Market Update | May 30, 2018

Macro View

Daily Insights

  • Latest salvo in trade spat highlights ongoing risk.China urged the U.S. to keep its word after President Trump’s latest move to stick with the proposed $50 billion in tariffs on Chinese goods, despite Treasury Secretary Mnuchin’s recent statement that the trade war was “on hold.” Commerce Secretary Wilbur Ross will visit Beijing June 2-4 to continue negotiations. Meanwhile, trade relations with the European Union and Japan have also grown more tense, suggesting trade risk is likely to continue to be discounted into stock prices in the near term until markets have more clarity. The latest news, which China characterized as “flip flopping,” does not change our expectation that a full-blown trade war will be avoided, that tariffs will have limited impact on U.S. and global economic growth, and that eventual bilateral agreements will end up being benign even though the path to get there may be circuitous.
  • If one thing about Italian politics is certain, it’s uncertainty. The latest bout of political uncertainty and wave of populism in Italy, though par for the course in the country, has sparked concerns about a possible departure from the Eurozone and upended global markets. Today on the LPL Research blog we’ll review recent market activity and the impact to investors’ expectations for U.S. rate hikes.Importantly, the massive Italian debt load, at $2.3 trillion (130% of GDP), is held primarily by the European Central Bank and French and German banks, providing a very strong incentive to avoid default (U.S. banks hold only marginal positions in Italian debt). The repercussions of “Quitaly” would be far more disruptive than Brexit, making “remain” our strong base case. We still favor the U.S. and emerging markets over Europe (and over broad developed international) for suitable clients.
  • Is the U.S. bank “baby” getting thrown out with the bathwater? The increasing risk of another European debt crisis, such as the currency union experienced in 2011-2012, has spilled over into the U.S. markets, banks in particular. U.S. banks have not sold off because of their exposure to Italian debt, but rather primarily because of the dramatic rally in U.S. Treasuries (10-year yields dropped 15 basis points, or 0.15%, yesterday alone) and flattening yield curve, which negatively impacts profitability. However, deregulation, rates, and the economic backdrop remain supportive of the group.
  • Markets clip a full rate hike off of Fed expectations. Practically overnight, markets have lowered expectations for future Federal Reserve (Fed) rate hikes by nearly one full hike. Just one week ago, the market-implied number of total Fed rate hikes in 2018 was approximately 3.5; an even split as to whether the Fed would hike rates a total of three or four times this year. That number fell considerably on Tuesday, with the market now pricing in just over 2.5 hikes. Though possibly an overreaction, we remain comfortable with our expectation for three hikes this year, as well as our forecast for the 10-year yield to range between 2.75-3.25% at year end.

Monitoring the Week Ahead

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  • Unemployment Rate (May)
  • Markit Mfg. PMI (May)
  • Italy: Markit ADACI Mfg. PMI (May)
  • France: Markit Mfg. PMI (May)
  • Germany: Markit Mfg. PMI (May)
  • UK: Markit Mfg. PMI (May)
  • Eurozone: Markit Mfg. PMI (May)
  • Italy: GDP (Q1)



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