Global Equities Fall on Inflation’s Rise, ECB May Increase Rate
Last Week Review
Global equities came under additional pressure from hotter-than-expected inflation, raising the odds of a monetary policy overshoot that causes recession. Global equities declined 1.6% with U.S., developed ex-U.S. and emerging market equities in the red. The Treasury curve flattened on the back of expectations for meaningful financial tightening that may weigh on longer term economic growth. The two-year Treasury yield was up 0.02% to 3.12% and the 10-year yield fell 0.17% to 2.92%. Credit spreads widened but not as much as they have in prior weeks, perhaps signaling that credit conditions already reflect a meaningful degree of economic weakness. Oil prices declined last week as energy prices have pulled back from year-to-date highs alongside rising recession risk.
U.S. Inflation Remains High
The U.S. Consumer Price Index rose 9.1% year-over-year in June — higher than 8.6% in May and expectations of 8.8%. The core Consumer Price Index, which excludes more volatile food and energy prices, rose 5.9%, a notch below 6.0% in May but above expectations of 5.7%. While energy drove the bulk of inflation, there was a notable broadening in inflationary pressures. Household inflation, which the Federal Reserve is closely watching, declined from May to June and fell below expectations. U.S. inflation rates remain too high for the Fed’s comfort. Last week’s inflation report likely will encourage continued policy tightening.
Investors Boost Fed Rate Hike Expectations
With the inflation report, investors priced in a 0.75% hike at the July Fed meeting. Outsized June inflation also raised the probability of a 1% hike to as much as 70% at one point. However, those odds trended down and ended the week at 20%. Comments from several Fed bank leaders indicated that a 0.75% hike is likely, but there is a material possibility of a 1% hike depending on incoming economic data. The Bank of Canada met last week and surprised with a 1% hike versus expectations of 0.75%. Stubbornly high inflation is forcing global central banks to pump the brakes on economic growth through restrictive policy.
Earnings from Financial Companies Disappoint
JP Morgan (JPM) and Morgan Stanley (MS) earnings last week fell short of expectations, driven by weaker investment banking fees. Investors, highly attentive to recession risk, were receptive to hearing the banks express a degree of confidence in the state of the consumer and business credit. But inflation, monetary policy and global political uncertainties remain a threat to the economic outlook.
This Week Preview
Europe Reveals Energy Contingency Plan
Last week, the Nord Stream 1 pipeline closed for regularly scheduled maintenance. It is scheduled to go back online this Thursday. However, there is risk that Russia does not resume its gas flows. Ahead of Thursday, Europe is expected to reveal its contingency plan should Russia take this action. As war continues in Ukraine, so does economic warfare between Russia and Europe. Investors will continue to assess economic risk related to the war.
Economic Data Expected to Show Less Growth
Flash Purchasing Manager’s’ Index data for the U.S. and Europe is expected to show a slower pace of economic expansion for both regions. Investors may be more sensitive to economic data as their fears shift from inflation to policy-induced recession.
ECB May Deliver Rate Hike
The European Central Bank is expected to announce a 0.25% hike on Thursday. The bank is also expected to give more detail on the tool it’s been developing to prevent intra-euro area yield fragmentation. The Bank of Japan is not expected to make a major policy change at its meeting this week.
Goldman Sachs, SAP to Report Earnings
Goldman Sachs (GS) and Bank of America (BAC) are among some of the U.S. banks left to report on Monday. SAP (SAP) will report out of the tech sector on Thursday and give a read on the health of business technology spending. Estimates call for second quarter U.S. earnings to finish up 4.2% year-over-year.
Source: Bloomberg for data, news developments and schedule of economic releases. Data as of July 17, 2022.
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