Italian relief keeps Europe steady

Summary

Global markets start another week on edge though there are signs European investors are looking beyond trade disputes.

Exactly when the long-trailed escalation of tariffs on China by $200bn will be announced is uncertain, though the White House ensures expectation is at ‘imminent’ level. Yet some European markets remain positive by midsession, whilst some, for instance, the FTSE 100, hesitated above the flat line for hours, much like S&P and Nasdaq futures contracts. It’s a reminder that the relationship between the trade dispute and risk appetite is not entirely predictable, even if investor scrutiny almost inevitably adds weight. Talk that Chinese economic ministry officials could call off preliminary discussions with Treasury Secretary Steven Mnuchin if new tariffs are imposed, coincided with the latest chunky slump in equity markets there. The VIX volatility index later rose 5% ahead of Wall Street’s session, its biggest daily gain so far this month. It shows the U.S. stock market is not expected to escape global gyrations entirely.

Tariff hit to fade fast on Wall St

Overall though, there are few real signs yet that tightening Washington trade policies are an outright negative for U.S. stock markets. Their outperformance should continue this week. Trump tweeted a short while ago that tariffs have put the United States “in a very strong position”. Looking at the qualified disparity in the year’s markets performance in favour of the States, the ‘strong position’ conclusion is less arguable than the tariff causality. On that basis, an announcement, if or when it comes, that the Commerce Department has imposed new import duties on China, need not be a bigger upset for the stock market than earlier ones. Since a first tranche of China-specific tariffs were proposed on 3rd April, the S&P 500 has risen 11%, advancing each month since.

Italian Budget relief

Europe’s STOXX index remained aloft past midsession, supported by southern European stock and bond markets. A decline in upward yield pressure in Italy fans out to Spain and Portugal (‘the periphery’), tightening spreads to benchmark German debt. Details of Italy’s Budget are set to emerge amid reports that Economy Minister Giovanni Tria will avoid challenging EU fiscal rules. Both stocks and bonds in Italy could therefore outperform the wider region further at the start of the week, if assumptions prove accurate, enabling Europe’s bank sector to keep a firm footing for longer. Elsewhere, gains are led by lightweight sub-indices, like struggling telecoms, and the lacklustre retail gauge. Trade/tariff sensitive industries like cars and also technology continue to arc lower as they have all year. Still, mining catches the tailwind from improving sentiment despite another tumble in Shanghai and Shenzhen. Once Italian Budget relief passes, Europe will become broadly vulnerable again, like weightier markets in Frankfurt, Paris. But the part of this quarter’s declines pegged purely on European misgivings is clearer.

Dollar fatigue is no retreat

For the purposes of taking the ‘risk’ temperature, at least the dollar part of that puzzle continues to follow a relatively straightforward contour. The greenback retains broad safe-haven appeal though the grind is increasingly fatigued. The only way for the euro, for now is, slightly up. Sterling also appears able to take or leave Brexit news and opt for moderate gains. Yet FX participants appear well aware that the dollar rally has notched definitive milestones. For one, the greenback is set for a third month above a huge USD/JPY symmetrical triangle. Traders have watched for months as regular safety-seeking forays in favour of the yen failed to push prices back below the structure. And whilst speculative positioning has retreated from muscular pro-greenback levels of earlier months, the latest CFTC data shows hot money is deeply entrenched long. The key takeaway is that with protectionism now a well-established part of the monetary and yield tailwind for the dollar, euro and sterling upward corrections have built in speed bumps. The broader ‘pain’ trade (EMFX and beyond) continues to tighten.