A shorter week in US markets with Columbus Day along with a light economic calendar didn’t stop a sharp sell off in equities: that began in the US but spread through global markets with little warning or a clear primary cause. The S&P 500 fell 5.4% with technology, industrials and commodities bearing the brunt of the sell-off. Consumer staples and other defensive stocks faring better points more to trade tension and macroeconomic fears rather than interest rate concerns. US 10-year Treasury yields retraced downwards 22bps on the week to 3.16%. Brent crude topped $85 a barrel earlier in the week but dipped back below $80 on Friday before being pushed-up again over the weekend as disputes resurfaced between Saudi Arabia and Turkey. Also on the last day of Golden Week in China, the PBoC cut the reserve requirement ratio by 100bp.
The Italian government and their proposed budget continued to be punished by the bond market pushing ten-year yields up through 3.50%, levels not seen since early 2014. Moreover Italian banks, with their €260bln in non-performing loans of the reported €2trln of loans held, own €102bln of outstanding loans and guarantees in the construction industry. Broadly, three of the largest builders are either insolvent or negotiating with creditors, with the construction sector already accounting for the highest default rates in the Italian economy. The problem in construction stems from years of tightening public spending that has ensured the once extremely lucrative government infrastructure contracts have dried up in the weakening economy. In fact, infrastructure spending has fallen 70% over the last ten years according to the University of Turin. Combine the construction industry financial problems with rising government bond yields of which the banks reportedly have holdings of around €375bln, and it is clear to see bank balance sheets are being severely pressured with very little available to help alleviate the strains.
Also last week the IMF published its Global Financial Stability Report which marked 10 years since the Global Financial Crisis. The report, titled “Are We Safer?”, highlighted how “short-term risks to the financial system have increased somewhat over the past six months” but also “new standards that have contributed to a more resilient financial system—less leveraged, more liquid, and better and more intensively supervised”. This tension between improvements in policy but much less-so in fundamentals support the reports view that “asset valuations remain stretched across several sectors and regions” and that “risks could rise sharply” across fragile economies through the likes of: escalating trade tensions, no-deal Brexit, renewed concerns over-indebted euro area fiscal policy and a faster-than-expected normalisation of monetary policy.
Looking ahead, on Monday we get data on US retail sales whilst the Italian government look to approve their latest budget, China CPI and UK employment data Tuesday, UK and EU CPI followed by Fed minutes on Wednesday, with China GDP and Japan CPI being published on Friday. Also it continues to be another busy week of earnings reports ahead as well as Brexit negotiations (or at least news about lack of negotiations).