Stagflation concerns continue to dominate markets

Stagflation concerns continued to dominate financial markets this week. Stock market implied volatility remained elevated despite main indices recovering on Tuesday and Wednesday. The US CPI release on Wednesday provided no relief for Fed as core prices increased by 0.6% m/m in April, higher than we expected (0.5% vs. cons. 0.4%). The annual increase in core prices, however, moderated to 6.2% from 6.5% in March as base effects start kicking in. Overall, the high inflation continues to add pressure on Fed to hike sooner and faster. We still expect 50bp hike in June and July, followed by 25bp hikes in September, November and December. Larger hikes are not our base case but cannot be excluded particularly if inflation pressures prove larger or more persistent than expected.

On Tuesday, German ZEW index confirmed the economy is going through a rough patch while future outlook was less gloomy than expected. The current conditions component continued to tumble to -36.5 in May from -30.8 in April, vs. consensus expectations of -35.0. The forward-looking component recovered to -34.3 from -41.0 in April against analyst expectations (-43.5). Recovery in sentiment was broad-based across industries with exceptions in retail, construction and IT sectors.

The Russian Victory Day celebration ended up a non-event for markets. While there were speculations Putin could declare a war and announce mass mobilisation of troops, none of these fears came true. While Putin’s speech was filled with propaganda, there was not much new to it, and some analysts even drew conclusions it might create room for deescalation. We think it is premature to expect such as Russia continues its attacks on multiple cities in Ukraine and seems quite determined to achieve control over the Eastern and Southern regions of Ukraine. That being said, we are relieved Putin’s speech signalled no escalation and maintain our base case of a protracted conflict in Ukraine.

In Research Global – Low metals supply could support prices despite the manufacturing downturn, 12 May, we highlight that the recent downturn in metal prices reflects rising recession risks, which weigh on the demand outlook. Still, tight supply still points towards metal prices remaining at elevated levels, while Chinese infrastructure stimulus provides backdrop for demand. Russia is not the only factor weighing on supply: Combination of Covid-disruptions, strikes and social unrest due to rising costs of living in EM producer countries all contribute toward metal supply remaining below pre-Covid trend.

Next week, we look for signals on how the global consumer is holding up in the context of rising prices, as we get retail sales data from the US on Tuesday and the EA consumer confidence data on Friday. Central banks remain in the spotlight with some Fed speakers on the wires and ECB minutes out on Thursday. For Fed, there seems to be a broad consensus on front-loading rate hikes by hiking 50bp the next two meetings. For ECB, markets will focus on any discussion about the timing and pace of upcoming rate hikes and the Governing Council's concerns about de-anchoring inflation expectations. Final EA HICP print is due on Wednesday. The week kicks off with a batch of data releases from China: retail sales, industrial production and property sales, but the main focus remains in the Covid outbreak after this week brought some relief as new cases fell in Shanghai.

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