. Growth stocks outperformed value stocks by a significant amount. With the chatter of peak inflation on the back of Powell’s testimony and the University of Michigan revising inflation expectations lower, we saw underweights in in growth names squeezed aggressively into the end of the week. Another factor in Europe was falling rate-hike expectations; following the weak PMI data, the market’s rate-hike expectations for the European Central Bank fell from 1.75% to 1.50%. Finally, with quarter end next week, it feels like there is more than a touch of winners being sold and vice versa at play.

Another dynamic for Europe was a move out of cyclicals as fears around future gas supply and economic outlook came to a fore.

These dynamics were reflected in European sector performance, with technology stocks and consumer staples higher whilst basic resources and autos were lower.

Fund flow data shows that EU equity funds recorded their 19th consecutive week of net outflows.

Asia and Pacific

Asian equity markets were mainly higher last week, with the MSCI Asia Pacific Index closing the week up 1.5%.

China’s COVID-19 outbreak remains the key focus for investors, with the outbreak shifting to other regions in Shenzhen and Macau. There was better news in Beijing and Shanghai, where outbreaks appear to be receding—both cities recorded single-digit daily infections by the end of last week. In Macau, closures of cinemas, gyms and bars were announced to try and curtail the spread. Despite the outbreak, President Xi Jinping pledged to meet economic targets for the year even as the government’s zero tolerance approach to combating COVID and a weak housing market put the growth goal further out of reach. Also, Hong Kong’s incoming leader John Lee said he plans to “quickly review” mandatory quarantine measures for incoming travelers, including suggestions to isolate at home or reduce the number of days required to stay in designated hotels.

In Australia, the Reserve Bank of Australia Governor Lowe reiterated that more hikes are coming to fight inflation. The market was expecting Lowe to track the Federal Reserve with a 75 basis point (bp) hike in July; however, he insisted a rise of 50 bps was more likely. This triggered a rebound in the Australian bond market.

The Week Ahead

This week, we will see quarter-end in focus, with much chatter of pension rebalancing impact.

In terms of macro data, European consumer confidence and CPI data are of interest. In the United States, gross domestic product (GDP) and manufacturing PMI data will be in focus.

Events: ECB Sintra forum (Monday); G7 Summit (Sunday); NATO summit (Wednesday); many central bank speakers (including Lagarde, Powell, Bailey and Carstens at Sintra on Wednesday); potential speech by Chinese President Xi Jinping (Friday); primary elections in a number of US states (Tuesday).

Marco data

Monday 27 June

  • US Durable Goods
  • US Dallas Fed manufacturing survey
  • US Durable Goods
  • US Dallas Fed manufacturing survey

Tuesday 28 June

  • Germany Consumer Confidence
  • France Consumer Confidence
  • Italy Industrial sales
  • US Retail inventories ex-auto
  • US Merchandise trade balance & Wholesale inventories

Wednesday 29 June

  • Eurozone Economic & Consumer Confidence
  • Germany CPI
  • US GDP & Real consumption

Thursday 30 June

  • UK GDP & CA Balance
  • France CPI & PPI
  • Germany Unemployment Change
  • Euro Zone Unemployment Rate
  • Italy PPI
  • US Jobless claims & Personal income

Friday 1 July

  • UK Consumer Credit
  • UK Manufacturing PMI
  • Italy CPI EU Harmonized
  • Eurozone CPI Estimate
  • US Manufacturing PMI
  • US Construction spending

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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. CNN’s Fear & Greed Index tracks seven indicators of investor sentiment. 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.

3. Source: Bloomberg, as at 24 June 2022.

4. Source: Financial Times, “EU warns against fossil fuel ‘backsliding’ as coal replaces Russian gas”, 20 June 2022.

5. Source: Financial Times, “IEA chief warns Europe to prepare for total shutdown of Russian gas exports”. 21 June 2022.

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