Day: 29 March 2022

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

Global equities were higher overall last week, with existing themes providing some push and pull. Central bank hawkishness, persistent inflationary pressures and the war in Ukraine are all existing themes which investors are still trying to digest. Despite the uncertainty, the MSCI World Index closed the week up 1.3%, while regionally, performance was fairly mixed, as the S&P 500 Index closed the week up 1.8%, the STOXX Europe 600 Index closed down 0.2%, whilst the MSCI Asia Pacific closed up 0.5%. This week marks the end of the first quarter, and it has been a very eventful quarter for markets. Through the quarter, the S&P 500 Index has traded within a 14% range of its year-to-date (YTD) highs; the STOXX Europe 600 Index trading range has been 18%; whilst the MSCI Asia Pacific Index has traded down as much as 16% from its highs.

Ukraine Crisis Continues

There was little change in our key market themes last week; however, it is clear that the market remains poised for some more positive headlines out of Ukraine. It has now been over four weeks since Russia launched its invasion of Ukraine, and there are very few signs that the conflict will be coming to an end soon. But, it still feels like hope is a big driving factor behind relative equity market strength despite the clear headwinds.  Headlines throughout last week suggested that the two sides remain far apart in negotiations. Ukraine’s Deputy Chief of Staff Ihor Zhovkva said that the Donbas and Crimea territories are non-negotiable, and the country would never surrender them. The Kremlin also advised that there was no progress on the key issues. Questions about Russia’s intentions in Ukraine were raised again last week, with reports that Russia will focus (for now) on taking full control of the Donbas region. This appeared to show a scaling back of the ambitions of Putin. Earlier in the week, US President Joe Biden said that he believed Russia’s President Putin’s back was against the wall, increasing the chances of the use of chemical or biological weapons.

Yet, despite the continued violence and the lingering uncertainty for the global economy, equity markets are now approximately 5% above pre-invasion levels. Positioning had been extreme so far this year, and this positioning was occurring well before Russia’s invasion of Ukraine. We saw significant rotation in January, with some broad risk-off moves as investors moved out of growth and into value. So, sentiment was already bearish, and the invasion exacerbated this trend. Despite the technical reasons for a bounce in equity markets, the same headwinds still persist. Investors should be wary of more hawkish central bank rhetoric, as commodity prices rose again last week and the true extent of the impact on the global supply chain is yet to be felt.

So, what next? We could see a challenging second-quarter ahead, particularly in Europe. Sentiment has fallen to levels seen during other crisis periods, and inflation will likely stay elevated amid global supply-chain disruptions.

Week in Review

Europe

Last week, European equities actually finished one of the least-volatile weeks YTD, down 0.2% overall, following a late selloff. Equity markets had been fairly resilient all week in the face of continued headwinds. Yet, stock markets were fairly stable, with TINA (“There Is No Alternative”) apparently back in play. Intra-day volatility was lower again. European equities have now recovered more than half of their YTD losses and we saw risk appetite returning somewhat. Nonetheless, it was another week of outflows for European equity funds, although the pace of these outflows has been slowing. Market volumes have been poor, post the previous week’s expiries.

Sector performance divergence was large again last week Unsurprisingly, the YTD outperformers led the way again last week, namely basic resources and oil and gas stocks, tracking commodity prices. In terms of the laggards, construction and materials, travel and leisure, and retailing stocks all declined. Bond markets continued their YTD selloff, with investors taking note of the hawkish tones from central bankers throughout the week. Also, there was a comment from German Finance Minister Christian Lindner, who said we can no longer rely on the European Central Bank (ECB) to drive growth as it fights inflation.

Also, notably, the Russian market opened again to local investors last week, closing the week down 16% in US dollar terms. Foreigners (“non-residents”), who pre-crisis accounted for around 48% of all volumes traded on the Moscow Exchange are still banned from trading. There was also a ban on short selling. This means that trading is hugely skewed and unreliable (from a price discovery perspective), especially as it’s been well flagged that the Russian government has been an active buyer in both markets. Earlier in the week, the US White House slammed the reopening of the Moscow Exchange as a “charade,” saying it’s not a real market.

United States

Last week was a much quieter week for US equity markets, both in terms of trading volumes and headlines. The S&P 500 Index edged higher through the week, closing the week up 1.8%. Elsewhere, the Dow Jones was up 0.3%, the Nasdaq 100 Index up 2.3%, while the small cap Russell 2000 Index was down 0.4%. With the recent recovery in the S&P 500, the index is now just 5% away from all-time highs and sitting comfortably around its 200-day moving average, a key technical indicator.

Looking at sector performance, energy was a significant outperformer, gaining as West Texas Intermediate (WTI) crude oil traded up 10.5% following Yemen’s Houthi rebels’ attack on Saudi Arabian oil installations. Materials were also stronger amid higher commodity prices; the Bloomberg Commodity Index gained 5% last week. In terms of losers, health care was the only sector in negative territory.

