Global stock markets were higher on Monday, and volatility was lower across the board. European equities were the main outperformer, with the FTSE 100 rising some 0.7%, and the German Dax index up more than 1%. Analysts are now pointing to a potential breakout for the German index, with a break above 15,600, opening the way for a move back to 16,300 record highs. China’s reopening and weaker energy prices are the main drivers of the Dax’s resilient performance in February, and there is hope that it could continue to outperform its US counterparts as we move into March. 

The Fed’s terminal rate could reach 5.5% 

There was no real driver for the mild recovery in US stocks at the start of this week, perhaps it was some squaring of positions ahead of month end, or because the US indices had their worst weekly performance of 2023 last week? US bonds have tended to fall sharply at the start of each week recently, however, the selloff in US bond markets was milder at the start of this week, the 2-year yield rose a mere 1 basis point, after rising 65 basis points in February. The driver was a major repricing of US interest rate expectations. The market has consolidated around 5.5% as the peak for US interest rates this year, with a near 56% chance that rates will reach this level by June, currently priced into the Fed Funds Futures market, according to the CME’s Fed watch tool. The “higher for longer” theme also remains - the market is currently pricing in a near 40% chance that US interest rates will remain at 5.5% through to year end. This is a major reversal from the start of the year when the market antipcated that rates would fall sharply in 2H. Now there is growing expectation that the UK and Eurozone may cut rates before the US, which is also giving the German Dax index a chance to outperform vs. the US S&P 500. 

Could M&A activity boost market sentiment? 

The market is still expecting tighter Fed policy, so what pushed stocks towards a mini recovery on Monday? News that Pfizer, the pharmaceuticals giant, is in talks to acquire Seagen in a deal that could be worth $30 billion, may have also boosted market sentiment, after a dearth of M&A activity in 2022. Share buybacks are also helping to prop the market up, or to stop it from falling further. Companies in the S&P 500 are projected to buyback $1 trillion shares this year. Authorizations as of February 17th, stood at $220bn, which is a record high for this point in the year, according to Goldman Sachs. Thus, there are some technicalities that could help market sentiment in the short term, especially now that the market has settled on a 5.5% terminal rate for the S&P 500. We would argue that any recovery in stocks could be shallow and short lived, another strong labour market report, or signs that core inflation is rising once again, could dent sentiment towards risky assets. Thus, if you are planning on joining a stock market recovery, short term strategies would be best. 

The Windsor Framework helps boost the pound

In the FX space, did the dollar fall because of a marked improvement in Investor risk appetite, or because the pound bounced sharply on the back of the Brexit deal? We think it was due to the latter. Well done to Prime Minister Sunak. He has scored an ace in renegotiating aspects of the UK’s Brexit deal with the EU and staging a highly orchestrated press conference with European Commission President Ursula von der Leyen. The key takeaways from the new deal include permanently removing the border in the Irish sea, the UK has been granted an emergency brake on EU laws applied in Northern Ireland and allows Westminster to set levies and VAT rates for Northern Ireland. Business leaders have praised the re-negotiated deal, but from a market’s perspective, the most important part of Monday’s deal was symbolic. Firstly, it looks like the UK and the EU have now drawn a line below the rancour of Brexit, and secondly, it could go some way to render the most anti-EU elements of Westminster powerless, as the bulk of MPs seem to support the deal. 

The Windsor Framework helped the pound to be the best performing currency in the G10 FX space at the start of the week, GBP/USD jumped more than 1% on Monday, EUR/GBP was stable, as one would expect. Overall, this deal could boost the pound in the medium term, as it further erodes the economic policy uncertainty that has hurt the pound since the Brexit referendum in 2016. It also holds out hope that the UK could improve trade relations with the EU more broadly in the future. Thus, we will be watching out to see if Monday’s news can lead to further momentum in EU/ UK relations down the line. 

Data highlights 

Elsewhere, the data highlights of the week include the Case Shiller US home price index for December, which is released on Tuesday. Home prices fell 0.6% in November, the fifth consecutive monthly decline. Prices could fall further, and there is no sign yet that the US housing market is turning a corner. On Wednesday we get final PMI reports for February, which are expected to confirm a bounce back for service and manufacturing sector sentiment in February. Perhaps the most important data releases this week will be Thursday’s inflation figures for the Eurozone. It could be a tale of two inflation measures, with headline inflation falling sharply, while core prices remain stubborn. The headline rate of Eurozone price growth is expected to fall 0.3%, with the annual rate falling to 8.2% from 8.6%. However, core prices are not expected to fall for February, and the annual rate of core price growth is expected to remain at 5.3%. Thus, the pressure remains for more rate hikes from the ECB in the coming months, which may protect the euro from sharp declines later this week. In the longer term, if headline prices fall below core price growth in the coming months, this won’t stop the ECB from continuing to tighten monetary policy, in our view. 

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