A dearth of any meaningful U.S. data over the next few days has shifted the financial market’s focus away from U.S. inflation and recession prospects and toward someone else’s problems: namely, Europe’s.
On Thursday, European Central Bank policy makers, led by President Christine Lagarde, are said to be ready to consider doubling the size of their next rate increase, to 50 basis points, given Europe’s worsening inflation, according to Bloomberg and Reuters. Annual inflation in the eurozone’s 19 countries surged to a record 8.6% as of June; since then, sweltering heat has only driven up electricity prices, while Russia’s invasion in Ukraine is creating a wheat-production crisis. Moreover, Europe may be in for a potentially devastating winter if it can’t get a key gas pipeline back up and running.
Financial markets were readjusting to the focus on Europe in a number of different ways on Tuesday. Treasury yields moved higher mostly in conjunction with their counterparts in Germany, the U.K. and France, one trader said. The dollar, which soared to almost 20-year highs earlier this month, has started to ease up: The ICE U.S. Dollar Index
was down 0.6% on the day, while the euro
among one of the G-10’s worst-performing currencies this year versus the dollar, actually made some headway by climbing 0.9% against the greenback. Meanwhile, investors dove back into U.S. equities.
“Definitely, the focus has shifted to more European-centric risks this week, given we have the ECB tightening policy for the first time in over a decade and there’s speculation over whether they will have the anti-fragmentation tool ready to deal with widening peripheral bond spreads. That, along with a Bank of Japan meeting this week, puts the U.S. in the back seat right now,” Mazen Issa, a TD Securities senior FX strategist, said via phone.
After the annual U.S. inflation rate came in at 9.1% for June and traders pulled back on expectations for a full point hike by the Fed on July 27, “it seems like we’re reaching this point where markets are a little more comfortable with the idea that the Fed may start to ease policy just after it stops hiking rates to around 3.5%, because the U.S. will likely be in recession by then,” Issa said. “The market is basically looking through that 9.1% reading. It is a tactical mindset at the moment, but the worse the data becomes, the more the market feels a little vindicated or believes the view that the Fed can only do so much before it has to start easing.”
“That’s leading to a bit of a risk rally,” the strategist told MarketWatch. “However, we’ve seen a constant repricing over the course of the last few months and this is not necessarily done yet in terms of the repricing that needs to happen. But markets are starting to find a bit of a sweet spot, where it might be able to navigate macro shocks with less volatility on the policy side.”
Meanwhile, U.S. investors have relaxed their expectations around the U.S. central bank’s next move, with a three-quarters of a percentage point hike now seen as more likely than a jumbo-size full point hike. A 75 basis point hike is being treated by many investors as the preferred option to a 100 basis point move, helping to improve sentiment even though it remains unclear how much more the Fed will have to lift rates.
Indeed, all three major U.S. stock indexes
turned higher on Tuesday, just a day after a report about Apple Inc.’s plans to slow hiring and spending in some divisions next year sent Dow industrials to their biggest drop in more than two weeks.
In commodities, gold prices
settled modestly higher, with August futures holding above $1,700 an ounce on Tuesday as the dollar continued to weaken against major currencies. And oil futures reversed course by trading higher, with U.S. benchmark
holding above $100 a barrel.