Weekly Markets Review

8th July 2024

Markets last week

Summary

• Markets were solid and stable showing progress amid political shifts

• The Labour Party’s landslide victory in the UK general election ended 14 years of a Conservative party government, causing a muted but positive market reaction

• UK equities rose, with the FTSE 250 up 2.5% and the FTSE 100 up 0.5%

• The 10-year UK gilt yield fell to 4.13%, and the pound strengthened by 1.3% vs. the US Dollar

• Volatility in US government bonds has been due in part to uncertainty over a potential second Donald Trump presidency with the yield curve steepening since the last week of June

• Weaker economic data has furthered the steepening of the yield curve, increasing the likelihood of interest rate cuts - a trend which continued last week

• US yields fell and equities rose; the 10-year US treasury yield ended at 4.28%, and the US equity market gained 2.0% in local currency terms

• The US tech sector rose 3.9%, while cyclical sectors like energy lagged

• Political uncertainty in Europe continued, notably in France with Marine Le Pen's political party, The National Rally, facing a surprise defeat

• The spread on French vs. German government bonds narrowed as Le Pen's chances diminished

• German bund yields rose due to hawkish comments from European Central Bank (ECB) members and its president, Christine Lagarde

• Commodities had a good week, with copper up 3.6%, and gold and West Texas Intermediate (WTI) crude gaining 2.8% and 2.0% respectively

• The week ahead: China inflation data on Wednesday and US inflation data on Thursday.
  

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Markets last week

UK market responds to Labour’s landslide

It was a solid and stable week in which financial markets made progress amid major political shifts in the UK. Labour’s landslide victory was the most seismic event, ending 14 years of a Conservative-led government. The outcome came as little surprise, and the market reaction was therefore relatively muted but marginally positive with UK equities rising and gilt yields falling. Investors in the UK seem relaxed by the prospect of a new administration with a significant majority. The FTSE 250, the UK’s more domestic oriented stock market, rose 2.5% while the more international and large-cap-based-FTSE 100 index gained 0.5%. The 10-year UK hilt yield fell 0.05% to close the week at 4.13%. The pound strengthened 1.3% vs the US Dollar.

US dynamics amid political uncertainty

Questions linger over the outlook for government bonds. Recently, we have observed renewed volatility in longer-term government borrowing costs, especially in the US, as uncertainty grows over the possibility of a second Trump presidency. Since the election debate, in which Trump's chances at winning the election in November seemed to improve, the US yield curve has steepened, driven by a rise in longer-dated bond yields. The curve remains atypically inverted. This steepening reflects market concerns that, although neither candidate is viewed as fiscally responsible, a Trump presidency could lead to further tax cuts in addition to elevated bipartisan spending (spending by both major political parties).

In simpler terms, both Democrats and Republicans in recent years have shown a high propensity to spend, but the budget deficit may widen more significantly under a Trump administration if further tax cuts are implemented. A Trump presidency with high government spending coupled with lower taxes is seen as potentially beneficial for equities and economic growth but detrimental to bonds. Such a scenario would likely lead to market demands for a higher risk premium on US government bonds. The steepening of the yield curve since the debate underscores this perspective. The spread between the two-year and 10-year yields has risen from -0.5% in the last week of June to -0.33% today.

The steepening has been supported by softer economic data which has kept short-dated yields suppressed relative to longer dated yields, a trend which continued last week. On Monday through to Wednesday, the ISM manufacturing data for June was unexpectedly weak with services sector activity falling into contractionary territory; manufacturing sector activity was also surprisingly weak. The jobs report on Friday saw the unemployment rate tick up to 4.1%, job growth was revised down by 111,000 in the previous two months and wage growth slowed adding to the backdrop of moderating US inflation. Such evidence of a mild slowdown of economic activity increases the likelihood of interest rate cuts, which in turn has kept risk assets buoyant with a positive outlook in the absence of any unforeseen shocks. In simple terms, we are currently still in an environment where economic data showing a slowing economy is garnering positive reactions from equity markets and sustaining a positive correlation between bonds and equities.

US yields fell and equities rose; the 10-year US-treasury yield ended the week at 4.28% while the US equity market gained 2.0% in local currency terms but only managed 0.7% in GBP terms due to the strength of the pound. The US tech sector continues to lead the charge rising 3.9% over the week while more cyclical sectors such as energy lagged.

European political developments and implications

Political events continued to create uncertainty in Europe, notably in France, where the left and centre parties formed a barrier to try to isolate Le Pen’s party, The National Rally, ahead of the second election. On Sunday, National Rally suffered a surprise defeat to a coalition of left-wing parties known as the New Popular Front and managed only third place behind president, Emmanuel Macron’s centrists. France now faces a hung parliament with questions around which parties will form a coalition government and who will be the next prime minister. French equities could face pressure when the market opens this morning given the left’s plans to raise taxes on wealth and dividends and to tighten regulation on banks.

The spread on OATS (French government bonds) vs Bunds (German government bonds) recovered last week as Le Pen’s chances diminished. The gap between 10-year French and German borrowing costs, which widened to as much as 0.85% the week prior recovered to 0.66%. The spread has widened slightly this morning as market’s have shown some caution to the prospect of a left-wing coalition government.

German bund yields rose last week on the back of the release of the ECB minutes as it was shown that some members of the governing council were opposed to the recent interest rate cut in view of sticky wage growth. President Christine Lagarde was also notably hawkish in comments made at the ECB’s annual retreat pointing to further inflation uncertainty ahead.

Note on commodities

It was a good week for commodities, particularly copper which rose 3.6% supported by signs of improving demand in China. It was also a good week for gold and WTI crude which gained 2.8% and 2.0% respectively. All three commodities are now up 16% year-to-date.

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The week ahead

Wednesday: China inflation

Our thoughts: The Chinese economy is exhibiting a mixed recovery, still grappling with deflationary pressures, and facing a struggling real estate sector and aging population. Year-on-year consumer price index inflation (CPI) is projected to be 0.4%, while producer price inflation (PPI) is forecasted at -0.8%. CPI measures the change in the prices paid by consumers, reflecting the cost of living. PPI indicates price changes at the wholesale level.

Thursday: US inflation

Our thoughts: Headline inflation for June is expected to fall to 3.1% from 3.3% year-on-year in May while core inflation (excluding volatile food and energy components) is expected to remain steady at 3.4%. To decipher the trend and help avoid noisy base effects it is important to analyse the monthly inflation rates, headline inflation is expected to rise from 0% to 0.1% while core inflation is anticipated to remain at 0.2%. Some disinflation is expected under the bonnet from used car prices and recreation.

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