EUROPEAN MIDDAY BRIEFING - Stocks Deep in Red as Recession Fears Mount

06/30/2022 | 05:45am

MARKET WRAPS

Stocks:

European stocks fell on Thursday as investors rebalanced portfolios ahead of the end of a grueling first half and awaited a gauge of U.S. inflation that Federal Reserve officials consider their preferred measure of rising prices.

Investors have become increasingly convinced that the pace of rate rises will prompt a recession. About 90% of investors expect the U.S. to enter a recession before the end of 2023, according to a survey by Deutsche Bank published Thursday.

Comments from Jerome Powell and Christine Lagarde at the ECB conference on Wednesday were setting in and weighing on investors on the final trading day of the quarter, said Jeffrey Halley, senior market analyst at OANDA.

"Powell and Lagarde suggested that they would keep hiking even if their economies slowed to rein in inflation. That raised recession risks," he said.

Stocks to Watch:

Lufthansa has one of the most challenging outlooks among European airlines, said Bernstein analysts, as it downgrades the company to underperform.

The analysts said that corporate travel and East Asian traffic, on which the German flag carrier relied heavily before the pandemic, were taking longer to recover.

Lufthansa's challenges include unresolved issues on capital allocation and coming share sales, the analysts said, noting that the German government still needs to sell its 14% stake, which it must do by October 2023.

"With asset sales likely either to fetch a lower price than previously hoped in a down market, or to be postponed, the balance of risks is to the downside."

Economic Insight:

There should be no doubt that the Federal Reserve, the European Central Bank and the Bank of England are willing to do whatever it takes to bring inflation back down to target even if this means going through a lot of pain, said Pictet Wealth Management.

The underlying policy trade-off should be equally clear by now: The more successful the ECB will be in fighting financial fragmentation, the higher policy rates can be raised, Pictet said after attending the ECB's forum in Sintra.

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Retail sales in Germany rose 0.6% on month in May, a soft headline in light of the plunge in sales at the start of the second quarter, with a 5.4% decline in April, said Pantheon Macroeconomics.

This indicates that spending--excluding services--took a big hit in second quarter. Nominal sales climbed by 2% on month, adding to the evidence that higher inflation is now a serious constraint on real economic activity, according to Pantheon.

It forecast retail sales rose 2% on month in June, consistent with a grim 3.2% on-quarter fall in the second quarter. However, Pantheon says retail sales are underestimating spending in the second quarter, due to the rebound in services consumption.

U.S. Markets

Stock futures tumbled, with the key indexes set to end a brutal first half of the year sharply lower. Both the S&P 500 and Nasdaq have been pushed into a bear market in the first six months of the year as investors have fretted over Fed rate hikes and the risk of recession.

A catalyst in the day ahead could be the U.S. personal consumption expenditures price index. The data will be closely watched, considering PCE is the Fed's preferred inflation indicator.

Forex:

The euro might struggle to rise as the ECB faces greater challenges in raising interest rates than the Fed, said ING.

The Ukraine war and NATO's expansion makes for a difficult investment environment and very low interest rates still make it cheap to hedge euro-denominated working capital or balance sheet exposure, said ING.

"EUR/USD seems to have sunk into a new 1.0400-1.0600 trading range and it feels that if the ECB were to start briefing on the chances of a 50 basis points [rate] hike in July, the euro would not get much of a lift anyway."

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The dollar could rise if May's U.S. core personal consumption expenditure price index data, the Fed's preferred measure of inflation, exceeds expectations, said ING.

The Fed is prepared to press ahead with raising interest rates, despite slowing economic activity data and equity weakness, until it is confident that inflation is under control. The money markets now price U.S. short-end rates peaking around year-end at 3.5%.

"Let's see whether sticky inflation this summer needs to price [the Fed funds rate] back at 4% again," ING said.

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The Swedish krona showed little reaction after the Riksbank raised its key interest rate by 50 basis points to 0.75%, as widely expected.

Sweden's central bank said it expects to raise its policy rate close to 2.0% by the start of next year in an effort to contain inflation. EUR/SEK last traded at 10.6818, little changed after the decision.

Ahead of the policy meeting, ING said the krona would struggle to benefit from the rate decision even in the event of a "hawkish" surprise. "The near-term outlook for SEK remains quite clouded given its high exposure to the unstable risk environment."

