Equity markets had to cope with more volatility in May, with the uncertainty surrounding the formation of an Italian government centre stage. Outside of Italy, share prices tracked lower, then recovered, but there did not seem to be any real sense of drama as events unfolded. It may seem strange that after the experience of the 10% equity market correction in February, share prices did not react more negatively to a fresh potential problem in the Eurozone. One reason may be that the largest economy in the world, the US, is still performing well, as demonstrated by the good employment data announced after the end of the month. Another reason is the perceived wisdom that any new economic crisis will be met by the usual response of central banks – more quantitative easing or, in the case of the US, fewer interest rate rises.
We have seen a stark contrast over the last few days with worrying political headlines from around the world contrasting with robust and upbeat economic news. Last week it was revealed that the US unemployment rate fell to the lowest level in 18 years in May while wage growth also picked up slightly. Manufacturing PMI’s in both the UK and US were also better than expected and inflation in the Eurozone picked up. It does not look likely then that Central Banks are about to be blown off course from their gradual tightening bias and the next Fed rate increase is still likely to occur on 13th June.
The biggest concern on the political front is probably trade and the risk that the current disputes descend into a full-blown trade war. The rhetoric from the Chinese over the weekend was quite hawkish and we are heading for a showdown at the G7 leaders’ summit in Quebec which starts on Friday. Italy also remains a concern, but the immediate risk of a Euro-related crisis has probably passed with the formation of a new government. However, it is hard to reconcile some of the views and policies of the leading parties with those of the EU establishment, so some sort of showdown probably lies ahead. Movements in Italian bond markets last week were almost unprecedented with two-year yields climbing as high as 2.75% having started the month at -0.3%, but they are now back to 0.75% as the panic subsides.
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