Currency Moves Drive Global Equities

By: Franklin Templeton

Currency Moves Drive Global Equities; Bond Yields Remain in Focus

Currency moves appeared to be the most significant driver of global equities last week. A stronger euro and pound weighed on European equities, while in the United States, equities once again posted strong gains on the back of a weaker US dollar. In Asia, stocks closed last week mostly higher, except in Japan where a stronger Japanese yen weighed on stocks.
Dollar Weakness Continues Despite Trump
The US dollar fell for the sixth consecutive week as several central banks around the world expressed plans to diversify their currency reserves away from the currency.
US Treasury Secretary Steven Mnuchin applied further pressure, as he told the Davos World Economic Forum on Wednesday of last week that a weaker dollar was good for the United States in terms of trade and opportunities.
President Donald Trump jumped into the debate mid-week, saying that he ultimately wants to see a stronger dollar. He claimed Mnuchin’s comments had been “taken out of context” and that the dollar was “going to get stronger and stronger”.
However, Trump’s reassurance provided only a temporary boost to the currency, reflecting not only the considerable momentum against the dollar but also the market’s ability to shrug off commentary from the president.
Euro Strength Continues and the ECB Weighs In
The euro had another strong week. US dollar weakness played a part, but signs of progress in Germany’s search for a new government also helped nudge the euro higher. Recall that the German Social Democrat (SPD) party agreed to enter official coalition talks with German Chancellor Angela Merkel’s Christian Democratic Union (CDU) party.
As expected, monetary policy and guidance from the European Central Bank (ECB) remained unchanged following the bank’s Governing Council meeting on Thursday (January 25).
Investors were watching for any commentary on the strength of the euro. The central bank’s post-meeting notes did not explicitly mention euro strength, but did say that the exchange rate remained a source of uncertainty. The ECB added that the impact on inflation of the strong euro required monitoring.
ECB President Mario Draghi stressed that it was important to consider whether currency moves were in fact due to an improvement in the economy, or on external factors.
Over the weekend, ECB Governing Council member Klaas Knot called for an end to quantitative easing (QE) as soon as possible, claiming there was no reason to continue with the programme.
Knot said ambiguity about the future QE after September could have a dampening effect on the euro. It seems clear to us the ECB Council is currently divided on when to signal a QE end date.
Another issue we’re watching is the growing amount of merger-and-acquisition (M&A) activity in Europe.
In our view, at least some of the activity stems from expectations that central banks around the globe could begin normalising their monetary policy. Reports of potential rising rates are driving companies to try to lock in M&A deals before the cost of capital rises in line with central bank interest rates.
Bond Yields Remain in Focus
Elsewhere, bond yields continued to widen across the globe. The US 10-year Treasury yield broke through 2.70% on Monday (January 29), having made new medium-term highs last week.
The German 10-year bund moved through the 65-basis-points (bps) level, while five-year bund yields broke into positive territory for the first time since 2015.
European equity markets recorded their first weekly decline of the year as currency effects weighed and the market focused on the ECB commentary.
The pound posted its strongest weekly gains in more than three months as it climbed back above $1.40 the first time since the Brexit vote. In turn, the FTSE 1001 underperformed broader European markets.
In the United Kingdom, Prime Minister Theresa May’s leadership came under further scrutiny as reports indicated that Conservative backbenchers were frustrated with her uninspiring Cabinet reshuffle earlier this month and the speed of her decision making.
In Italy, the March 4 election generated concerns over the potential political risk for the eurozone.
The centre-right Lega Nord’s leader Matteo Salvini described the euro as a failed experiment and presented outspoken anti-euro economists among his election candidates. In contrast, the left-wing, eurosceptic Five Star Movement, which is leading some polls, presented a 20-point programme which made no mention of a referendum on Italy’s membership of the eurozone.
Many economists are predicting that the Italian election will turn out just like many across Europe—with a hung parliament, which of course will likely only lead to further uncertainty.
US equities finished with strong gains for a fourth straight week, supported by the weaker US dollar.
On Monday (January 22), the government shutdown ended after both houses of Congress voted in favour of a stopgap measure to fund the government until February 8.
It was a busier week for US macro data, although there wasn’t anything particularly game-changing. The most interesting release was fourth quarter gross domestic product (GDP) growth, which came in at 2.6%, just shy of the consensus for a 3% rise.
It was another week of gains for most Asian equity markets last week, as energy sector stocks in Hong Kong outperformed and equities in South Korea and China also gained on the back of US dollar weakness.
Japanese equities lagged as the stronger Japanese yen weighed on Japanese exporters. However, it is important to remember that the Japanese equity market has had a great run and made multi-year highs earlier last week, so an element of profit-taking was likely a factor here.
The Bank of Japan (BOJ) meeting was a central focus for Asian equity markets. BOJ Governor Haruhiko Kuroda Kept policy unchanged, while his speech on the deadline for achieving 2% inflation in FY19, if anything, was more dovish than some had expected.
In macro data, Japanese core consumer price inflation showed an increase in line with the consensus at 0.9%.
Week Ahead
Monetary Policy
The highlight of the week will be the US Federal Reserve (Fed) monetary policy meeting on Wednesday (January 31), which will be US Fed Chair Janet Yellen’s last Federal Open Market Committee (FOMC) meeting.
In Europe, the following data releases will be published: Spanish GDP, French GDP, eurozone GDP, and eurozone CPI. It’s also the start of earnings season in Europe, with a lot of companies reporting fourth-quarter earnings.
In the United States, the January monthly employment report, including nonfarm payrolls data, is due out on Friday (February 2).
In Asia, Japanese industrial production figures will be released.
US President Donald Trump is set to deliver his first State of the Union address to US Congress on Tuesday (January 30).
The noise around Brexit negotiations is likely to pick up as UK Prime Minister Theresa May comes under renewed pressure from Eurosceptic backbenchers in her own Conservative party.
In Germany, focus remains on the coalition negotiations between the CDU and SPD.

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