Notes from the Trading Desk – Europe

The digest

Last week was choppy as investors digested central-banker commentary, macro data and corporate earnings. Of note, a number of Federal Reserve (Fed) speakers stuck to their hawkish narrative and some weak US macro data raised doubts over a “soft landing” for the US economy. In Europe, there likewise was some hawkish European Central Bank (ECB) commentary, although we did see further commentary that the outlook for Europe is improving. On the week, the market moves were lacklustre, with the MSCI World Index down 0.4%, STOXX Europe 600 Index down 0.1%, the S&P 500 Index down 0.7% and the MSCI Asia Pacific Index up 0.8%.¹ 

US Fed in focus

Last week saw a mid-week wobble for US equities on the back of some weaker macro data and a few hawkish Fed comments. US retail sales (excluding autos) month-over-month fell 1.1%, which was worse than expected. December Industrial Production was down 0.7%, also worse than expected, and some investors took the view that “bad news was bad news”. The suggestion is that these weak numbers indicate a soft landing is less likely, and on Wednesday, the S&P 500 Index fell 1.6%. It was only a couple of data points, so one could argue it is too early to jump to conclusions. But what was interesting was the change in market reaction, as for a while the default response to weak macro was “bad news is good news”, which could lead to a less-hawkish Fed.

Another interesting dynamic last week was the US December Producer Price Index, which fell 0.5%, the most since April 2020, but importantly, the market reaction was fairly muted. This suggests the market is pricing in a peak inflation, so the focus has now turned to growth and outlook for a hard or soft landing for the US economy.

In terms of Fedspeak, last week saw several policymakers reiterate that there is still work to be done to tame inflation. Federal Open Market Committee (FOMC) speakers included:

• Governor Brainard (voter) who is one of the more dovish speakers, reaffirming that it will take time under restrictive monetary policy to return inflation to the 2% target;
• NY Fed President Williams (voter) also stressed that the Fed still has work to do; and
• Dallas Fed’s Logan (voter) argued rates could have to move to a higher level than expected.

Over the weekend, the Fed entered its blackout period ahead of the 1 February meeting. The market expects a 25 basis points (bps) hike², and the final Fed speaker last week, Christopher Waller, did nothing to change that narrative. He stated: “I currently favour a 25-basis point increase at the FOMC’s next meeting at the end of this month…Beyond that, we still have a considerable way to go toward our 2% inflation goal, and I expect to support continued tightening of monetary policy”. With the 25 bps rate hike seemingly priced in, we think the Fed statement and any commentary around the future rate path will likely be more impactful.

Europe outlook/ECB

After being the pariah for so long, European equities saw their first inflow in 49 weeks (a whopping US$200 million!).³ This ties in with the BofA Fund Manager Survey, which saw a small thawing of sentiment on Europe, with eurozone equities as an “overweight” for respondents since Feb 22.⁴

In addition, inflows into US-listed European exchange-traded funds sharply ticked up, another indication that investors are warming to Europe.

Why the change in sentiment? The energy outlook for Europe has shaped up to be far more positive than feared, thanks to robust gas reserves and falling gas prices. Furthermore, the sudden reopening of China’s economy was a clear boost to Europe (for example, luxury brands). German Chancellor Olaf Scholz recently said he was “convinced” Germany would not fall into recession and Banque De France Governor Francois Villeroy de Galhau said “For Europe, we should avoid recession this year”.⁵

While we’ve seen some improving estimates for Europe’s economy, we should keep in mind there are still hawkish voices at the ECB. Over the weekend, Klaas Knot called for 50 bps hikes in both February and March, saying the time to slow tightening is still far away.⁶ We subsequently heard ECB President Christine Lagarde state she was determined to stay the course, noting inflation is still too high.

UK in focus: All-time high for the FTSE 100!

