Get our take on the key economic data to watch this week, what the ECB is doing in its bond markets and also why earnings season has been just about passable. 

As the markets have become more focussed on the fundamentals, every week is an important week, even in mid-August! This week traders need to contend with UK GDP data, US CPI, the tail end of earnings season and some important actions from the ECB. Below, we give our take on what to look out for and why they are important for markets. 

UK GDP: no recession, yet 

UK GDP data for the second quarter of this year is released on Friday. Analysts expect the UK economy to have contracted by 0.2% in the three months to June, after a surprise increase of 0.8% of GDP for Q1. While the UK economy won’t have fallen into a technical recession like the US for Q2, things are not looking good. Economists are expecting the economy to have fallen by 1.3% in June, with further declines expected during the summer months. The decline in growth in Q2 is expected to have been mostly in the non-services sectors of the UK economy, including manufacturing and industrial production. The index of services is expected to rise by 0.9% over the last three months, however, any sign that the service sector is weakening by more than expected and we could start to see the market fret that the Bank of England’s gloomy forecasts for the UK economy are coming true. It is worth noting that the service sector is expected to rise by more in Q2 than Q1. However, overall growth in June is expected to have slowed partly because of the extra bank holiday for the Q         ueen’s Jubilee. We will assess how much this event impacted growth when the report is released on Friday. 

The markets make life harder for the BOE 

It is worth noting that the BOE is not forecasting the UK to enter recession until Q4 2022, it then expects 5 quarters of negative growth. This is a hugely worrying economic forecast and it is driven mostly by constraints on householders’ due to the surging cost of energy. The only silver lining to the BOE’s forecasts was that a growth decline of this magnitude would help to put a lid on inflation and allow the BOE to cut rates down the line. The problem for the BOE right now is that the market does not seem to be taking the BOE seriously, for instance 10-year bond yields have risen since the BOE meeting to 1.975%. The FTSE 100 has risen some 110 points since the BOE meeting last Thursday, whereas the pound has declined. Essentially market moves post the BOE meeting are extremely unhelpful for the BOE going forward. If the pound rallied post the meeting, then it could help to suppress the cost of some imports, instead GBP/USD is back flirting with the $1.2060 level. 

US CPI: when core outpaces headline 

Elsewhere this week, US CPI for July is released on Wednesday. The market is expecting the headline inflation rate to moderate, with monthly inflation expected to rise by 0.2% last month, compared with a 1.3% monthly rise in June, and the headline annual rate is expected to moderate to 8.7% from 9.1%. While that looks good on the surface, it will take more than a decline in headline inflation to turn the Fed away from its mission to bring down inflation. Core prices are expected to advance by a hefty 0.5% in July, pushing the annual core rate of inflation up to 6.1% from 5.9%. Considering average hourly earnings also surged in July, rising 0.5% on the month, and pushing up the annual rate of US wage growth to 5.2% from 4.9%, and it’s getting easy to see why the Fed is concerned that inflation is becoming embedded in the US economy. 

With core CPI expected to outpace headline CPI last month, even as food and fuel prices plateau, we could see property and vehicle prices surge. The 5-year 5-year forward inflation rate, which is used by the St Louis Federal Reserve Bank to measure long-term inflation rates has also crept back up recently to 5.31%; we would expect this to climb higher if July’s inflation rates are stronger than expected. Looking ahead, there remains a risk that core CPI could be harder to tame, especially if geopolitical tensions rise between Taiwan and China. This could hit the production of semiconductors, which is a crucial component to more than 40% of manufactured goods worldwide. Thus, US inflation data this week comes at a critical stage for the global economic outlook, and it is hard to see how market risk sentiment can be maintained if core inflation is surging ahead, even as headline inflation may have peaked. 

Earnings season: good, but no cigar

Elsewhere, earnings season is also worth a mention this week. As of the end of last week, of the 87% of companies on the S&P 500 who had reported earnings, 75% of them had reported actual EPS above estimates. Companies, on average, are reporting earnings that are 3.4% above estimates, this is below the 5-year average of 8.8%. The energy sector has had the largest percentage of companies beating earnings estimates and by a large margin, however, there have also been earnings beats for companies in the industrials, materials, real estate and health care sectors. On average companies in financial services, consumer discretionary sectors and communications sectors reported earnings below estimates. Thus, Q2 has been a strong quarter for the energy sector, however, even companies that have reported earnings above estimate, they are doing so by a smaller margin on average than the last 5-years. Added to this, analysts now expect the blended earnings growth rate for companies in the S&P 500 to be 6.7%, which would be the lowest earnings growth rate reported since Q4 2020, at the height of the pandemic. Thus, Q2 earnings season is passable, but no cigar. 

Will ECB bond purchases be enough to keep a lid on Italian bond yields? 

Elsewhere, we will also be watching Italian bond yields closely this week, after we noticed that 10-year yields had crept up slightly to 3.058% on Tuesday. This comes even though the ECB is spending billions using its pandemic-era bond buying programme to try and keep a lid on the bond yields of its most indebted nations, including Italy. Between June and July, the ECB spend EUR 17bn buying Spanish, Italian and Greek bonds, compared with a fall of EUR 18bn of Dutch, German and French bonds held by the ECB. Thus, the deviation in the Eurozone bond market is very high, with the proceeds from maturing bonds from countries such as Germany and the Netherlands being used to fund the purchase of bonds in Italy and Spain. While this is more than some people expected, it shows that the ECB is serious about protecting its most fiscally weak members’ bond markets from rising borrowing costs. However, the ECB will also need to watch spreads closely in the current volatile macro environment. Any sign that the ECB’s bond purchases are not enough, and we see Italian 10-year bond yields rise back above 3.2-3.3% level, then the euro could tank. Right now, EUR/USD is stable and is just above parity at approx. $1.02. 

This material is published by Minerva Analysis LTD for information purposes only and should not be regarded as providing any specific advice. Recipients should make their own independent evaluation of this information and no action should be taken, solely relying on it. This material should not be reproduced or disclosed without our consent. It is not intended for distribution in any jurisdiction in which this would be prohibited. Whilst this information is believed to be reliable, it has not been independently verified and Minerva Analysis LTD makes no representation or warranty (express or implied) of any kind, as regards the accuracy or completeness of this information, nor does it accept any responsibility or liability for any loss or damage arising in any way from any use made of or reliance placed on, this information. Unless otherwise stated, any views, forecasts, or estimates are solely those of Minerva Analysis’ employees, as of this date and are subject to change without notice. We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Past performance is not a reliable indicator of future results.

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