Markets Update: Poor Start for Stocks, Yields and Pound
Fawad Razaqzada May 28, 2019 7:38 AM
Today marks the first full trading day of the week for UK and US market participants. After the long bank holiday weekend, investors on both sides of the pond are reacting to at least three fundamental events that have taken place over the past few days: 1) The outcome of the European elections; 2) the latest in the race to replace UK Prime Minister Theresa May, and 3) a fresh warning by the US President Donald Trump about raising import tariffs on China.
The markets’ initial reaction to these developments at the European open this morning was not a great one. The benchmark European cash indices gave back their entire gains made in the futures market on Monday, although they were off lows when this report was being written. The bond market rally continued, pushing yields on German, UK and US 10-year debt to fresh 2019 lows. In FX, both the pound and the euro opened lower, with the former falling more sharply than the latter. This helped to keep the EUR/GBP near last week’s high after it had staged an extended rally over the past several weeks amid raised uncertainties over Brexit and UK politics.
After last week’s sharp rebound from a fresh 2019, the EUR/USD has been little changed so far this week. The fact that the single currency has held its own relatively well so far this week is at least partially due to relief that mainstream parties held off competition from populists in the European Elections. This means that pro-European parties will continue to have a majority in the European Parliament. However, the problems for the EU are far from over with Brexit being a major headache and Italy’s inability to reduce its borrowings a toothache for Brussels. With Italy breaking the EU’s budget rules, a hefty fine is looming, which could further damage the nation’s finances. Underscoring these concerns, the yield spread between German and Italian debt widened, while the FTSE MIB index dropped to its lowest level since mid-February.
Although the pound has fallen, it looks like UK investors are not too concerned about the fact that Nigel Farage's Brexit party has performed well in the European elections. They know full well that the outcome of Brexit will eventually be decided by the UK rather than the European parliament. Meanwhile, the list of Tories competing to become the next PM after Theresa May’s resignation is growing. Sajid Javid has become the latest to throw his hat into the ring, joining the likes of bookies favourite Boris Johnson and Michael Gove.
Finally, Donald Trump was at it again: During a state visit to Japan on Monday, the US President warned that American tariffs on Chinese goods “could go up very, very substantially, very easily.” There was no immediate response from China, although authorities there have continually played down the impact of US tariffs on its economy.
It is difficult to say whether the weakness in the stock markets this morning was related to Trump’s latest tariff warning, for it is also reasonable to expect that some of the negativity related to the escalation of the US-China trade spat might be priced in by now. The falling bond yields might help to keep the stock market bull trend intact anyway, although should the situation between the world’s largest economies deteriorate further then equities could come under renewed selling pressure.
Looking ahead, this week’s economic calendar is quite quiet. So, headlines surrounding Brexit and the ‘hunt for Britain’s next PM’ remain potential drivers for the British pound this week. Our full week ahead report can be found HERE.
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