Despite the gloomy backdrop for the UK economy, it is worth noting the FTSE 100 Index made an all-time high midweek (in British pounds), but then drifted a little into the end of last week to close down 1%, as a stronger pound and weaker energy names weighed on the market. The more domestic-focused FTSE 250 Index was one of the worst-performing European markets last week, falling 1.3% amidst some profit warnings. Weak December retail sales and consumer confidence data further highlighted the ongoing challenges. The weaker-than-expected January GfK consumer confidence reading was driven mainly by deteriorating assessment of the personal financial situation and the state of the economy over the past year. Earlier in the week, UK Inflation data was broadly in line with market expectations, with the year-over-year (y/y) Consumer Price Index up 10.5%.

The week in review

Europe

Last week was choppy for European markets, with the STOXX Europe 600 Index closing unchanged. It was a week of two halves; in the first half, we saw a continuation of the grind higher, before an abrupt pullback on Thursday. The pause for breath was due to concerns around the US economic “soft landing” looking less likely based on weak macro and some further hawkish Fed commentary. In addition, we had some hawkish commentary from the ECB, which added to the cautious tone.

Looking at the technical picture, the index did appear to hit overbought territory earlier in the week and failed at a key resistance level (4200).

Sector-wise, travel and leisure stocks fared best, while autos underperformed.

United States

US equities finished the holiday-shortened week lower overall. The S&P 500 Index closed last week down 0.7%, the Dow Jones Industrial Average closed down 2.7%, the Russell 2000 Index was down 1.0%, whilst the Nasdaq outperformed, up 0.7%, helped by the year-to-date rotation to technology. The market seemed to pause for breath last week as earnings came more into focus. US earnings have been mixed so far and earnings expectations are starting to fade, according to FactSet. The rotation into last year’s losers continued again last week, with communication services stocks particularly strong this year.

Another trend which is worrying US investors is the divergence in economic outlooks between the United States and Europe. Whilst recent eurozone data has been coming in ahead of expectations, US data has been lagging. US December Retail Sales fell more than expected, down 1.1%, whilst December Industrial Production was a notable miss, down 0.7%. The Empire Manufacturing survey, which measures manufacturing activity in New York state, plummeted in January to the lowest level since the early months of the pandemic; new orders and shipments collapsed 32.9. Large corporations are also cutting staff, as Microsoft and Google became the latest to announce layoffs. The week ahead could be an interesting one for US data with Purchasing Managers Indices (PMIs) on Tuesday, gross domestic product (GDP) data on Thursday and personal spending data on Friday.

The latest BofA Fund Managers Survey showed US equities are at their most underweighted position since October 2005.⁷ Falling gas prices, a weaker US dollar, as well as China’s reopening have spurred investors to move into stocks in Europe, China and other emerging markets. The market still looks undecided on the Fed’s terminal rate this year.

The US debt ceiling was in focus as well last week. US Treasury Secretary Janet Yellen told members of Congress that the United States had reached its debt ceiling, ultimately raising the risk of a US default on its bonds for the first time ever. The debt ceiling currently stands at US$31.4 trillion, and unless Congress raises it, the government will run out of money. Yellen urged Congress to act, stating that failing to do so would cause global economic damage.

Finally, elsewhere in the Americas, there have been reports that Brazil and Argentina are in preliminary discussions to form a common currency for financial and commercial transactions. The plan is expected to face plenty of political and economic hurdles, and with the recent political changes, very little practical progress has been made so far. The two countries, representing South America’s two largest economies, issued a joint statement that sharing a currency could help boost regional trade.

Asia

Asian markets were not quite as strong as in the prior week, but  pushed  ahead again last week, with all major markets in the green. The recent weakness of the US dollar seemed to be helping emerging markets, boosting the region in general.

China’s mainland market had another good week on the back of better-than-expected economic news and further signs of a thawing in US-China relations.

Despite the Lunar New Year holiday this week (markets are shut all this week, reopening on 30 January), investors were in an ebullient mood, as China’s fourth-quarter GDP and December’s major economic data was better than expected. Some of this better data was no doubt due to Beijing’s lifting of strict COVID-19 restrictions, together with a raft of pro-growth policies implemented mostly in the second half of last year. Many economists now predict that China’s economy will grow around 5% this year and this is also supported by many of the Chinese provinces, which have also set growth targets of 5% or more.

