Global Stocks Fall on Inflation’s Rise, Fed Likely to Boost Rate
Last Week Review
Global equities declined 4.4% last week. It was a somewhat a quiet week prior to equity headwinds following the European Central Bank (ECB) meeting on Thursday and U.S. inflation data on Friday. Returns were weakest in the U.S. (-5.1%) and developed ex-U.S. markets (-4.6%), while emerging markets fared a bit better (-0.8%). U.S. interest rates rose with the two-year Treasury yield up 0.41% to 3.06% and the 10-year yield rising 0.22% to 3.16%. Euro area interest rates increased materially on the back of more hawkish ECB monetary policy. Credit spreads widened by 0.04% to 1.26% for investment grade bonds and 0.30% to 4.39% for high yield bonds.
U.S. Inflation Tops Expectations
The U.S. Consumer Price Index inflation measure pushed higher in May to 8.6% year-over-year (expected 8.2%), marking a new recent high, from 8.3% in April. Core inflation (excluding more volatile food and energy prices) declined in May to 6.0% year-over-year (5.9% expected) from 6.2% in April. Markets reacted negatively with U.S. equities down 3.0% on Friday and investor expectations for Federal Reserve rate hikes moving higher. While food and energy were both key drivers in the headline figure, core inflation showed less signs of easing than expected. Housing was a key contributor to the month-over-month core reading while airfare rose 13% and used car prices increased as well. Moving forward, a less-robust overall growth outlook, higher interest rates and moderating wage pressures may help ease inflation. However, there is a wide degree of variability around the outlook.
European Central Bank Signals Sustained Hikes
The ECB delivered a hawkish message at its policy meeting. It signaled a 0.25% hike in July (as expected) and opened the door to a higher than expected 0.50% hike in September if the medium-term inflation outlook persists or deteriorates. The statement pointed to gradual but sustained hikes after September. Also of note, the ECB announced an end to its large-scale asset purchases in July. The hawkish signals coincide with an upward move in ECB officials’ inflation forecasts following record-high euro area inflation prints. While the central bank is poised to exit an era of negative rates, it remains sensitive to the considerable downside economic growth risks that the euro area is facing.
China’s Equities Respond to Mixed Factors
China exports increased 16.9% year-over-year, easily beating expectations of an 8.0% rise. Imports rose 4.1%, also beating expectations to a lesser extent. Easing lockdowns support exports through lesser supply chain constraints. China’s COVID-19 situation remains an economic constraint. Last week, parts of Shanghai returned to lockdown in response to a small level of new cases. On a positive note for China equities, its government has shown signs of easing its regulatory crackdown.
This Week Preview
War Pressures Linger
Financial market risk from the war in Ukraine has somewhat stabilized but remains elevated overall. Several knock-on effects should continue to be watched (ex. energy shortages). Any type of economic escalation remains a key risk.
Fed Anticipated to Deliver Another Rate Hike
The Fed is widely expected to announce a 0.50% hike on Wednesday. Markets are currently pricing in a 0.50% hike in July and have also started fully pricing in a 0.50% increase in September following Friday’s inflation report. The Fed has succeeded in resetting investor expectations for interest rates higher. The question now is if expectations are high enough to support an orderly fall in inflation. Investors currently expect the Fed funds rate to top out around 3.5% in 2023. There will be a good deal of focus on the post-meeting press conference for details on the Fed’s latest thinking. Also, the Bank of England (Thursday) and the Bank of Japan (Friday) will announce policy decisions this week.
China Balances Economic Risks
Economic data scheduled for China includes retail sales and industrial production. Most data points are expected to remain relatively weak. China economic activity has picked up as lockdown measures have somewhat eased. Policy support has increased through greater fiscal and monetary support measure, and most recently some pullback in its regulatory crackdown. However, China still faces several headwinds with COVID-19, a weak property market and fragile consumer demand.
Source: Bloomberg for data, news developments and schedule of economic releases. Data as of June 12, 2022.
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