Bonds:

Italian government bond spreads have continued to impress and the recent tightening should be a supportive backdrop to Italy's end-of-month auction later Thursday, said Commerzbank.

"The launch of the new 5y BTP, along with taps in a 10y and floater should thus not pose significant challenge to the recent tightening dynamics."

The 10-year BTP-Bund yield spread has been trading below 200 basis points in recent days, benefiting from the ECB's plans to create a new anti-fragmentation tool, of which Italian government bonds are likely to be the main beneficiaries.

Deutsche Bank said the 10-year Italian BTP-German Bund yield spread is more likely to widen to 240 basis points than to narrow to 160bps.

According to the results of the bank's June 2022 global financial market sentiment survey "70% of respondents see the risks as still being towards wider spreads, possibly feeling that there is a need to test the ECB's verbal assurances."

The survey was conducted between June 27 and 29 and covered 475 market professionals across the world.

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The massive widening of spreads since the end of February already points to a significant economic downturn in the corporate bond segment, said Erste Group.

Year-to-date performance remains negative in all credit segments, with investment grade down 13.1%, investment-grade hybrid down 14.5% and high yield down 12.6%.

Erste has attributed the weakness in the credit segment to the war in Ukraine, high inflation and monetary tightening.

Energy:

Oil prices edged higher ahead of an OPEC+ meeting at which member states will discuss production levels

Despite growing concerns about market tightness, the cartel's members and allied oil-producing nations are expected to stick to a plan outlined at a previous meeting to raise oil supply by just under 650,000 barrels a day in August. Regardless of what production levels the group agrees to, the oil market is concerned that the group is falling behind its quotas due to a lack of spare capacity.

"The headache for the oil market is the inability of OPEC+ to deliver the promised volumes," said DNB Markets.

Read: Don't Expect Any Surprises from OPEC+

Metals:

Gold futures were flat despite other recession hedges falling having acted as headwinds for the precious metal this year.

"Gold is still underperforming, catching a down draft from the deflated commodity super cycle thanks to front-loaded Fed hikes," said SPI Asset Management.

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Base metal prices were lower in London, with a lack of Asian buying outweighing the positive sentiment from China's decent PMI data.

"Whilst we had a very decent China PMI print showing a V-shaped recovery from April lows, metals in general barely reacted to this," said Marex's Asian team. "Asia has not been a buyer of metals in general," keeping prices lower.

DOW JONES NEWSPLUS


EMEA HEADLINES

Riksbank Lifts Key Rate and Signals Slower Pace of Asset Purchases

Sweden's central bank on Thursday lifted its key policy rate to 0.75% from 0.25%, raised its rate path and signalled a slower pace of asset purchases as it fights against high inflation becoming entrenched in price-setting and wage-formation.

Economists polled by The Wall Street Journal before the decision had all expected a 50 basis points hike.


German Jobless Claims Rose Strongly in June, Unemployment Rate Up

Jobless claims in Germany rose strongly in June due to the registration of Ukrainian refugees in the German labor market, the Federal Employment Agency said Thursday.

Jobless claims rose by 133,000 on month after declining by 5,000 in May. Economists polled by The Wall Street Journal had forecast a decline of 5,000.


Uniper Shares Plummet After Scrapping 2022 Outlook Due to Russian Gas Supply Crunch

Shares in Uniper SE fell sharply after the German utility scrapped its earnings targets for the year as it struggles to overcome natural gas supply restrictions from Russia.

At 0750 GMT, shares traded 14% lower at EUR14.20 as the company said it is substituting gas volumes at higher prices and talking to the Germany government about how to secure liquidity.


Iran, U.S. Nuclear-Deal Talks End Without Progress


Russia's Surprising Economic Headache: A Strong Ruble

After its first default on international debt in a century amid a grinding war with Ukraine, one might expect Russia's currency to be suffering. But Russia has the opposite problem.

The Russian ruble has soared to a roughly seven-year high against the U.S. dollar-an astounding turnaround for a currency that earlier this year was in free fall after Russia invaded Ukraine. The ruble on Wednesday had risen 42% against the dollar this year, making it the best performer against the greenback, according to a Dow Jones Market Data analysis of 56 currencies.


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06-30-22 0544ET

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