Political risk grows, can risky assets keep up?

It’s the start of a new month and the final month for Q4, which means the usual torrent of start of the month data. Payrolls, PMIs, US ISM’s and central bank meetings in Canada and Australia will keep traders on their toes. The key themes that are dominating the markets include: will the UK and Europe show further signs of economic stagnation into year end, can the US economy maintain its strength and continue to create jobs at a decent pace, and will stocks manage to maintain strong gains into year-end? Added to this, there is a hefty dose of political risk ahead too. 

December – what’s in store? 

The latter question about the potential for equities for the rest of the year will, in part, depend on the strength of the economic data. US stocks had their best month since June in November, and the S&P 500 finally broke through the 3,000 barrier, as investors’ expectations rose about the potential for a US/China trade deal. However, stocks fell at the end of last week after the US/China trade deal was thrown into doubt by the US Congress’ support for the Hong Kong protestors. The Thanksgiving holiday means that news flow around the trade deal has been sparse, however the next major date for traders to note is December 15th, when the US is scheduled to impose another round of trade tariffs on Chinese consumer imports. As we have mentioned, this is likely to dominate market sentiment in the next few weeks: either the US imposes the sanctions and risk sentiment falls, or the tariffs are postponed, and stocks rise. The prospects for a US/Chinese trade deal are likely to dominate market sentiment for US stocks in the run up to Christmas, as long as the US economic data stays stable and the Fed remains on hold next week. 

Deciphering economic data, will the US reign supreme? 

At the start of the week, investors remain in sanguine mode, European stocks are higher, and futures markets are predicting a mildly positive open for US indices later this afternoon. However, we would be wary of reading into this early price action at the start of a new week, especially as US traders are coming back from Thanksgiving today. In our view, price action will be more reliable later this afternoon/ early Tuesday, so if you are trading today, we would recommend taking short term positions only. 

Later on Monday the market will have time to digest the manufacturing PMI data from Europe and the US. So far, European manufacturing indices have picked up slightly for November. The all-important German reading was 44.1, which although higher than October’s figure, is still mired in negative territory. Overall, the figure for Europe was 46.9, which is unlikely to boost the euro. EUR/USD has dropped back from 1.1020 earlier today, and it looks like it may test the key 1.10 level at some point. The range in EUR/USD has been fairly tight in recent days, and last week’s low of 1.0980 managed to attract buying interest. This is now key short-term resistance, however, as liquidity picks up after Thanksgiving, we could see this support level tested once more, which may open the way to a deeper decline in EUR/USD, particularly if the US data remains strong this week. The October lows of 1.0880 may come into focus if we get a daily close below 1.10 in the coming days. 

German political risk, will it hurt the Dax? 

Political risk may also weigh on the euro this week after the opposition Social Democratic Party elected two left wing candidates to lead the party, they have threatened to lead their party out of coalition with Angela Merkel unless she renegotiates the 2018 coalition agreement. This matters for a couple of reasons: 1, a collapse in the coalition could lead to a general election and the CDU party doesn’t look that perky according to the polls, 2, if Merkel can renegotiate the coalition government then she may have to agree to leftist economic terms, including a sharp rise in infrastructure spending, tougher climate change laws and a stimulus package to help the German economy. Since financial markets tend to prefer centrist governments with conservative fiscal policies, this could hurt financial markets in the long term, although the prospect of a fiscal stimulus could soften some of the blow of a leftist influence in German politics. Thus, at this stage the implications of a political shift in Germany is too ambiguous to price into financial markets, and the Dow is actually up a decent 0.6% so far on Monday, and if the current momentum remains in place, then we could see a fresh record high for this index above 7,450. 

The impact of rising support for Labour hits smaller British companies 

Elsewhere, the other major political risk to watch is the UK, the latest polls showed growing support for Labour’s Jeremy Corbyn, however, we prefer to look at the FT’s poll of polls, which aggregates a variety of polls. This shows the Conservatives on 43% and Labour on 32%. If labour continues to see support rise at its current pace, then a Tory majority cannot be guaranteed for the 12thDecember election. We will produce a UK election special later this week, but for now, the prospect of a Labour government has not weighed on financial markets, the UK’S FTSE 1O0 is up more than 0.7% so far on Monday. Interestingly, it is a tale of two indices at the moment for the UK, as the FTSE 250, the broader, more UK-focused index remains in a downward trend and has missed the gains that the larger index experienced in November. Thus, more UK-focused stocks could be at risk if Labour continues to gain in the polls. So far, consumer led stocks including Pets at Home, Watches of Switzerland and Restaurant Group are the biggest fallers at the start of the week, suggesting that consumer stocks could be at risk if Labour wins the election due to the expectation of higher taxes for the better off. 

GBP/USD is also falling slightly this morning, a drop below 1.29 could also be down to rising support for labour. Key levels that could cushion the downside for this pair include 1.2885 and 1.2830, two recent lows. Overall, GBP/USD is likely to be driven by the polls in the lead up to this election, and the outcome of the leaders debate on 6thDec could also drive the currency at the end of the week.