Politics has dominated markets this week, as the Italians struggled to form a collation government following their general election in March, compounded by news that support was growing to oust the Spanish Prime Minister Mariano Rajoy of the People’s Party over corruption. Not to be outdone, the United States (US) announced that the postponed tariffs on steel imports would commence on Friday, causing howls of retaliation globally. Robust inflation data, both in the US and Europe, and supportive economic leading indicators were largely ignored.
The US S&P (Standard & Poors) 500 Index closed down 0.6% over the week as of 12pm London time on Friday. The EuroStoxx 600 index is down 1.0%, Japanese Topix index is down 1.3%, MSCI Emerging Markets down 1.4%, Australian S&P/ASX 200 index down 0.7%, whilst the UK’s FTSE All Share has remained relatively defensive over the week, only falling 0.1%.
10-year US Treasury yields, which move inversely to price, fell as low as 2.78%, having only just broken through 3% a week ago, as investors rushed to defensive assets. The 10-year Treasury has now drifted back up to 2.89%. Similarly, 10-year UK Gilt yields fell as low as 1.2%, and are currently trading at 1.29%. The 10-year German Bund got as low as 0.21% before rebounding to 0.40% by Friday.
At the end of last week, the Italian President Sergio Mattarella, rejected the proposed coalition government between the anti-establishment Five Star Movement and the far-right League, on the grounds of the selection of an overtly anti-Euro finance minister, Paolo Savona. The President subsequently summoned a former IMF (International Monetary Fund) official, Carlo Cottarelli, known as “Mr Scissors” for making cuts to public spending in Italy, to form an unelected government of technocrats. It was clear very early on that this would be rejected by the Italian Parliament, potentially leading to a constitutional crisis and the prospect of a follow on general election later in the year. This would have heightened the risk of the election becoming solely focused on membership of the Euro.
This culminated in the main Milan stock index, the FTSE MIB sliding by as much as 5.5% by Tuesday, and yields on 2-year Italian sovereign bonds, which move inversely to price, to rise above 2% for the first time since 2013, touching a high of 2.72%. Similarly, the difference between 10-year Italian sovereign bonds and German sovereign bonds widened to as much as 3% as investors fled from Italian assets.
However, talks resumed between the Five Star Movement and the League, and by the end of the week a coalition government had been formed without such an openly anti-Euro bias. 2-year Italian sovereign bonds rallied, now yielding 0.7% and the Italian stock market finished the week a mere 0.2% down, outperforming the wider European market.
Just to confirm that European politics is anything but boring, rumours started to mount mid-way through the week that the minority Socialist Party in Spain, led by Pedro Sánchez (known as “Mr Handsome”), had drummed up enough support from within the Spanish Parliament to oust Prime Minister Mariano Rajoy of the People’s Party on the grounds of corruption, a charge vehemently denied by the Prime Minister.
The Spanish IBEX 35 index fell just over 4% at its lowest point, but amazingly rallied by 2.5% on Friday as it was confirmed that the Prime Minister had been ousted, leaving the way open for Pedro Sánchez to become an unelected Prime Minister. This unlikely event had become possible as the Socialist Party rallied support from the far-left Podemos party and pro separatist parties, including the Basque Nationalist Party and two Catalan nationalist parties.
And if Europe was not grabbing the headlines enough this week, a key US regulator added the US unit of Deutsche Bank to a list of “problem” lenders, leading to S&P Global Ratings cutting the credit rating on Deutsche Bank from A- to BBB+. Year to date the bank’s share price is down 42%.
On Thursday the US announced that the postponed tariffs on steel imports into the US would be implemented as of Friday. This is a blanket tariff, covering many countries that would consider themselves allies of the US. The European Union has already cited retaliatory tariffs on imports of Levi jeans, Harley Davison motor bikes and Bourbon whisky, whilst both Canada and Mexico have said they would also retaliate.
The Australian S&P/ASX 200 finished the week lower by 0.7%, following its third straight week of losses. The index declined at the end of the week following the announcement of US tariffs on steel imports. In particular, miners came under pressure with Rio Tinto falling 0.6% amid concerns that its Canadian operations may be hurt by the tariffs.
Elsewhere in economic news, it was announced this week that the Australian national minimum wage will be increased by 3.5% to AUD 18.93 per hour from the 1st of July. The wage hike is likely to be welcomed by the Reserve Bank of Australia (RBA) who wish to see a further pickup in wage growth and inflation before they decide to normalise their base interest rate, which has stayed at a record low of 1.5% for the past 20 months.
The latest US core personal consumption expenditures index, the Federal Reserve’s preferred measure of inflation, was released for April this week, and showed inflation at 1.8% for the year, unchanged from March, but close to the Fed’s target of 2% and sufficiently high to suggest a further rate rise is on the cards for June.
Whilst inflation in the Eurozone accelerated sharply, rising to 1.9% in the year to May, up from 1.2% in April according to Eurostat. A significant proportion of the increase was due to energy, which rose 6.1% over a year, whilst food, alcohol and tobacco also posted a rise of 2.6%. Core inflation, excluding food and energy, came in at 1.1% for the year, versus 0.7% in the previous month.
The oil price rallied this week having fallen last week on news that Opec and Russia were set to boost oil output to compensate for lost supply from Venezuela and Iran once sanctions were imposed. A report suggested this week that the major oil producers might not be in such a hurry to raise output as investors had thought, leading to Brent crude rising to $77, having fallen to $75 last week.
The gap between Brent crude oil and US West Texas Intermediate (WTI) is now at its greatest since early 2015. This has occurred as the US shale industry has been pumping more oil as the oil price has recovered, but the US is lacking the pipeline infrastructure to transport the oil to the refineries, leaving the existing pipelines overrun with oil. This situation is not expected to correct itself for most of this year as pipelines are still in the process of being built.
The political storm that whipped up in Europe this week certainly caught investors’ attention, however, if you looked at the history of politics in Europe, if this concerned you, you would have never invested in Europe. In addition, although there are signs that growth in Europe is easing from the highs of 2017, it remains in much better shape than that of the European crisis of 2011. Leading economic indicators remain strong but are moderating, and the Euro has come off its highs versus the dollar which will help exporting companies. Despite inflation accelerating in May, the European Central Bank continues to operate extremely easy monetary policy, and this is unlikely to change whilst the economic recovery remains in its relative infancy.
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