Tuesday, August 20, 2019

Stocks continue to rebound and China cuts its Loan Prime Rate. All eyes on Italy today

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Market recap: Trade war tensions ease as Huawei wins another 90-day reprieve

It was the news the market was expecting - the US Commerce Department has again extended the 90-day temporary general licence for China’s largest telecommunications corporation Huawei, meaning the company can continue to do business with its US counterparts. The reprieve was originally set to expire yesterday, but has now been extended until November 19th. It was frustrating news for US president Donald Trump, who stated on Sunday that he does not want his country to do business with Huawei (even though his administration was involved in deciding whether to extend the company’s grace period). But the US’s Commerce Secretary claimed an extension was vital to prevent disruption at some rural US telecom networks.

In addition to the extension, the Commerce Department declared that another 46 Huawei affiliates have been added to a blacklist, called the Entity List, which was created last May. The total number of affiliates now on the list has passed 100 and includes companies from Argentina, Australia, France, and Italy.

Wall Street continued its rebound on Monday after massive losses last week. The market has been busy analysing favourable US retail sales figures released recently, which have helped ease recession fears mooted by the bond market last week. While most experts don’t believe Huawei’s licence reprieve will bring the trade war to a conclusion any sooner, it is an indicator that both sides seem willing to talk and negotiate. The S&P 500 jumped 1.2% on Monday, and is now 3.5% off its July 26th highs, as the market reacted positively to forthcoming trade talks between the US and China in September.

Meanwhile, the People's Bank of China (PBOC) announced on Saturday an interest-rate reform to reduce financing costs for corporations suffering from the economic slowdown. The PBOC set the one-year Loan Prime Rate (LPR), essentially the rate that banks offer their best clients, at 4.25%, down from its previous rate of 4.31%.

The PBOC also requires lenders to price new loans based on the revised LPR. The new rate will reduce the cost of borrowing in a bid to boost investment and support the economy, but whether this can actually help lift the economy immediately is up for debate. Currently, corporations are finding there is less demand from the public, in part because of the currently doom and gloom surrounding the outlook for the global economy. That means cheaper funding costs may not be significant to encourage corporations to spend and invest more. However, the move shows that China has joined the rate-cut trend recently implemented by many major central banks all over the world, in a bid to lower lending costs and stimulate investment in domestic markets.

Today’s analysis: Is Europe about to fall into chaos? Keep an eye on events in Italy

The Trade War and Trump may finally shift from the headlines today, as Italy’s Deputy Prime Minister Matteo Salvini, the leader of the far-right League Party, is expected to put forward a vote of no confidence in the current government lead by Giuseppe Conte.

It has been a troublesome few years for Italian politics. Since 2018’s general election, the country’s government has been led by a coalition between Luigi Di Maio’s Five Star Movement and Salvini’s League party. It was called the first populist government in modern Western Europe and it immediately clashed with the EU regarding last year’s fiscal budget. The coalition did not want the budget to be regulated by the GDP-debt ratio set by the EU commission.

In May’s European elections, Salvini’s League Party came top with 34% of the votes in Italy, while Five Star secured around 17%. With both parties in disagreement over many policies, Salvini called for a snap election in October in a bid to gain a majority. Salvini has announced he will put forward a vote of no confidence today, with prime minister Giuseppe Conte tipped to resign today, meaning the country’s president, Sergio Mattarella, the leader of the Democratic Party of Italy, will take over. The Five Star Movement has claimed Salvini is no longer, “a credible interlocutor,” and will surely back Conte, but whatever happens today, it is clear the rocky marriage between Five Star and the League Party is over.

If chaos does ensue today, we expect that the euro and the European stock market to suffer, as Italy flounders without political stability once again. The market will also be watching to see whether Salvini can really call for an election.

Sergio Mattarella will likely examine whether there is another stable majority in parliament and, if not, when the next election should be. The market is now discussing the possibility of a center-left alliance (the coalition between Democratic Party and Five Star Movement) as analysts predict that Five Star would lose most of its support to the League Party if there was a general election.

If Five Star Movement and the center-left Democratic Party do team up to prevent a snap election and a League Party-led government, the euro and European stock market will be more stable and may make gains. But if an election does take place, the League Party is tipped to lead the next Italian government - and that means the euro and European stock market could fall, as Salvini’s relationship with the EU is fractious at best, and next year’s budget discussion would be full of uncertainties again.

We expect the latter scenario is more likely, as we don’t believe Five Star can form a stable coalition with the Democratic Party. They are also not on the same page when it comes to policies, especially with regards to infrastructure and fiscal policy.

Italy Senate Composition