May's Gamble Backfires
Sener Arslan | Jun 09, 2017 20:07
Let us start with the election in the UK. Mrs. May’s decision to call a snap general election back on the 18th of April came as a surprise to the market and immediately strengthened the GBP, as opinion polls looked like the Tories would get an increased share of the vote and therefore a better hand in negotiating the Brexit with the EU. She did not have to call the snap election, as the votes would have been due in 2020. It seemed nevertheless to be a good thing to do. However, the results backfired as voters returned a hung parliament in the UK.
Political risk will continue to hang over the pound for the foreseeable future, with lots of headline risks around. As we see it in the market this morning, FTSE 100 stocks, which mostly export abroad benefit from the GBP weakness, while more UK-oriented smaller companies in the FTSE 250 will face a difficult time because the path of domestic policy is now very opaque.
What were the other major economic developments this week?
Job Openings hits an all-time high in the US, with 6.044 million jobs remain open to being filled. Hiring on the other side pulled back last month with just over 5 million. As we have written in the past, the structural challenge holds on in the US job market with non-skilled labour force find it difficult to join the job market. We have seen this trend since years now, and this would show that the job rate will stay at this slower pace throughout 2017.
Exports and imports for May came in much higher than expected with exports growing 8.7%, while imports jumped 14.8%. This is good news for the global trade and economy. Lastly, Chinese central bank’s foreign exchange holdings swelled by USD 24bn last months, taking it to the highest level this year, following a sharp decrease in the holdings after the central bank stepped in to halt a depreciation in the renminbi in 2015.
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In its release yesterday, the European Central Bank has trimmed its medium-term inflation outlook, while increasing slightly and growth outlook for the eurozone. According to the ECB, inflation will only not be able to hit the target of 2% shortly. Mr. Draghi dropped the previous warnings that the growth outlook remained “tilted to the downside” and said they were now “broadly balanced”. As we wrote last week, the stimulus will continue and is according to the ECB needed to support the stronger inflation.
How did the market perform this week?
The market has traded sideways this week, with major indices trading within small ranges. The Swiss Market Index corrected considerably this week, in majority due to correction of Roche (SIX:RO). The shares of Roche took a downbeat on Tuesday after investors responded to news that a combination cancer therapy did not add substantial value. The stock is down 6.7% for the week with a weight of approximately 20% within the SMI.
The performance of leading stock indices.
Airlines stock continue to have a positive year with a performance of 0.75% this week and a return of 9.40% since on a YTD basis. Gold miners also advanced by 2.66% and brought the monthly gains back up to 6.4%.
Oil was again hit hard this week after the data showed an unexpected rise in US petroleum stocks with a sharp drop for petrol and diesel use. On weekly basis, the Brent and Crude dropped by 4% each. The market was completely caught off guard here, as the EIA said crude stocks in commercial storage expanded by 3.3 million barrels to 513.2 million barrels, while a decline of similar size was expected.
Yields on the shorter end of the curve increased in Brazil and Mexico, while the yields on the longer end of the curve increased in Argentina. We have seen, on the other hand, a decline in yields across the curve in Turkey and Russia. Spreads for Emerging Market corporate and high yield bonds widened, given the weakness in the oil price.
What will happen to the US Dollar Index and how will it affect the other CCY’s?
Investors become less optimistic about the outlook for the US economy. We see the dollar at its lowest level since the election of Donald Trump. By the start of the year, the Dollar Index touched a 14-year high of 103, as investors made bets that Mr. Trump’s proposed policies (tax cuts, deregulation, and infrastructure spending) would boost US economy, the yields, and the US dollar. However, with the administration’s agenda seemingly hampered by continued controversy, investors want to rather see actions, before we see another turn in the Dollar.
We also saw a roller-coaster ride for the Mexican Peso in the in the initial weeks of Mr. Trump’s presidency, reaching a historic low of 22 to the dollar. But by today the CCY trades back at 18.20 and has erased all its post-election losses. While the economic fundamentals of the Mexican economy are stronger and the CCY could trade a tick higher here, there are still lots of catalysts in the market, that could change the currencies direction.
What effects will the yield curve flattening in the US have on the bank stocks?
The difference in yields between the 2 and 10 year Treasury notes dropped to 86 bps, the lowest level since last year in October. After the election of the US President, we have seen a rally towards 135 bps, given the expected pro-growth policies promised by its campaign.
Pro-growth policies would have boosted inflation and sparked higher interest rates in the future. As we have noted in the past, banks need a steeper yield curve, they in the short-term and lend it over longer periods, meaning that flatter curve pressure profits. The financials lag the broader market YTD with DJ Financials only being up 3.32% vs. the broader S&P 500 index, which is up by 12.32%.
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