EUROPEAN MIDDAY BRIEFING - Stocks Mixed as Fed Policy Weighs

01/27/2022 | 06:54am

MARKET WRAPS

Stocks:

European stocks trade mixed but looming interest-rate increases and tighter monetary policy continue to weigh on investor sentiment and could usher in volatility.

The moves built on a bout of volatility in the U.S. stock market that has seen major indexes swing wildly in intraday trading this week. The VIX hit its highest level in a year on Wednesday.

Markets have been buffeted by concerns about central-bank policy around interest rates and inflation and geopolitical tensions over Ukraine and Russia.

"Market volatility has escalated due to fears about the change in Fed policy. We believe the Fed has been as explicit as possible, yet uncertainty about the extent of liquidity has the markets on edge," said John Lynch, the chief investment officer at Comerica Wealth Management.

"Clarity on the timing and extent of rate hikes, as well as the degree of balance sheet reduction, should help calm markets," Lynch added.

Uncertainty over a potential Russian invasion of Ukraine is casting a pall, analysts said. Russia is a major energy exporter and oil prices have remained high even as stocks have fallen. The Fed won't be comfortable about inflation until oil prices decline, said John Vail, chief global strategist at Nikko Asset Management in Tokyo.

Shares on the move: Shares in easyJet climbed 0.8% after the European budget airline reported a narrowed first-quarter pretax loss and higher bookings following a U.K. move to ease pandemic restrictions.

"The reduction in travel restrictions announced by the U.K. government on Jan. 5 and the further drop in testing requirements finally gave the airlines some good news and easyJet saw an immediate boost in sales off the back of the announcements," Hargreaves Lansdown analyst Matt Britzman said.

"That comes after a tough couple of months where Omicron fears and restrictions meant passenger load dropped down to 67% in December, with a further drop to 50% expected for January." Shares in IAG, Ryanair and Air France-KLM also gained.

Stocks to Watch: Banco de Sabadell's earnings for the fourth-quarter should support shares as the figures confirm an improving net-interest income through 2021, stronger fees and commission income, and provisions for nonperforming loans under control, Renta 4 Banco equity research analyst Nuria Alvarez said.

The year 2022 could be a good one for the company in terms of generating net interest income, she said. The Spanish bank reported a net profit of EUR161 million in the fourth quarter, well above the EUR45 million expected by analysts polled by FactSet.

Diageo posted adjusted operating profit of GBP2.7 billion in the first half, with sales rising above forecast, and said that while it has made a strong start to 2022, it expects near-term volatility to remain. Read analysts' views here [https://newsplus.wsj.com/search/realtime/company/?searchParts=[{%22t%22:%22symbol%22,%22q%22:%22djn:djnabout:DGE.LN%22,%22c%22:%22UK:DGE%22,%22n%22:%22Diageo%20PLC%22,%22cs%22:%22STOCK/UK/XLON/DGE%22,%22ds%22:%22DGE.LN%22}, {%22t%22:%22operator%22,%22q%22:%22and%22,%22n%22:%22and%22}, {%22t%22:%22freetext%22,%22q%22:%22market%20talk%22,%22n%22:%22market%20talk%22}]&searchFilterState=open&includeDefaultFilter=true].

Read Barrons.com: British Airways Owner Has Long Runway for Postpandemic Growth

Data in focus: Any significant rebound in Germany's subdued consumer confidence levels will take some time as high energy prices continue to weigh on spending, ING's global head of macro Carsten Brzeski said.

The GfK consumer-confidence barometer points to slightly better income expectations for households, while willingness to buy also increased marginally but remains at one of its lowest levels since the start of the pandemic, he said.

"Even a lifting of the social restrictions over the coming weeks will not immediately lead to any sharp pick-up in private consumption," Brzeski said.

U.S. Markets:

Stock futures swung as looming interest-rate increases and tighter monetary policy continue to weigh on investor sentiment and could usher in volatility.

Earnings season is ongoing and is seen as the next big test of whether the stock market's sky-high valuations can be justified.

