Market Summary Another Momentous Week in Europe

Another momentous week in Europe, with markets affected by a new U.K. prime minister, a terrorist attack in France, a coup attempt in Turkey and a banking crisis in Italy. Not for the first time this summer, European leaders appealed for calm.

Just three weeks after the Brexit vote in the U.K., Theresa May has taken control of the government. She has already called for the Treasury to spend more on infrastructure projects to keep the economy on track in the difficult months ahead.

Markets welcomed the speed of the U.K.'s transfer of power. However, so soon after spectacularly misjudging Brexit, investors got it wrong again on Thursday when the Bank of England's Monetary Policy Committee decided, on an 8-1 vote, not to reduce prime lending rates. Governor Mark Carney was accused of "teasing" money markets, but they are still pricing in a cut by the end of summer.

Markets responded to the surprise by selling core government bonds and pushing sterling to its highest level this month against the U.S. dollar. The global rally in equity prices also continued unabated, with investors seeing the U.K.'s delay in lowering its 0.5% interest rate as indicative of a resilient local economy. There were also positive signals for the global economy, including an encouraging start to the second-quarter earnings season.

Nevertheless, with their mood still clouded by implications of the Brexit decision, European investors were spooked last week by a crisis in the Italian banking sector. Italian banks have been beset by a surge in nonperforming loans, and unease has been fueled by the new European financial stress test for banks, the results of which are due for release July 29. Talks between Rome and European Union officials have sought to ease the risk to private creditors.

As a result, European equity funds suffered their largest-ever weekly withdrawals, with an outflow of US$5.8 billion by Wednesday evening (when seven-day measurements are taken). This eclipsed the previous record, set in October 2014, when the market reacted to fears of a German economic slowdown. Investors fled to the relatively safety of the U.S., whose equity funds received the largest single weekly takings since September 2015. Despite the incoming funds, U.S. equities closed the week on a subdued note. 

The flight to safety also saw Germany become the first eurozone country to sell 10-year bonds with a negative yield. The auction saw Germany effectively charge investors 0.05% to lend it money for 10 years. Switzerland and Japan last year became the first countries to sell benchmark 10-year government debt at negative yields, and increased bond prices in the market have seen many yields subsequently trade below zero.

The month-to-date has been good for mined commodity prices, with all of the major metals higher. As mentioned in last week's Backfill, the price of nickel has started to improve at last, breaking through US$10,000 per tonne, and zinc breached US$2,200 per tonne, which is its highest since May 2015.

Even thermal coal is up 25% from the US$49 per tonne at the end of last year, closing at over US$62 per tonne on Friday. The market was helped by news that China's Jiangxi province is to close 205 coal mines with a combined capacity of almost 13 million tonnes per year as part of the local government's five-year plan to close 283 coal mines with an annual capacity of 18.7 million tonnes. The central government is seeking to cut China's coal-mining capacity by about 10%, or 500 million tonnes over the next five years.

Nevertheless, coal is increasingly unloved by investors. One of Sweden's largest pension funds, the Fourth Swedish National Pension Fund, known as AP4, last week announced that it will drastically cut its exposure to fossil fuels. AP4 will "decarbonize" its US$14.7 billion global equity portfolio by 2020, and will instead commit US$3.2 billion to low carbon investments.

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