Why June may not signal a recovery for financial markets

May could the month that traders hope to forget, particularly if they were bullish on risk. Commodities, risky FX and stocks all fell during the past 4 weeks, while safe havens such as the yen and the Swiss franc rallied strongly. The Vix, Wall Street’s fear gauge, closed the week above 18, it has been trading at relatively elevated levels all month, which is a clear sign that confidence in financial markets has been shaken. 

The main drivers of the decline in risk sentiment were the escalating tensions, and trade tariffs, between the US and China, the European elections, the UK’s political strife and search for a new Prime Minister, and a deteriorating economic backdrop. The question now is, have markets fallen far enough to trigger a recovery? 

Why the wheels could be coming off the US economic band wagon  

We believe that the final point, disappointing economic data, could be the most important as we move into June. The stats are worrying, out of 49 economic statistics released by the major financial centres last week, 27 came in below forecast, while only 15 surpassed expectations. Economic data in the US was skewed to the downside, with disappointing inflation data, pending home sales and a widening trade deficit, all weighing on sentiment. Weakening economic signals combined with Trump’s trade war chatter was a recipe for disaster for US stocks, the Dow Jones was down more than 3%, while the Nasdaq and the S&P 500 were both 2.5% lower. The dollar, which is considered a safe haven, actually rose on the week, however its performance in a risk-off trading environment is driven by market dynamics, and is not a reflection of the US economy, which is starting to show some worrying signs of slowdown. 

Why the pressure is on for the pound 

European markets did not fare much better; however, the FTSE 100 was protected by the weakening pound. The UK equity index declined some 1.5% over the week, however, the pound tumbled more than 3%. This decline can be attributed the “no deal” Brexit rhetoric that is permeating the Conservative Party leadership battle. While we don’t think that Donald Trump’s choice of Boris Johnson to become PM and for Nigel Farage to lead Brexit negotiations will come to anything, it does highlight the very real threat that the Conservative government could still lead the UK to a no-deal Brexit later this year, unless a moderate candidate manages to secure the top job in UK politics. With the majority of candidates for Theresa May’s job Brexiteers (or born again Brexiteers, in some cases), the political uncertainty is likely to weigh on the pound until the new leader of the Tories is announced in late June. In Minerva’s view, this opens the way for a drop below $1.25 in GBP/USD in the coming weeks.

Our weak outlook for sterling is bolstered by the latest CFTC positioning data on GBP, which suggests that the speculative trading community (hedge funds etc), are selling sterling once again, reversing a trend from April and early May that saw a decline in short GBP positions. This suggests that it will be harder for the pound to stage a meaningful rally in the medium term, and there could be further selling pressure to come. 

Why the euro could be due a recovery 

Europe didn’t fare much better last week, German data was particularly disappointing, there was also a decrease in inflation pressures reported across the block, and the ECB’s financial stability report highlighted the central bank’s dovish stance towards monetary policy. Interestingly, the euro managed to bounce late in the week, and the recovery continues; see our trade idea below where we explain our view on the euro. 

Trade idea: signs that the euro could be in recovery mode 

EUR/USD fell last week, however, it managed to recover at the end of the trading week. Support at $1.11 managed to hold, which is a positive sign, added to that some technical indicators also suggest that the euro could be about to embark on a period of recovery. Some positive hammer patterns have been noted in the last couple of trading sessions, thus, in time we may see a reversal in EUR/USD, which has been grinding lower for some time. Some key resistance levels that EUR/USD needs to break through before we can allow ourselves to get excited about a potential recovery include: $1.1180 in the short term, $1.1215 and then $1.1250 – the high from mid-May.  The ECB meeting this Thursday may disrupt a euro recovery in the short term, however, expectations are high that the ECB will be ultra-dovish, thus even a slight deviation from this could be euro positive. Italy, for once, could also be euro positive as weekend news reports suggests that Rome is showing a more conciliatory attitude to Brussels and is promising to adhere to EU fiscal rules in its next budget. 

3 things to watch this week 

1, Chinese trade war counter-offensive 

Late on the Sunday, Beijing announced another round of tariff increases on $60bn-worth of US goods, as well as a probe into US delivery firm FedEx. Nikkei futures suggest a lower open for the Japanese stock market at the start of the week, and we would expect Asian stocks generally to come under pressure. Elevated levels of trade tension have been kryptonite for financial markets in recent weeks, thus we expect global markets to react negatively to this news from China. Expect a potential sell-off to extend even further if the US retaliates. Overall, we do not think that the conditions are quite right for a recovery in risky assets at the start of this week. 

2, Fundamental data watch 

We mention above how deteriorating economic data is a major concern for markets. There is a raft of economic indicators scheduled for release this week including global PMI reports for May, an ECB meeting, Eurozone GDP and employment data, Eurozone trade data, UK GDP estimate for May and the US employment report rounds off the week. Another week biased towards disappointing data could aggravate risk sentiment further. 

3, The end of Theresa May’s stint at Downing Street 

Prime Minister May officially resigns on Friday 7thJune, although she will remain caretaker PM until the next leader of the Conservative Party is chosen, most likely at the end of this month. Thus, we expect a hiatus in actual Brexit negotiations between the UK and the EU, and instead a ramping up of rhetoric by her potential successors. So far, the balance seems to be tipped in favour of a Brexiteer prime minister, unless this shifts dramatically then we would expect the pound to continue to price in the prospect of a no-deal Brexit this week. Even if the pound manages to find its feet at the start of the week, a small “recovery” back to $1.2675 could trigger a fresh bout of selling. We remain unconvinced that the pound can stage a meaningful recovery in the current political environment.