Strategy & economics
The market stories of May: our charts of the month
Political crisis unsettles Italian financial markets
The prospect of an anti-establishment alliance taking power in Italy was the initial trigger for a material move lower in Italian financial assets.
The Eurosceptic stance of the two parties – the left-leaning Five Star Movement (M5S) and the right wing League (formally known as the Northern League) – unnerved financial markets. Bond yields saw a sharp spike higher and the spread (the yield premium investors demand to hold Italian bonds) to equivalent term German bond yields increased, as highlighted in the chart below. The move reflected weaker confidence in the outlook for Italian debt given higher perceived risk.
When President Mattarella rejected the alliance’s nomination for finance minister, apparently owing to his strong anti-euro stance, the two parties withdrew their proposals to form a government. The president subsequently moved to appoint former International Monetary Fund official Carlo Cottarelli as interim prime minister.
As a result, the likelihood of fresh elections, and the opportunity for anti-establishment, Eurosceptic parties to attain a firmer mandate increased, exacerbating financial market concerns. The risk of contagion also saw other peripheral eurozone bond yields move higher, as the chart below illustrates. By contrast, German bond yields fell.
Past Performance is not a guide to future performance and may not be repeated.
The uncertainty that another election would bring appeared to prompt M5S and the League to re-start coalition talks. These reached a successful conclusion and a new cabinet, with a different candidate for finance minister, was proposed and later approved by President Matarella. With the threat of another election easing, Italian bond yields fell back at the end of the month.
US-China trade discussions ongoing
The second round of US-China trade negotiations saw a Chinese delegation head to Washington DC in May.
In advance of the visit, President Trump unexpectedly took to Twitter to announce that he was working with President Xi Jinping to enable Chinese telecoms equipment producer ZTE to “get back into business, fast”, referencing the loss of jobs in China. US companies had recently been banned from supplying ZTE for seven years on national security grounds.
Following the talks the US agreed to halt the implementation of tariffs on $150 billion of imports from China. Meanwhile China pledged to increase purchases of US goods in an effort to reduce the bilateral trade deficit. It also announced the termination of an investigation into imports of US sorghum, removing the heavy duties imposed as part of the probe. The impact of the ongoing trade uncertainty was captured by vessel data showing movements of bulk carrier the RB Eden.
The ship is carrying grain produced in the USA. It left Corpus Christi, Texas in March bound for Shanghai. It got halfway when China implemented a 179% duty on imports in April, and then headed back towards Cartagena, Spain. After reaching Cartagena, but before it docking, the ship performed U-turn number two on 18 May, after China announced it was no longer conducting anti-dumping and anti-subsidy probes into sorghum. It is now on its way to Singapore…
Is the slowdown in eurozone growth transitory?
Economic growth in the eurozone unexpectedly slowed to 0.4% quarter-on-quarter in Q1, according to preliminary data from Eurostat. The abnormal weather experienced over the period, in particular heavy snow falls in late February and early March, are likely to have been a factor.
Viewed on a regional basis, growth data from Northern European countries such as France, Germany and the UK saw significant deceleration relative to recent quarters. This chart below indicates no impact in member countries where the weather was less inclement, notably Spain and Italy.
Eurozone GDP growth Q1 2018 versus Q4 2017
Source: Eurostat, ONS, Schroders Economics Group, 21 May 2018. EZ19 is a composite figure for the 19 member eurozone.
Meanwhile in Germany, a severe influenza outbreak led the sickness rate to spike. According to the German Federal Ministry of Health, 7% of the workforce covered by public health insurance were absent from work in March, twice the usual rate.
Source: German Federal Ministry of Health, UBS, Schroders Economics Group, 23 May 2018. 1Persons in public health system not working due to sickness as % of all publicly insured (on 1st day of month).
Crude oil resumes ascent before falling back on potential OPEC action
Crude oil prices took another leg higher at the start of May as President Trump opted to withdraw the US from the Joint Comprehensive Plan of Action (JCPOA), widely referred to as the Iran nuclear agreement. This sparked concerns over global supplies, which were already exacerbated by falling output in Venezuela.
Towards the end of the month, Organisation of the Petroleum Exporting Countries (OPEC) members subsequently opened the door to easing production limits to offset these supply risks. As a consequence, Brent crude prices fell back to sit close to the levels seen at the start of May.
EM currencies have seen some pressure; notably Turkey and Argentina.
As 10 year US bond yields saw further pick-up in early May, the US dollar strengthened. This was a headwind for a number of emerging markets currencies but it was the Turkish lira and the Argentinian peso which came under the greatest pressure and took the headlines.
Turkey is exposed to global liquidity tightening due to its wide current account deficit. Inflation has continued to exceed expectations and the central bank has resisted more material interest rate tightening. Comments from President Erdogan suggesting that interest rates are the "mother and father of all evil", together with his plan to take a greater responsibility for monetary policy, have concerned investors. Early elections, scheduled for June, have also served to increase uncertainty. As the lira continued to lose value, the central bank was forced to announce an emergency interest rate hike of 3%, taking the main policy rate to 16.5%.It later announced plans to simplify its system of interest rates, suggesting a return to more conventional monetary policy.
Argentina’s government has taken a gradual approach to correcting the economy’s macroeconomic imbalances. US dollar strength, together with the impact of drought, which has pressured agricultural exports, compelled the government to expedite these adjustments in May. The central bank responded to initial weakness in the currency by hiking interest rates to 40% and the government pledged to speed up the pace of its fiscal reforms. When the currency did not stabilise, President Macri subsequently announced plans to approach the IMF for a stand-by arrangement.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
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All data contained within this document is sourced from Cazenove Capital unless otherwise stated.