Notes from the Trading Desk – Europe

The digest

Last week equities edged higher on hopes of China’s reopening from COVID-19 lockdown and a somewhat less-hawkish speech from Federal Reserve (Fed) Chair Powell. The stronger-than-expected US November non-farm payrolls number tempered the mood on Friday, but markets still held on to positive territory for the week. The MSCI World Index was up 1.1%, the STOXX Europe 600 Index was up 0.6%, the S&P 500 Index was up 1.1% and the MSCI Asia Pacific Index was up 2.24%.¹

Powell speech fuels optimism

US equities jumped on Wednesday following Powell’s speech, where he suggested the pace of rate increases could moderate soon. He stated: “The time for moderating the pace of rate increases may come as soon as the December meeting…Given our progress in tightening policy, the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level”.²

Regarding the possibility of a “soft landing” for the US economy, Powell said this remains “very plausible” and “still achievable.” However, he accepted that the path to such an outcome has been narrowing. These comments contrast with the November 2 Fed meeting press conference, where Powell stated he would rather overtighten and then adjust rates lower than to fail to tighten enough.

These comments had a meaningful impact on the market on the day, with the Nasdaq jumping 4.4% and the S&P Index closed at a two-month high, breaching its 200-day moving average, a key technical marker. The 10-year Treasury yield was down nearly 12% at 3.63%.

That said, we did see some of the optimism wane on Friday, following a stronger-than-expected US November employment report. Non-farm payrolls came in at 263,000 jobs added, higher than anticipated.

The Fed is now entering its blackout period ahead of the next meeting and interest-rate decision on 14 December . Worth noting, the November Consumer Price Index (CPI) print comes out on 13 December. So, there is still plenty for investors to focus on going into year-end.

The market is now pricing in a 50 basis-point (bp) rate hike in December (current rate 3.75%-4%) and the Fed terminal rate around 5%.³

Week in review 

Europe

European equities recorded their seventh consecutive weekly gain last week. Headline moves were muted, with the STOXX Europe 600 Index only up 0.7% over the past five days, but there are still a few interesting moves under the hood.

With colder weather arriving in Europe, we have seen European gas futures trade up 17% in the past two weeks. German gas reserves are still at 98% and reserves in the broader European Union (EU) are  at 93%, so still looking healthy, but this is a dynamic to keep an eye on.⁴ Given the market’s gains in the fourth-quarter, further sharp gains in gas futures could give an excuse for some profit-taking. EU luxury was also in focus, which rose as hopes rose for an easing of COVID lock-down measures.

Looking to the United Kingdom, it is worth noting that nationwide house prices fell 1.4% month-over-moth in November, the biggest monthly fall since June 2020. This reading captures the impact of Kwasi Kwarteng’s mini budget.

Sentiment regarding UK domestic stocks remains weak, with the FTSE 250 lagging European indices, down 1% last week, in contrast to the FTSE 100 Index, which was the best-performing, up 1%. In terms of macro data, we saw the chances of a larger ECB December rate hike fall after lower-than-expected German and Spanish inflation prints. Eurozone CPI came in at 10% for November vs. 10.6% prior. The market is now pricing a rate hike of 55 bps in December. That said, there were some hawkish comments from the European Central Bank (ECB), with President Christine Lagarde saying that authorities need to convince the public that price gains will be brought back to the ECB’s medium-term target in a “timely manner.”

Looking through to the year end, the most notable European catalysts are the ECB and BoE meetings on 15 December. UK CPI comes out the day prior. We then have options expiry on 16 December, which will be the last liquidity event of the year.

To put the recent recovery into context, it is worth highlighting that including dividends, the STOXX Europe 600 Index is now higher than it was before the war began, even if, in absolute terms, it’s still down about 3%.⁵

In terms of fund flows, European equities recorded their 42nd consecutive week of outflows (UD$0.9 billion).⁶

Last week, the European Union agreed to set an oil price cap on Russian oil exports at US$60. There is a grace period until 19 January, so it is unclear what the impact on oil market flows is going to be until then. The Kremlin rejected the price cap, and Deputy Prime Minister Alexander Novak said Russia would only sell to countries “that will work with us under market conditions”. The Russian government is said to also be considering a production cut, which could lead to oil price spikes. Supply disruptions and a recovery of demand in China could lead to tightening in the oil market in coming weeks.

United States

US equities gained for the second week in a row last week amid the Powell midweek comments. The November employment report, which came out on Friday, appeared to momentarily dampen investor spirits, but the path of least resistance seems to remain to the upside. With the now-familiar “good news is bad news” logic in mind, markets sold off after the stronger-than-expected non-farm payrolls reading. The unemployment rate was unchanged at 3.7% in November, in line with expectations. For investors, a stronger report implies that the economy may be able to withstand more aggressive interest-rate increases, which may alter Fed thinking. The more hawkish print wasn’t enough to save the further slide in the US dollar last week—the dollar has now given back more than half of its year-to-date gains.⁷

The countdown is now for the upcoming December Fed meeting, so it was only natural that Powell’s comments and the employment report garnered the most attention last week. However, there were a few other data points last week which the Fed likely has paid notice to. With investors on the hunt for signs of deflation, the October Personal Consumption Expenditures (PCE) reading was up 0.3%, a little lower than expected. Also, the Institute of Supply Management (ISM) Manufacturing Prices Paid index fell to 43.0, its lowest reading since May 2020, and down from 46.6 in the prior month. The October personal savings rate came in at the second-lowest reading ever recorded, with data going back to 1959.