One of the main talking points last week was Federal Reserve (Fed) policy, as Chair Jerome Powell stuck with a hawkish stance in comments earlier in the week. He stated his primary goal is to reduce inflation while preserving a strong labour market. He also noted the Fed will first remove the excess accommodation to move to a “neutral” rate stance but will shift to a “tight” stance if necessary. Importantly, when asked if anything would prevent a 50 basis-points (bps) hike at the next meeting, he answered “nothing.”

Following that, we saw some investment banks raise their interest-rate hike expectations. Fed fund futures now price in a 76.8% chance of a 50 bps hike in May, and futures markets now see eight 25 bps hikes this year. In this context, we have seen sharp moves in bond markets, with the US 10-year yield up 32.5 bps on the week, but notably up 14 bps last Friday alone. The US Treasury market has had its worst month since the election of President Donald Trump in 2016.

ASIA-Pacific

Last week was mixed in Asia, with new coronavirus cases, regional lockdowns, the ongoing accounting standards dispute between the United States and China, Japanese economic policy and of course the Ukraine-Russia war dominating headlines.

The MSCI Asia Pacific Index closed the week up slightly amid a strong showing from Japan, with strength in Japan as the Japanese Nikkei 225 Index closed the week up 4.93%, despite the market being closed last Monday.

The strong performance in Japan was mainly due to expectations of further economic stimulus and reassurances from the Bank of Japan (BoJ) that it will maintain its accommodative monetary policies. Last Wednesday, the market surged on reports of a stimulus package that sent the yen to six-year lows.

Japan’s Prime Minister Fumio Kishida is poised to order a package of measures as he seeks to address a deteriorating economic picture. Towards the end of the week, BoJ Governor Haruhiko Kuroda maintained his stance that a weaker yen is a plus for the Japanese economy, while recognizing some downside to the currency’s drop.

China’s mainland equity market closed lower last week as volatility continued amid heightened US-China tensions over Russia, risk of Chinese stocks being delisted in the United States and China’s new COVID-19 lockdowns. China’s government said last Tuesday that it will step up policy support for the economy and capital markets, reiterating earlier vows to shore up battered investor confidence in the face of weaker growth, a slump in property market and regulatory crackdowns on tech businesses.

Of note, the People’s Bank of China (PBoC) left the loan prime rate unchanged and trade in property developer Evergrande was suspended last Monday. China again denied sending military aid to Russia and repeated that it will help de-escalate tensions. However, it also noted its normal trade and economic relations with Russia, criticised sanctions on Russian oligarchs and said would not accept external coercion or pressure; so, mixed signals and actions continue. Last Wednesday, corporate developments lifted sentiment after online retailer Xiaomi followed Alibaba in making a buyback announcement, with some analysts thinking that Tencent could be next.

Surging COVID-19 cases continued to be a concern, with Shanghai reporting record new infections and China’s cabinet dispatching task forces to 10 provinces and municipalities, including Shanghai, to help oversee control. Chinese regulators continue to make efforts to avert delisting of Chinese stocks from US exchanges.

In Hong Kong, we saw a stronger start to the week, but that didn’t last, and the benchmark index there closed broadly flat, down 0.04%. Carrie Lam, the city’s leader, said she would lift a flight ban from nine countries starting 1 April, which will allow Hong Kong residents and travelers from countries including the United States and the United Kingdom to quarantine in a hotel for seven days, down from the current 14 days.

Macro Week Ahead Highlights

Monday 28 March:

• The week starts with Bank of England (BoE) Governor Andrew Bailey scheduled to speak at a Bruegel event. Later in the day, UK Chancellor Rishi Sunak is due to appear before the Treasury Committee to discuss the Spring Statement.
• US merchandise trade balance and wholesale inventories

Tuesday 29 March:

• Germany consumer confidence
• France consumer confidence
• Spain retail sales
• UK consumer credit

Wednesday 30 March:

• BoE Deputy Governor Ben Broadbent speaks on ‘The MPC at 25’ at Niesr and the Money Macro and Finance Society.
• Spain Consumer Price Inflation (CPI)
• Italy industrial sales
• Eurozone economic confidence
• Germany CPI
• US ADP employment
• US gross domestic product and real consumption
• Russia’s activity data for February (5pm) won’t capture much disruption from Putin’s invasion of Ukraine, which began 24 February. But weekly price data, due at the same time, will fill in the picture through March–expect inflation to spike to about 15% from 9.2% in the month prior.

Thursday 31 March:

• UK GDP and current account (CA) balance
• UK nationwide house price survey
• France CPI and Producer Price Index (PPI)
• Germany unemployment claims rate
• Spain CA balance
• Italy Harmonised Index of Consumer Prices (HICP) inflation
• Italy unemployment rate
• Eurozone unemployment rate
• US jobless claims

Friday 1 April:

• Eurozone CPI
• US March employment report
• US manufacturing – Institute of Supply Management

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Wei Li, Global Chief Investment Strategist of the BlackRock Institute together with Alex Brazier, Deputy Head of he BlackRock Institute, Elga Bartsch, Head of Macro Research, Vivek Paul, Senior Portfolio Strategist and Scott Thiel, Chief Fixed Income Strategist all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

Key Points:

Outlook update – We now prefer U.S. and Japanese equities over European stocks due to the energy shock. We stay underweight bonds because of the inflationary backdrop.

