ECB, UK inflation and a mixed bag of earnings increase market jitters once again

Market sentiment remains anxious, at one point today US stocks were up nearly 1%, following on from a brighter mood in Europe and Asia, however they closed the session down more than 0.96%. The driver of this shift in sentiment was Apple, who announced that it would slow hiring and spending growth in certain regions. This news comes ahead of Apple’s earnings that are scheduled for release next week. Overall, the key themes remain: the market appears to have settled at a 75bp hike for the Federal Reserve next week, CME Fedwatch is now suggesting that there is a 71% probability of a 75bp rate hike from the Fed next week, last week the balance was in favour of a 100bp rate hike. The ECB is expected to hike rates later this week, the PBOC has promised supportive monetary policy to help beleaguered home builders in China, which as a sector is larger than the entire US stock market, and US earnings season continues to ramp up. 

Don’t expect the end of the bear market this summer 

There are two themes that have guided our analysis so far this year: 1, fundamentals matter more than technicals at this stage of the economic cycle, so it’s important to be aware of key economic data releases, and 2, bear markets historically last 9 months, thus any uptick in sentiment, like we saw at the end of last week, is most likely temporary and a bear-market rally. We would categorise the sharp rise in stocks at the end of last week, as a weak market clinging to any bit of good news, namely that consumer confidence was better than expected for July. The University of Michigan index of Consumer Sentiment rose to 51.1 from 50.0 in June. While this was better than expected, it remains close to historic lows, and the index of consumer expectations continued to decline, reaching its lowest point since 2011. The share of consumers who blamed inflation for eroding their living standards continued to rise reaching 49%, which is the worst reading since the financial crisis. Interestingly, these negative views endured even though oil prices have fallen, and gas pump prices are significantly lower over the month. Another bright spot in the report was that inflation expectations held steady or improved. Median year ahead inflation remained steady at 5.2%, while long run inflation expectations fell to 2.8%, below the 2.9-3.1% median expectations of the last 11 months. This may only be a small improvement; however, it is feeding the narrative of peak inflation in the US. 

Waiting for a US recession…

Overall, the economic picture in the US is mixed. US homebuilder sentiment fell to its lowest level since the early months of the pandemic, as a sharp rise in US interest rates causes fear to build about the future of housing demand. In fairness, this is exactly what the Fed wants to see as surging shelter costs are a large contributor to rising core inflation, thus a slowdown in this sector could lead to a less aggressive Fed down the line, which, in theory, should be good news for risky assets. 

However, the threat of recession is real, the Fed is unlikely to take its foot off the gas in the next 6-months, which is about the extent of forward planning that goes on in the investment community. So, stocks remain ripe to be sold off. The corporate earnings data has been mixed at the start of this important week. Bank of America and Goldman Sachs both beat expectations when they announced their results on Monday. BOA results saw stronger revenue on the back of higher interest rates; however, the firm boosted its provisions for credit losses. Profits also sunk by 32% compared to last year. The Bank said that its consumer clients remained resilient last quarter with strong deposit balances and spending levels. Loan growth is also strong. This does not sound like an economy that is on the brink of recession, however, there can be no doubt that rising interest rates and sky-high levels of inflation will hurt the consumer, the question now is when that will happen. GS saw earnings growth boosted by record IB revenue and M&A growth. This is typical GS, benefitting when the rest of the market is hurting! 

We will continue to watch earnings reports closely, including Netflix. Morgan Stanley said that it expects a “streaming recession”, and plenty of people I know (not an empirical survey), would ditch Netflix subscriptions first if push came to shove. The Apple news needs to be looked at in the context of next week’s earnings release, however, if one of the world’s most valuable companies is laying off workers, risk seekers should take note. This murky outlook is supportive of a defensive equity trading strategy and that the much-feted recession could be closer than we think. 

ECB preview: rate hike a certainty but what will come in September? 

Elsewhere, the ECB meeting is worth watching for two reasons: 1, a rate hike and 2, details on its anti-fragmentation tool that is designed to help deal with wayward southern economies’ debt levels, although whether it can deal with wayward Italian politicians is another matter. A 25bp rate hike is now expected from the ECB, which would bring their main deposit rate to -0.25%. The big news would be any sign that the ECB is going to hike rates by 50bps in September. The pressure is on for the ECB to do the impossible: raise rates while at the same time bring down peripheral Eurozone members’ debt spreads with Germany, after the Italian- German yield spread blew out to a 1 month high on Friday. Thus, the ECB needs to come out with a tool that is bold, flexible, and credible to halt the volatility in some members’ bond markets. At this stage, it looks like the anti-fragmentation tool will have to include some purchasing of southern debt, thus QE is likely to be resurrected later this week. If the ECB can make a decent go of its anti-fragmentation tool, and signal interest rates returning to above zero in the next few months, then we may see a further recovery for EUR/USD above parity in the second half of this week, with $1.05 the key resistance level from here. 

UK inflation still far from peak 

Elsewhere, GBP/USD will also be in focus on Wednesday as the market waits for the much-anticipated UK inflation figures. Consumer prices are expected to rise to 9.2% from 9.1%, with monthly headline prices rising 0.7%. Core inflation is expected to moderate a touch to 5.8% in June. However, this may not be a sign that inflation has peaked in the UK, as oil prices march higher at the start of the week on the back of US President Joe Biden failing to secure a commitment to an oil production increase from Saudi Arabia last weekend. Added to this, the energy price cap is expected to rise again later this year, which will add more pressure to UK prices. The upward forces on UK inflation are not just energy related however, the weak pound is also making imports significantly more expensive, and the battle to be the new Prime Minister has seen many candidates promise tax cuts, which could stimulate the economy even more and make it harder to bring down inflation in the long term. Thus, expectations are likely to rise that the BOE will hike rates by 0.5% at its meeting on 4th August. The pound was higher at the start of the week after the dollar fell, however, it remains below the key $1.20 level. We may need to see further declines in the dollar and more signs that the BOE will “go large” at its next meeting for the pound to shift meaningfully to the upside.