European equities retrace, but the US holds firm. The TPP weekend update

Europe falls but the US equity market seems oblivious to Middle East tensions.

Europe

The pan-European STOXX Europe 600 Index ended the week 1.80% lower as an escalation of conflicts in the Middle East made investors cautious. Major stock indexes also fell sharply. Italy’s FTSE MIB dropped 3.26%, France’s CAC 40 Index fell 3.21% and Germany’s DAX lost 1.81%.

The UK’s FTSE 100 Index dropped 0.48%.

Bank of England (BoE) Governor Andrew Bailey said in an interview with The Guardian newspaper that the bank could become “a bit more aggressive” in lowering borrowing costs if the inflation rate continues to fall. However, Chief Economist Huw Pill warned against cutting rates too far and too fast. He said inflation among services firms and pay growth represented "a continued source of concern."

There was good news on the UK construction sector, as a survey showed it grew in September at its fastest pace in two-and-a-half years.

The headline S&P Global construction purchasing managers’ index rose to 57.2 from 53.6 in August. It remained above the 50.0 mark that separates contraction from expansion for the seventh month in a row and signalled the steepest rate of growth for 29 months.

Tim Moore, economics director at S&P Global Market Intelligence, said: "UK construction companies indicated a decisive improvement in output growth momentum during September, driven by faster upturns across all three major categories of activity.

"A combination of lower interest rates, domestic economic stability and strong pipelines of infrastructure work have helped to boost order books in recent months.

In the eurozone, the Purchasing Managers’ Indexes (PMIs) pointed to weaker eurozone growth and inflation falling below the European Central Bank’s (ECB) 2% target combined to strengthen expectations of an interest rate cut in October. Annual headline inflation in the eurozone slowed to 1.8% in September, the lowest level since April 2021 and below forecasts for 1.9%. Core inflation also eased to 2.7% from 2.8% in August. The eurozone composite PMI reading for September was revised higher to 49.6 from 48.9. (PMI readings less than 50 indicate a contraction in activity.)

Comments from ECB officials indicated that their gradualist approach to easing monetary policy may be shifting. ECB President Christine Lagarde, for example, hinted that borrowing costs might soon be lowered. "The latest developments strengthen our confidence that inflation will return to target in a timely manner," she told a European Union parliamentary hearing. "We will take that into account in our next monetary policy meeting in October." Executive Board member Isabel Schnabel suggested that inflation is increasingly likely to ease back to the 2% target and dropped her usual warning that rates must not be cut too early.

US

What started as a relatively quiet trading week quickly picked up steam as U.S. markets opened on Tuesday, following reports that Iran was preparing to launch a retaliatory ballistic missile attack against Israel. Later that day (evening in the Middle East), Iran fired nearly 200 missiles directly at Israel. While many of the missiles were intercepted, there were several hits in the southern and central parts of the country and threats of “more devastating attacks” if Israel responded. Stocks pulled back sharply, with the S&P 500 Index down 1.38% at the close of trading. Markets stabilized on Wednesday, however, perhaps because worst-case scenarios failed to materialize.

A late rally helped large-cap stocks notch their fourth consecutive weekly gain despite growing tensions in the Middle East and news of a dockworkers’ strike at Eastern seaports. While weighing on sentiment generally, the prospect of a wider war in the Middle East sent oil prices to their highest level in about a month, benefiting energy shares. Conversely, the Middle East worries appeared to weigh on cruise line stocks and the consumer discretionary sector. Nike also fell sharply on Wednesday, after the company withdrew its full-year sales guidance.

Tuesday brought another complication for the markets in the form of the start of a walkout by the International Longshoremen’s Association, which effectively closed operations at every major port on the East and Gulf Coasts, which together represent the capacity to handle as much as half of all U.S. trade volumes. Fears of a new round of broken supply chains and inflationary pressures dissipated on Thursday evening, however, following news of a temporary agreement that will delay any walkout until mid-January.

