Uncertainty Lingers Following the U.K.’s Election
Weakness in futures prices early Monday suggests there is more pain on the way. The fall in tech lent support to a rotation into the previously laggard financial sector, which had already begun to firm earlier in the week. Financials rose 3.6 percent for the week, with half of the gains coming on Friday. Also, catching a rare bid was energy, which added 2 percent on the week, with most of the gains also coming on Friday. The gains came despite a 4 percent decline in the price of crude following a reportedly large build in inventories earlier in the week.
Unanswered Questions Remain in the U.K.
The U.K. vote was a stunning defeat for Theresa May’s Conservative party, weakening her hand as the Brexit negotiations get underway. An already difficult situation has been made worse as the EU’s hand has been strengthened by the outcome. Yet the FTSE 100 index fell just 0.6 percent on the week, perhaps because here too, the vote leaves as many questions as it resolves. Once again, it was the currency that absorbed the worst of it. The pound fell from 1.30 versus the dollar to 1.27 following the vote. That still leaves the pound well above the 1.23 level where it began the year, but well below the 1.43 level just prior to the Brexit vote one year ago.
The contrast with Sunday’s first round of legislative elections in France could not be more pronounced. The big question following Emmanuel Macron’s victory in the recent presidential election was whether he would have the political support in the assembly to push through the reform agenda of his fledgling En Marche party. But that question moved closer to resolution with Sunday’s vote. As the headline in Monday’s Financial Times emphatically states, “Macron Set for Sweeping Majority in Parliament.”
At the same time, the populist Five Star Movement reportedly suffered heavy losses in local Italian elections, which should reinforce the recent strength in the euro.
Elsewhere in the Eurozone last week, the European Central Bank (ECB) left policy unchanged at its meeting on Thursday, although in a nod toward the perhaps not-so-distant future, it said that it wouldn’t lower its deposit rate further. As in the U.S., the bank has been encouraged recently by firming economic data, but also restrained by stubbornly low inflation. First quarter GDP was revised higher last week to an annualized pace of 1.9 percent from the previous 1.7 percent estimate. The slight shift in emphasis edges the bank closer to a determination of the future of its own quantitative easing program, which for now remains in force.
And in what may be a precursor to other similar occurrences, last week the ECB engineered the swift takeover of the failing Spanish Banco Popular by its competitor, Banco Santander. Under the central bank’s new and untested resolution authority, shareholders and junior bondholders absorbed the losses, but taxpayers were spared. Many other banks throughout the region are also believed to be in a precarious state, saddled with crushing levels of bad debt, and are possible candidates for a similar resolution. The relative success of the Banco Popular resolution will no doubt give the ECB confidence that other such rescues can also be successful.
All Eyes on the Fed this Week
This week it will be the Federal Reserve’s turn, when it meets amid widespread expectation that it will raise its overnight rate a second time this year and a fourth time in this cycle. But it, too, has been confronted recently with softer inflation data and only scattered evidence of an expected reacceleration of activity. While few expect the Fed to refrain from acting this time, what it must say about upcoming meetings and the possible timing of the start of unwinding its balance sheet will be scrutinized.
While last week’s U.S. economic calendar was light, this week’s calendar is full. Activity in the important consumer sector will be revealed with the May report on retail sales on Wednesday. Expectations are modest, but better excluding autos and gasoline. Also on Wednesday is the May report on consumer prices. This report will also be important for the Fed. According to the Bloomberg consensus, the headline year-over-year Consumer Price Index rate is expected to fall slightly (2.0 from 2.2 percent), while the core rate is expected to be unchanged at 1.9 percent. On Thursday, industrial production in May is likely to slow from April’s pace, and on Friday, housing starts are projected to have declined from April, and consumer sentiment, which is expected to be unchanged, will close out the week.
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