So, maybe the US economy isn’t quite as resilient as the jobs report suggests? For now, markets continue to trend higher, and volatility has fallen back to levels last seen in August.

Bank of America’s Bull & Bear Indicator jumped to 1.95 from 1.4, the highest level since May, meaning that the “buy signal” for risk assets could be nearing an end.⁸ Interestingly, US-focused equity funds saw their largest outflow since April last week, shedding US$16.2 billion.⁹

Asia

Last week was somewhat mixed in Asia, with Japan’s equity benchmark closing the week down 1.79%. A moderation of inflows after the last few months of very strong buying prompted questions over whether investors were starting to rotate out of Japanese equities and into markets in Hong Kong/China on the back of Chinese reopening hopes. Hong Kong’s market was the standout performer in the region last week, closing up 6.27%, with China’s mainland market closing up 1.76%.

Japan’s market was down 1.79% last week as exporters suffered due to yen strength. There was also some rotation out of Japanese equities and into Hong Kong/China as investors focused on positive COVID-19-related developments in China. Growing expectations that the Fed will slow the pace of it interest rate hikes also impacted market sentiment.

The yen strengthened to its highest level in over three months in anticipation of the Fed pivoting to a more dovish stance.

On the economic front, Japan’s industrial production index fell 2.6% month-over-month in October. This decline, which was more than expected, resulted from decreases across the production machinery, electronic parts and devices, and chemicals industries. Consumer confidence weakened in November, led by a deterioration in the labour market and wage growth.

Equities on China’s mainland closed last week up 1.76% amidst signs the Fed may slow the pace of hikes and, more importantly—hope for the relaxation of COVID-19 control policies. Major cities like Guangzhou, Chongqing, Beijing and Tianjin shifted away from the city-wide lockdown and switched to “precise control”. Tourism and retail stocks rallied accordingly.

The market had fallen earlier in the week following reports of civil unrest in major cities nationwide.

However, signs that China was edging away from its zero-tolerance policy helped markets rally. China’s National Health Commission announced it will boost vaccination rates among the elderly, a move seen as crucial for the economy to fully reopen. In addition, China’s most senior official in charge of the COVID-19 response said that efforts to combat the virus were moving to a “new phase” as the omicron variant weakens and more people are vaccinated. There were also media reports that Beijing plans to start allowing low-risk infected individuals to isolate from home rather than in government quarantine sites.

Data-wise, China’s November Manufacturing PMI came in at 48, and the Non-Manufacturing PMI at 46.7, both lower than expected. The private Caixin China General Manufacturing PMI rose more than expected, to 49.4. However, the measure remains in contraction territory (sub-50).

The week ahead

Looking ahead to the end of the year, this week and next look to be crucial in terms of setting investor sentiment. This week, the Reserve Bank of Australia (RBA) holds its policy meeting, and Chinese CPI data stand out. In the United States, Producer Price Index (PPI) data on Friday will be one of the last pieces of data the Fed see prior to its meeting 13-14 December. The US Senate runoff in Georgia will also be interesting. Next week, the US and UK CPI data are due out, and next week, and the US Fed, ECB and Bank of England hold their respective policy meetings.

Monday 5 December

• United Kingdom: New Car Registrations (Nov), Official Reserves Changes (Nov), S&P Global/CIPS UK Services/Composite PMI (Nov)
• European Union: Retail Sales (Oct)
• France: Industrial/Manufacturing Production (Oct)
• Japan all household spending
• US Factory Orders/Ex-Transportation (Oct), Durable Goods Orders/Ex-Transportation (Oct), Cap Goods Orders/Ship Nondefense Ex-Air (Oct), ISM Services Index (Nov)

Tuesday 6 December

• Germany: Manufacturing Orders
• United Kingdom: BRC Sales Like-For-Like (Nov)
• China Trade Balance
• US Trade Balance (Oct)

Wednesday 7 December

• France: Trade Balance (Oct), Current Account Balance (Oct)
• Germany: Industrial Production (Oct)
• Italy: Deficit to Gross Domestic Product (year-to-date), Retail Sales (Oct)
• United States: MBA Mortgage Applications (Dec), Nonfarm Productivity, Unit Labour Costs, Consumer Credit (Oct)

Thursday 8 December

• UK: RICS House Price Balance (Nov)
• China CPI
• United States: Initial Jobless Claims (Dec), Continuing Claims (Nov)

Friday 9 December

• United Kingdom: BoE/Ipsos Inflation Next 12 Months (Nov)
• France: CPI Index (Nov)
• United States: PPI Final Demand/Ex-Food and Energy/Ex-Food, Energy, Trade (Nov), Wholesale Trade Sales/Inventories (Oct), University of Michigan Sentiment/Current Conditions/Expectations/1-Year Inflation/5-10 Year Inflation (Dec), Household Change in Net Worth

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