Financial markets performed a little bit better in May, as some of the uncertainties seen in the first quarter dissipated and equities seemed to ride on the tailwind of a healthy earnings season. But it hasn’t all been smooth sailing, with Italian political uncertainty upsetting global markets and investor concern increasing over the threat of a trade war.
Italian uncertainty upsets global markets
The tense fractions between the President and the two populist parties caused a spike in Italian government bond yields, and uncertainty rippled through global markets.
What many feared was the start of a meaningful crisis was short-lived, and tensions unwound as Italy agreed on its new government. There’s no longer any immediate risk, and government bond yields have retreated back for now, but we’re keeping an eye on how things develop.
Importantly, key questions still have to be answered around how the coalition will govern, the populist agenda they might put forward, and future stability in the Eurozone.
Should investors be concerned about the threat of a trade war?
Trade emerged again as a potential risk to global markets in May, with the US implementing tariffs on steel and aluminium imports from a range of different countries. Mexico, Canada and the EU have said they will retaliate.
It’s widely acknowledged by economists that higher tariffs generally lead to slower economic growth and potentially higher inflation, which isn’t the best environment for global markets.
So far we aren’t too concerned by this rhetoric, but if an aggressive retaliation rally sees tariffs increase significantly on a broader range of goods over a range of countries, this could impact global growth and sentiment on the global financial market.
How is the US macro backdrop developing?
The US labour market is facing an interesting change in dynamic, after a period of record low unemployment levels and muted wage growth. More recently, the rate of pay growth has starting to pick up again, signalling that the economy is in a healthier position, with households feeling better off.
But from a financial markets perspective, this acceleration in wage growth raises a couple of concerns. This momentum could spark an acceleration in inflation, which could force Central Banks to tighten monetary policy more aggressively.
For now, inflation expectations still remain well-anchored, and we see little reason to change our expectations. Nonetheless, it’s something the team will be focussing on over the coming weeks and months.
