Monday 19 February 2018

Daily Market Update: Sterling sell-off takes a breather

The headquarters of the Monte dei Paschi di Siena bank in Siena
The headquarters of the Monte dei Paschi di Siena bank in Siena

Richard Ramsey

Risk aversion and ongoing concerns over Brexit remained to the fore yesterday.

European equities completed their third successive day of declines with the Euro Stoxx, FTSE 100 and ISEQ falling by 1.8%, 1.25% and 1.75% respectively. Wall Street’s S&P 500 fared much better with a 0.5% gain yesterday following some encouraging US economic data. Over the last 24 hours another four UK property funds have halted investors form taking money out.  This brings the total to seven so far this week. Investor sentiment appears to have turned this morning with most of the European exchanges up over 1% in early trading.  The recent sterling sell-off has also reversed with the pound gaining against both the dollar and the euro over the last 24 hours. GBP/USD has risen from $1.292 to $1.298 over the last 24 hours or so.  EUR/GBP opened at 85.6p yesterday morning and is currently changing hands at 85.3p. We still expect further sterling weakness in the weeks ahead. Meanwhile EUR/USD is little changed this morning at $1.1075.    

The key release yesterday was the Fed’s FOMC minutes of the June 14-15 meeting. The view amongst policymakers was that they should refrain from further interest rate hikes until the consequences of the UK’s vote on EU membership became clearer. The minutes of the meeting which took place ahead of the 23rd June vote revealed widespread unease over the Brexit vote. Policymakers also cited a slowdown in employment as a reason for keeping interest rates on hold. We will get a clearer picture of the health of the US labour market with releases today and on Friday. Before last month’s vote, the Fed had signalled two interest rate hikes this year.  Now it looks increasingly likely that the FOMC could sit on its hands for the rest of the year. To date, the Fed has raised rates just once off their record lows.

Despite caution from the Federal Reserve, the incoming economic data suggests the US economy is performing well in the second quarter.  The influential ISM non-manufacturing report, a barometer for service sector activity, exceeded market expectations in reaching a seven-month high in June.  The acceleration in the pace of growth in activity was accompanied by a surge in new orders and a pick-up in employment growth. The latter follows a decrease in staffing levels in May. You may recall last week we also saw an encouraging ISM manufacturing report.  Viewed together, the two ISM reports suggest the US economy is well placed to weather a Brexit storm at this stage. Today in the US the focus turns to the labour market.  Ahead of Friday’s all important non-farm payrolls (the most closely watched release in the global economic calendar) we have the ADP private sector employment report. The pace of job creation has eased in the second quarter with the June figures expected to show a continuation in this trend.  Following a net gain of 173k jobs in May analysts have pencilled in a 160k net gain for June.  This compares with a net gain of 200k in Q1.

In the Eurozone, concerns over the Italian banking system continue to mount. According to Bloomberg, talks between Italy and the European Commission to recapitalise Banca Monte dei Paschi di Siena (a name we are likely to become more familiar with in the weeks ahead) and other banks appear to be stuck on whether creditors should face losses if taxpayer funds are used. The Italian banks suffer from a high concentration of non-performing loans.  According to the Wall Street Journal, in Italy 17% of the banks’ loans are non-performing.  This compares with 5% the US during the worst of the 2008-09 financial crisis. Political risk is also mounting in Italy with four opinion polls showing that the populist Five Star political party, which is led by a comedian and wants Italy to ditch the euro, is now the largest party in Italy. The current Prime Minister, Matteo Renzi, is holding a referendum on constitutional reform this autumn. Renzi has said he will resign if he loses the vote. On the Eurozone economic data front, we have seen unexpected declines in German industrial production for May from figures released this morning.  This follows weaker than expected factory orders figures yesterday.

Finally, Australia is at risk of losing its coveted triple A credit rating.  Australia, which has enjoyed 25 years of consecutive economic growth, has been placed on negative watch by Standard & Poor’s following its inconclusive election result. Political risk is clearly not just confined to Europe. According to another credit rating agency, the creditworthiness of countries is deteriorating at a record pace in the first six months of the year. Fitch Ratings has downgraded 14 sovereign borrowers so far this year including the UK. Falling oil prices, a stronger dollar and the UK’s pending exit from the EU have been cited as factors. So far this year, Moody’s has downgraded 24 countries with Standard & Poor’s lowering the ratings on 16 sovereigns. 

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