The week ahead: Central banks and inflation in focus, as French woes are set to continue

When politics and financial markets collide, the effects can be brutal, as the French and European markets are finding out. The French Cac 40 closed down more than 7% last week, the Eurostoxx 50 index was down more than 5% on a currency adjusted basis, and the FTSE 100 fared better, falling 1.4%. This compares with the US indices, the S&P 500 closed up 1.5% while the Nasdaq 100 was higher by more than 3%. All stocks in the Cac 40 registered losses last week, however, there was some big divergences in performances. Internationally focused firms including Michelin, Danone, Carrefour, L’Oreal and Hermes were more resilient than French banks, Société Generale lost more than 14% last week, and BNP Paribas lost nearly 12%.

French political chain reaction hits European corporate credit risk

The turmoil started in the bond markets. The French 10-year yield spread with German 10-year yields surged to its widest level since 2012. French 10-year yields are more than 76 basis points higher then German yields. This is nowhere near the level of spreads between Greek and German bond yields at the peak of the Eurozone sovereign bond crisis, but it does highlight how France is no longer acting like a Northern European nation when it comes to its sovereign bond markets, and it is now closer to the southern European nations. It is worth noting that French election risks are seeping into multiple factors of the European financial system. Macron announced a snap election last Sunday night, this caused French bond yields to rise, French stocks sold off led by French banks, which caused French bond yields to rise even more as traders added a bailout premium to French sovereign debt, this caused credit default swaps on investment grade European corporate entities, as measured by the Itraxx index, to rise to its highest level for 7 months.

UK politics, child play in comparison to France

Politics are a serious threat to financial market stability in 2024. Unexpected results in India and Mexico, along with the prospect of Marine Le Pen’s party winning enough seats in France’s parliamentary elections to form a government, are causing havoc as we move towards the end of the second quarter. The relative stability in the UK, UK 10-year Gilt yields declined last week, is a sign that the days when UK politics caused waves of panic in financial markets could be over.

French election panic could moderate, but risks remain

The question is, what happens now? If French stocks sell off at the same pace this week as they did last week, then there is a real risk that French banks will need a bailout. We doubt that this will happen. While political uncertainty is still likely to weigh on French asset prices until the final round of voting on July 7th, there have been some developments over the weekend that could ease some market fears at the start of this week. The leader of France’s far right party, Marine Le Pen, who is expected to win the most seats in the upcoming French parliamentary elections, has said that she will work with centrist President Macron and will not try to push him out of office if her party wins the election. Her party, National Rally, is on track to win 35% of the vote in the first round on June 30th, with the left wing Popular Front set to win 26% and Macron’s Renaissance party is currently in third place and expected to win 19% of the vote. This may reduce the risk of institutional chaos in the aftermath of the vote, which may calm French sovereign debt markets slightly. However, the National Rally have not set out their manifesto in detail, but it has said that it would slash fuel duty, reduce the retirement age to 60 and increase public sector wages, which could cause France’s already elevated budget deficit to rise further. The markets are crying out for French fiscal restraint, and so far, the National Rally and the Popular Front have not been willing to do this. Thus, we do not expect a meaningful recovery rally in French stocks and bonds any time soon.

ECB speakers could boost the euro after a torrid week

Aside from the French elections, the focus in Europe this week is likely to be Wednesday’s verdict from the European Commission on the state of Eurozone member’s fiscal deficits. It is likely to admonish countries for breaching the bloc’s 3% deficit limit, which may focus minds on the risks to France’s fiscal position. Also, several ECB speakers are expected to clarify the ECB’s stance on the future of monetary policy, after the bank made the highly unusual move of cutting rates and at the same time raising their inflation forecast earlier this month. The euro was the worst performer in the G10 FX space last week, and was down 0.5% vs, the USD, although the single currency was lower, it fared better than European stocks. At the start of trading this week, EUR/USD attempted to break back above $1.0700, however, it has lost a bit of ground early on Monday. Futures markets are expecting a mildly higher open for European stocks that could trigger a mild recovery across European asset prices at the start of the new week.

The BoE and CPI in focus for the UK

Elsewhere, inflation reports and central bank decisions will be in focus. The Bank of England is expected to keep rates on hold this week. There is a mere 3% chance of a rate cut this Thursday, which is to be expected this close to an election. It is also worth noting that after this week’s meeting the BOE will be in a quiet period up to the election on 4th July. Ahead of this week’s BOE meeting we will get the CPI data on Wednesday. The 2% target rate is expected to be met, with the headline annual CPI rate expected to fall to 2% for May. This would mean that UK CPI is lower than European and US levels, at least for now. The core rate is also expected to moderate to 3.5% from 3.9%, and service price inflation is also expected to retreat to 5.5% from 5.9% in April, although this is still an elevated level. The risk is that high wage growth could keep upward pressure on service price inflation in the coming months. Unless we see service prices fall in a meaningful way in the coming months, then we think that an August rate cut may also be unlikely. The market is currently pricing in a 47% chance of a rate cut in August, with UK interest rates expected to end the year at 4.77%.

How June rate cut hopes have been dashed

Not that long ago we were looking for rate cuts to start with gusto in June, that was not to be, and instead elevated rates that are higher for longer are here to stay. What is interesting is that this is not spooking financial markets right now, and instead political instability has been the catalyst for the market sell off.

Will the US consumer bounce back?

In the US, the focus is likely to shift to retail sales. The market is expecting the US consumer to bounce back in May, with core retail sales expected to rise by 0.4%. This could ease some concerns about the strength of the consumer after the weaker than expected University of Michigan consumer confidence report for June, which fell to its lowest level since November last year. This weighed heavily on US airline stocks and cruise stocks at the end of last week as markets worried that the US consumer could cut back on spending on discretionary products and experiences like holidays after a post-Covid boom.

Japanese inflation to give mixed messages about price growth

Japanese inflation will be watched closely this week, especially after the BOJ did not lay out details about cutting its monthly bond purchases as its meeting last week. The market is expecting national CPI to creep higher in May, with core prices rising to 2.9% from 2.5%, however, core prices are expected to retreat to 2.2% from 2.4%, which could reduce chances of a rate hike from the BOJ when they meet next month.

FTSE: Will Ashtead de-list from the UK?

Elsewhere, the focus for the FTSE 100 this week will be Ashtead earnings. The equipment rental company has threatened to leave the UK and list in the US, so this will be worth watching. Homebuilder Berkely Group will also release earnings. Any news about optimism about the aftermath of the election and the enthusiasm of all the main parties to promote home building should be noted and could boost the homebuilding sector in the FTSE 100 and the FTSE 250.

Raspberry Pi in focus

Raspberry Pi closed its first day of general trading on Friday at 420p, well above the 280p list price, however, it also struggled in the latter part of Friday as general risk sentiment withered. Raspberry Pi had tried to attempt 500p, but that was a step too far. Even so, the market has high hopes for Raspberry Pi, and if we see it continue to make gains then it could boost London’s image as a place for tech companies to list, which is positive for the overall index in our view.  

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