Market backdrop – Bond yields sprinted higher last week, with U.S. 10 year Treasuries hitting near three year highs. Signs of weakening economic activity emerged in Europe.

Week ahead – U.S. inflation and jobs data this week could guide the Fed in its rate hike path. We believe it will deliver on its hawkish rate projection this year but then pause.

Much has changed since our 2022 outlook. The tragic war in Ukraine has resulted in a global energy shock. We see this increasing inflation, pressuring consumers and hurting growth, especially in Europe. The Fed has started to talk tough on inflation and has projected a large increase in rates. In our latest outlook update, we remain underweight bonds even as nominal yields have shot up this year, and reduce our European equities overweight in favor of U.S. and Japanese stocks.

Low real yields support equities

Russia’s invasion of Ukraine has taken a horrible human toll and has resulted in a spike in commodities prices that is driving food and energy insecurity. This is dampening economic growth and exacerbating supply-driven inflation, with Europe most exposed among developed markets (DMs) as it tries to wean itself off Russian energy. Rising inflation has kept real, or inflation-adjusted, yields near record lows, as the chart shows, even as nominal yields have sprinted upward. Central banks are scrambling to normalize policy and raise rates this year – but we don’t expect them to go quite as far in total hikes as markets currently expect. We expect long-term yields to edge up as investors demand more compensation for the risk of holding bonds amid high inflation. The result? We see more pain for bonds but believe stocks can thrive amid historically low real rates.

Markets respond to Ukraine war

Going into 2022, we nudged down portfolio risk as we saw a risk of markets pricing in aggressive central bank actions in an effort to contain inflation. This played out and pushed down both bonds and stocks – faster and harder than we expected. We added to our DM equities overweight at the expense of credit last month on a tactical horizon. Since then, three things have become clear to us: The commodities shock will make inflation even more persistent, the impact differs greatly by region, and central banks actually have made hawkish pivots in response.

Where does this leave our macro outlook?

We believe the Fed will go ahead with its projected rate increases for this year, but then will pause as the effect of tightening on growth becomes clearer. We expect that the Fed and other central banks eventually will be forced to live with supply-driven inflation, rather than take policy rates above their neutral level. Doing so would risk destroying growth and employment, in our view. As a result, we expect the sum total of rate hikes to be historically low given the level of inflation. Investors will start to question the perceived safety of government bonds, we believe, against this backdrop of high inflation and debt levels. What are risks to our base case? First, central banks could slam the brakes and cause a recession in an effort to contain inflation. Second, inflation expectations could become unanchored: Markets and consumers could lose faith that central banks can keep a lid on prices. This possibility makes the first risk more real.

All this means that we see more downside risk for government bonds – even as 10-year U.S. Treasury yields are hovering near three-year highs. DM government bonds are less effective portfolio diversifiers in periods when supply shocks dominate, as they do now. Within the asset class, we prefer short-maturity bonds over long-term ones. Markets have been quick to price in the Fed’s hawkish rate projections. We think this repricing in short-term rates is overdone as we don’t expect the Fed to fully deliver on its projected grand total of rate increases over the next two years.

We remain pro risk on a tactical horizon and prefer equities over credit. The inflationary environment favors stocks, in our view, and many DM companies have been able to pass on rising costs and keep margins high. We also like the combination of low real rates, the restart’s economic growth cushion and reasonable equity valuations. We reduce our overweight to European equities as we see the energy shock hitting that region hardest. Also, prices have rebounded from the year’s lows. Why not shift to an underweight? We expect the European Central Bank to only slowly normalize policy. We increase our overweight to Japanese stocks on prospects of higher dividends and buybacks, and supportive policy. We like the U.S. stock market as we see its quality factor resilient to a broad range of economic scenarios, brightening its appeal.

Market backdrop

Government bond yields climbed last week, with 10-year U.S. Treasuries hitting near three-year highs, before falling back on worries of economic weakness. Data showed the Ukraine war’s economic impact is starting to affect economic activity in the euro area. The U.S. economy for now looks resilient, and we prefer U.S. stocks over European ones as a result.

U.S. inflation and employment data may guide the U.S. Fed in the pace of raising rates after it delivered its first hike since 2018. We believe the Fed will deliver on projected rate increases this year but then pause. Inflation data won’t reflect the jump in energy and food prices resulting from the Ukraine war, we think. Jobs data are likely to show a post-Omicron boost.

Assets in Review

Week ahead

• March 31 – U.S. consumption and PCE inflation; Czech Republic monetary policy meeting
• April 1 – Euro area inflation; U.S. employment report

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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of February 28th, 2022 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

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This information has been accurately reproduced, as received from  BlackRock Investment Management (UK) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.