May speech hits sterling more softly than steel hits stocks
The idea that Theresa May’s set piece speech was mostly aimed at the UK and not intended as a genuine turning point in negotiations helped explain the pound’s regained poise—though it didn’t last. Sterling’s reversal on Friday—near similar prices that have capped the rate all week—shows there was perhaps more meat in May’s comments than expected.
Even-handed hard facts
“Hard facts” were in line with the staged release of excerpts this week. But May calling out inconsistencies between existing EU trade agreements and some of Brussels’ trade prerequisites was less on the radar. May’s cogent and carefully laid out case will not necessarily drive negotiations forward, so in the short term, paradoxically were read as negative by sterling buyers. Overall, the speech was even-handed. Politically, it will fend off the Eurosceptic wing of the Conservative Party for a while given that it exposed hints of unreasonableness in the EU’s position. Nor did it exacerbate concerns the government could lose forthcoming votes relating to custom arrangements after Labour threw its official backing behind a customs union this week. It didn’t dispel such concerns either.
Sterling wilts, euro spikes
For sterling, after holding mid-January support against the dollar ($1.3790-40) the tougher test remains resistance that was formerly support as high $1.3835. As ever, progress against the euro was more telling. A spike out of the declining channel in place since September was a reminder of the faster pace of the Eurozone’s growth. Updated producer price rates for the region were a little short of forecasts largely due to easing energy prices.
FTSE spared DAX’s steel thrashing
The ‘grown-up’ tone of May’s speech was also little help for the FTSE and investors also largely looked through sterling’s weakness this time, partly reacting to Downing St. laying bare the tortuous logic ahead in trade negotiations. Still, the UK benchmark’s fall was quite in line with larger European indices save for the DAX. Germany’s main index suffered a deeper ‘steel tariff’ discount from ThyssenKrupp’s tumble to the bottom and weight from heavyweight steel consumers like Daimler, VW, and BMW. Wider European markets continued to react more to potential follow-on developments (retaliation, imported inflation) hence the DAX was on course for its worst week since early February’s global sell-off, breaking below a rising trend line in place since July and on the brink of memorable 11,888, where the index has bounced repeatedly for about a year.
A weekend in Italy
It was perhaps not the best weekend for markets to be heading into an Italian election. European volatility readings look too complacent: consider a stock market dazed from the steel-tariff battering that also wounded the greenback and the most concerted Treasury fightback for weeks. In theory, the stock market’s slide has created an advantageous reference for opportunistic selling into Italy’s general election. Break’s beyond Friday’s closing prices, particularly in Europe, will conjure increased momentum and volatility. For now though, investors aren’t feeling prospects for the most bearish election result in Italy. It would require that the Berlusconi-led grand coalition fails to gain a desired majority. Then the coalition would have to break-up and subsequently reassemble along rightist lines – including 5-Star. Finally, Berlusconi’s Forza Italia would have to be persuaded to join. All parties have ruled-out such an alliance, but unpredictability is the crux of mild but lingering market doubts. These doubts have lifted one-week at the money euro options to three-month highs, though they’re short of French election levels. It’s no coincidence that 10-year Bund yields were also matching late-January lows, though bund selling was threatening to return at last check. The relevance of short-term optics in the Italy/Germany spread was questionable amid such gyrations. Even here though, peripheral yield widening has been negligible since late last week, and then, it was led by Spain and Greece.
Treasury yields race lower
The European benchmark yield retreat was in unison with those of Treasurys. The 10-year yield has notably given back as much as 17% this week, the most aggressive toughening in bond prices since December. The yen’s intransigence even as the dollar made headway has finally soured the greenback’s wider recovery. Alternatively, dollar buyers were merely taking profit. A 16-month yen high followed Bank of Japan governor Kuroda’s comments about a possible exit on condition of on-target inflation by 2020, was further encouragement after steel tariff news. Eventually, we expect the market to apply a very large discount to such official comments given the size of the BoJ’s JGB involvement, and growing its involvement as a buyer of Japanese equities to boot.
Markets: ‘tariffs don’t work’
Investors were less ready to dismiss the 25% rise in taxes on imported steel and 10% on aluminium and it was interesting to see that retaliation fears which upended global markets had enveloped the U.S. steel shares after buoying them in the immediate wake of the news. Investors appear universally unconvinced that concerns over dumping and other anti-competitive moves by importers can be addressed by tariffs. Exacerbation of market imbalances is more likely than a permanent fix for U.S. manufacturers. For instance, the EU has already rattled its own tariff sabre. This could help bring a similarly brutal end of week for U.S. equities as Thursday’s.
That said it’s difficult to follow the most bearish train of thought around revived risk aversion to its most logical conclusion. So far, we are not reading events of the last 18 hours or so as the beginning of a second leg of last month’s long awaited global stock market correction, or at least not yet.
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