Asia

Japan’s stock markets suffered sharp losses around the start of the week as investors digested the country’s latest political developments. Shigeru Ishiba won the Liberal Democratic Party’s (LDP’s) closely contested leadership election on Friday, September 27—with the surprise win over Sanae Takaichi in a runoff vote making Ishiba Japan’s new prime minister (PM). His monetary policy views are considered slightly hawkish, leading the yen to initially strengthen and sending stock markets lower.

While markets recouped some of the lost ground over the week as Ishiba adopted a more dovish tone than had been anticipated, weighing on the yen, the Nikkei 225 Index and the broader TOPIX Index still registered respective declines of 3.0% and 1.7% over the week. The yen weakened to around JPY 146 against the USD, from about JPY 142 at the end of the previous week.

Despite a generally dovish tone being adopted by Japan’s top government officials, the yield on the 10-year Japanese government bond rose to 0.87%, from the prior week’s 0.80%, tracking U.S. Treasury yields higher as strong U.S. economic data tempered expectations that the Federal Reserve would cut interest rates aggressively.

Chinese stocks surged in a holiday-shortened week as optimism about Beijing’s comprehensive support measures offset disappointing data. The Shanghai Composite Index gained 8.06%, while the blue-chip CSI 300 Index rose 8.48%. In Hong Kong, the benchmark Hang Seng Index climbed 10.2%, according to FactSet. Markets in mainland China were closed on Tuesday for the National Day holiday and will reopen on Monday, October 7. Hong Kong markets were closed Tuesday but reopened Wednesday.

China’s factory activity contracted for the fifth consecutive month amid weak demand. The official manufacturing Purchasing Managers’ Index (PMI) rose to an above-consensus 49.8 in September from 49.1 in August, according to the country’s statistics office but remained below the 50-mark threshold separating growth from contraction. The manufacturing PMI has now been in contraction for all but three months since April 2023, according to Bloomberg. The nonmanufacturing PMI, which measures construction and services activity, fell to a lower-than-expected 50 in September, its lowest level in 21 months.

The Week Ahead

Next week brings the start of the third-quarter earnings season for US companies, with Wall Street banks JPMorgan and BlackRock among those in line to report.

First, though, London is set to see a quieter week on the companies front, with Hays and pub group Marston's among the big names updating.

A quiet Monday is set to be followed up by Unite Group's report on Tuesday, as PepsiCo also updates from across the Atlantic.

Marston's then features alongside CMC Markets on Wednesday, before Thursday sees Volution take centre stage on another quiet day.

Hays will then close out the week for companies in London, before several Wall Street banks kick off third-quarter earnings season in the US.

Macroeconomic headlines next week are set to revolve around gross domestic product in the UK and inflation in the US.

Thursday brings both producer price and consumer price index readings for September from the US, as markets continue to weigh the depth of further base rate cuts by the Federal Reserve.

Anticipations are for consumer price rises to have eased to 2.3% throughout the month, after falling to 2.5% and the slowest rate since early 2021 in August.

The core rate, excluding volatile energy and food prices, is expected to have scaled back from 3.2% to 3.1% in the meantime, with a reading in line with forecasts set to support the narrative for a further cut to base interest in November.

Markets are pricing in an average 34 basis point cut at the Federal Reserve's next meeting, following September’s 50 basis point cut, stretching to 70 points by the year-end.

In the UK, attention will be on Friday’s gross domestic product reading for August.

Following economic growth of 0.7% in June and 1.2% in July, figures from Trading Economics show expectations are for a 1.1% uptick in August.

A reading below this would mean Britain’s economy grew slower than expected for a second month running but was still heading in the right direction after last year’s shallow recession.

House price figures for the UK are also due from the Royal Institute of Chartered Surveyors and Halifax next week, alongside retail sales data on Tuesday.

While our traders will be watching the numbers, the main focus has to be on the Middle East and whether or not we will see further escalation. We hope not, but portfolios need to be protected, and many trading strategies are currently cautiously underweight.

Enjoy the rest of your weekend.

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