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Market Insights – May 5th, 2018

Weekly financial & economic analysis.

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Essentials

The risk of a trade war has intensified, as the US administration has followed through on its threats and imposed tariffs of 25% on steel imports and 10% on aluminium imports. It has also said it is considering slapping tariffs on imports of cars. Any aggressive retaliatory measures by the USA’s trading partners would be a cause for concern.

In May, a sharp rebound in energy prices sparked a surge in European inflation, which reached 9% year over year, up from 1.2% in April. Core inflation (excluding energy and food) rose at a slower pace, coming in at 1.1% year over year.

India’s GDP grew by 7.7% in Q1 2018, up sharply on the previous quarter and well above analysts’ expectations. This acceleration can mainly be put down to a positive base effect following the shock caused by the economy’s demonetisation in 2017. Upward revisions for the agriculture sector also helped to boost this solid figure.

 

 

The sword of Damocles over Europe

Although the stage looked set for eurozone stock markets to continue to outperform, political uncertainties have once again put a damper on things. In Italy, the markets were spooked by the prospect of new elections, which would have turned into a referendum on whether Italy should keep the euro. Paradoxically, the announcement that a populist government had been formed calmed these fears, prompting a market rally after the sharp correction. Yet, while the worst-case scenario has been avoided, the uncertainties remain. On the one hand, voters are expecting major, rapid change. And on the other, the new government is by no means pro-European. While its fiscal policy should involve more spending, this will increase the country’s already very large debt, at a time when the European Central Bank is getting ready to wrap up its asset purchase programme. What’s more, the reforms needed to boost competitiveness could well fall by the wayside. These fears also had an impact on financial markets elsewhere in Europe’s periphery. Matters were not helped when Mariano Rajoy lost a vote of no confidence in Spain, where a new – and possibly transitional – government will now be formed pending fresh elections. But although political uncertainties have increased in Spain, we think the situation there is quite different from that of Italy. A change of government is unlikely to derail the country’s strong economic recovery, and there probably won’t be any major changes in economic policies in the short term. We also think the markets have overreacted to the situation in Portugal. The economy there is healthy, and the socialist government has managed to make good on most of its promises. Eurozone stock markets will be particularly vulnerable to any more bad news, making it unlikely that they will outperform in the near future. But the good news is that the euro should remain relatively weak in light of these uncertainties, which is positive for stock markets with a large proportion of exporting companies. The banking sector fared particularly poorly in the correction, and we are now buying BCP, the second largest bank in Portugal, following its major dip.

 

Is unemployment too low in the States ?

Unemployment hasn’t been this low since December 1969, when the Glorious Thirty period of growth was coming to an end. US employment figures were released last Friday and once again outstripped economists’ optimistic expectations. There were 223,000 new jobs in May, which is well above the forecast of 190,000 and pushed unemployment down to 3.8%. But can unemployment fall even further? The economic data published last week would suggest that it can. US GDP grew by 2.2% in Q1, boosted by capex. The ISM manufacturing index, which is still close to its ten-year high, points to continued strength in the coming quarters. It is hard to imagine unemployment rising in this climate, given that it would take just 90,000 new jobs a month to keep it at its current level.

However, one of the knock-on effects of this tight jobs market is the slow but steady rise in wages, which were up 2.7% over the year. A surge in inflation, which is not our core scenario at present, would inevitably raise fears of a ramp-up in the Fed’s monetary policy normalisation – and that always prompts a recession. So let’s hope for some – but not too much – good news on the jobs front.

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