Notes from the Trading Desk – Europe

Equity markets experienced mixed fortunes last week. US markets outperformed following the midterm elections but European equities lagged as uncertainty from the Brexit situation and Italy’s budget spat with the European Union (EU) weighed on sentiment.

Mid-Term Results Largely as Expected

The US midterm elections played out largely as expected. Democrats took control of the House of Representatives and Republicans held the Senate. The equity market’s reaction was positive. The S&P 500 Index gained 2.1% on Wednesday, its best daily performance post-midterm results since 1982.

Given this result was very much in line with expectations, there was some surprise that the markets performed so well. We view the market response as a relief rally, reflecting the removal of some political uncertainty.

The new political balance in Washington means the Democrats will not likely be able to reverse any of President Trump’s prior “market friendly actions”, but it could put the brakes on further radical fiscal plans. Some commentators felt an entirely Republican-controlled Congress could have opened the gates to further extreme expansionary measures, which could in turn have driven the US Federal Reserve (US Fed) to accelerate its interest- rate-hike policy.

The Democrats are likely to support further infrastructure spend, but it will be interesting to see how rhetoric on topics such as drug pricing and campaign financing unfolds.

Leading Democrats have been vocal in supporting a tough stance in trade tensions with China, so we may not see much change from the Trump administration on this front.

May Struggles In The Brexit Maze

Hyperbole on Brexit ratcheted up even further last week.

The week began along familiar lines: reports of progress towards a deal, followed by political uproar from whichever group the plans upset, before finally someone poured cold water on the proposals.

Press reports last week suggested that UK-EU negotiators were close to a breakthrough, but disagreement over the future border between Ireland and Northern Ireland remained a key stumbling block.

Even if a deal is agreed upon, there remains a large question mark over UK Prime Minister Theresa May’s ability to secure Parliamentary approval for her plan.

Last week also saw the shock resignation of UK government minister Jo Johnson (an ardent “Remainer” and brother of former Foreign Secretary Boris) over Mrs. May’s Brexit plans. He described her current Brexit plans as unacceptable and said a second referendum was the only option.

It seems as if Mrs May’s best hope of getting any deal she secures with the EU through Parliament may rest with Eurosceptics who vote for her plan on the basis that any Brexit is better than none.

A Significant Week for Crude Oil

Crude oil prices entered bear market territory as a multitude of factors weighed on sentiment. Prices had fallen for a record 10 consecutive days by close of business on Friday.

The lead up to the United States renewing sanctions on Iran at the start of November had offered support to oil prices. However, markets had not predicted the extent of the waivers the United States granted to China, South Korea and India. As a result, the impact of those US sanctions on Iran was softer than expected.

Global oil demand has also been weaker of late, so the supply relief coming from these waivers led oil prices lower. In addition, US inventories marked their seventh straight week of builds last week. The overhang from the broad market de-risking we have seen in the last month is also playing a part. October saw broad risk-off sentiment with concerns around global growth and geopolitical factors also weighing on the market.

In turn, the move we have seen in underlying commodity prices since the start of October has led the oil and gas sector in Europe to largely underperform the market during that time.

Oil prices did experience a bounce early this week after the Organization of the Petroleum Exporting Countries (OPEC) appeared to have laid the foundations for a production cut. Comments from Saudi Arabia’s oil minister Khalid al-Falih confirmed his country would scale back production by around 500,000 barrels per day in December, which offered support. Other oil-producing nations such as Russia and Oman also released statements which appeared to support oil production cuts.

European equities were mixed last week with defensive sectors, including utilities, among the outperformers. On the other hand, cyclicals lagged.

With the third-quarter earnings season more than three quarters complete, European companies have continued to underperform their US counterparts.

Political tensions in Italy show no sign of waning; not only between the Italian government and the EU, but also between the two coalition parties themselves. Disagreements emerged last week over certain domestic policies, including migration and justice as well as anti-corruption. Deputy Prime Minister and leader of the 5-Star party Luigi Di Maio warned the coalition could be at risk should no agreement be found on these disputes.

The rift between Italy and the EU over the latest Italian budget rumbled on. The EU expressed continued concern over Italian debt levels. Italy’s Finance Minister Giovanni Tria re-iterated that the budget would not be altered, despite the pressure.

The European Commission published a set of economic forecasts which showed Italian debt-to-GDP ratio rising to 3.1% in 2020, above the EU’s 3% limit.

Tria fought back, stating that the figures provided an “inadequate and partial analysis” which ignored “clarifications provided by Italy”. Prime Minister Giuseppe Conte weighed in, saying the EU had not fully understood Italy’s strategy for growth.

UK macro data came in weaker. Car registrations were down nearly 3% on the year and purchasing manager index (PMI) data was weaker. The business component of the PMIs showed its worst reading since July 2016. Despite this, the UK’s third quarter GDP was revised up to 0.6% from 0.4% previously. Meanwhile, the trade deficit narrowed.

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