Yellen plans to travel to Beijing soon following the first face-to-face meeting with Chinese Vice Premier Liu He. China’s Ministry of Commerce said the talks are aimed at strengthening economic and financial policy coordination, and implementing the agreements made during a summit between Chinese President Xi and US President Biden last year.

Equities in Hong Kong had a good week, with the technology space leading the way  as China’s video-game regulator issued fresh licenses, seen as a positive sign for the recovering industry. Also, the Hong Kong Stock Exchange and China bourse said it would expand the stock connect eligibility list, boosting the space.

Biotech finished strong after reports that 111 drugs are added to the China National Healthcare Insurance list. Solar and wind names soared after 6 Ministries released a renewable energy development plan.

Japan’s equity market did well last week amidst the highly anticipated Bank of Japan (BoJ) announcement and the China reopening story, especially ahead of China’s Lunar New Year celebrations. Airline stocks performed particularly well.

Last week, the BoJ decided to keep its yield curve control unchanged and maintained its loose monetary policy. JGB yields fell, and the yen weakened as a result. The BoJ said that risks to inflation are skewed to the upside, leaving open the possibility that forecasts would be revised up at the time of the next release in April.

On the economic front, core CPI rose 4% y/y in December, a 41-year high, as rising costs were passed onto consumers. Producer prices also surged over the same period.

Elsewhere, Prime Minster Kishida said that the legal status of COVID could be downgraded to the same level as flu, which was obviously seen as a positive sign and could certainly boost the tourism sector. If this does go ahead in the spring, it could mean a loosening of testing and quarantine requirements and even the requirements to wear masks.

The week ahead

Holidays/markets closed          

Monday 23 January: China, China Connect, Hong Kong, Indonesia, South Korea, Malaysia, Singapore, Taiwan

Tuesday 24 January: China, China Connect, Hong Kong, South Korea, Malaysia, Singapore, Taiwan

Wednesday 25 January: China, China Connect, Egypt, HK, Taiwan

Thursday 26 January: Australia, China, China Connect, India, Taiwan

Friday 27 January: China, China Connect, Taiwan

Macro Week Ahead Highlights

Eurozone and UK PMIs will be a focus, as well as the German IFO survey on Wednesday.

In the United States, MBA Mortgage Apps, PMIs, fourth-quarter GDP and Dec PCE Inflation, are a few things to be mindful of.

Asia will be quiet, as China’s markets are closed all week for Chinese Lunar New Year.

Monday 23 January

• United States: Leading Index (03:00pm UKT).

Tuesday 24 January

• UK Flash Composite PMI
• Euro-area Flash Composite PMI
• ECB Governing Council member Klaas Knot speaks at Future of the Financial Sector conference in Frankfurt.
• United States: S&P Global US Manufacturing PMI

Wednesday 25 January

• Eurozone: Germany Ifo Survey
• ECB Executive Board member Fabio Panetta speaks in the European Parliament, and ECB President Christine Lagarde makes a speech at the Deutsche Boerse annual reception
• United States: MBA Mortgage Applications

Thursday 26 January    

• Eurozone: Italy Consumer Confidence Index; Italy Manufacturing Confidence
• United States: GDP Annualised quarter-over-quarter; Durable Goods Orders; Initial Jobless Claims; New Home Sales

Friday 27 January

• Eurozone: M3 Money Supply y/y
• United States: Personal Income; Personal Spending; University of Michigan Sentiment

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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. Source: Bloomberg, federal funds futures. As of 23 January 2023. There is no assurance that any estimate, forecast or projection will be realised.

3. Source: Bloomberg, “BofA Says Non-US Funds Shine as China Opening Fuels Capitulation.” 20 January 2023.

4. Sources: BofA Global Fund Manager Survey (23 January), EPFR.

5. Source: Bloomberg, “ECB’s Villeroy: We Should Avoid a Recession This Year”, 18 January 2023.

6. Source: CNBC, “European Central Bank member says market is mispricing rate hikes, expects more to come”, 19 January 2023.

7. Sources: BofA Global Fund Manager Survey (23 January), EPFR.