"What I'm looking for this earnings season is inflationary pressures and margins-if companies are able to hold onto their profits," Fahad Kamal, chief investment officer at Kleinwort Hambros said. "Are they able to pass along prices, are they able to maintain pricing power?" As central banks rein in liquidity, that is what becomes really important, he added.

McDonalds, Mastercard, Comcast, Blackstone and Southwest Airlines are set to post results before Thursday's opening bell. Apple, Visa and food and beverage giant Mondelez are due to report after markets close.

Tesla shares declined 0.8% in off-hours trading after the electric-vehicle maker posted a record profit. Chief Executive Elon Musk said that he wouldn't introduce new models this year and that the company had been affected by supply-chain disruptions.

Data on gross domestic product in the final quarter of 2021 will go out at 8:30 a.m. ET. Economists forecasted the economy grew at a solid pace, propelled by consumer spending, business investment and efforts to rebuild inventories. Momentum may have been affected in recent weeks by the Omicron.

Fresh data on jobless claims, a proxy for layoffs, will also be released at 8:30 a.m. Analysts are anticipating a decline amid a tight labor market. Information on orders for durable and capital goods in December is scheduled for the same time.

Forex:

The dollar is likely to remain supported into March when the Fed holds its next meeting, at which it could make an aggressive start to its interest rate hiking cycle, ING said.

"A debate over whether the Fed starts the cycle with 25bp or 50bp should keep the dollar bid into March," ING analysts say. Fed Chairman Jerome Powell essentially confirmed that the central bank would start lifting rates in March and refused to rule out a hike at every meeting this year. The DXY dollar index rose 0.9%, having earlier hit a six-week high of 96.8580.

Cryptocurrencies edged down, with bitcoin extending its decline into a third day to trade below $36,000. Ether fell 1.7%. Meta Platforms, formerly known as Facebook, is winding down its plans to build a cryptocurrency payments network and is selling its technology to a small bank, The Wall Street Journal reported.

The euro looks set to weaken further versus the dollar as the Fed expects to start raising interest rates while the European Central Bank is in no rush to follow suit, ING said.

"So far the ECB is firmly sticking to the script that the bump in inflation will not hurry them into hiking," ING analysts said. "Until something substantially changes here, expect EUR/USD to stay under pressure."

ING expects EUR/USD to fall to 1.10 by the end of the first quarter and to 1.08 by the end of the second quarter.

Bonds:

The Fed's message was "very hawkish" and went further than the market's already lofty expectations, said Till Keller, managing director for Germany, Austria and Switzerland at Ebury. Anticipating a 25 basis-point interest-rate rise in March, Ebury forecasts a total of four rises in 2022 as a bare minimum.

Keller finds that the perhaps most "hawkish" element of the FOMC's communication was Powell's comment that he didn't rule out the Fed raising interest rates at every meeting in the remainder of the year.

"While we see this as unlikely, the acknowledgement that every meeting from now on is a 'live' one is a clear signal of intent that policymakers are firmly committed to controlling U.S. inflation," Keller said.

Neuberger Berman recommends a defensive positioning in interest rates, particularly in the U.S., expecting the bond market to reprice the Fed's terminal rate as growth and inflation exceed its targets.

"We believe a repricing toward a 2.25% terminal funds rate--from 1.75% currently--is a reasonable expectation," said Jon Jonsson, managing director at the asset manager, adding that this would likely imply a 10-year U.S. Treasury yield target of approximately 1.85%-2%.

"Given the ECB will be on hold in 2022, we believe defensive positioning in U.S. rates will likely be appropriate in the near term," Jonsson said.

The ECB's communication is set to continue to drift in a more hawkish direction over 2022, as inflation remains sticky and staff forecasts gradually attain the 2% inflation target, said Spyros Andreopoulos, senior economist for Europe at BNP Paribas Markets 360.

However, any hawkish surprise at the ECB's Feb. 3 meeting is now less likely as financial conditions have tightened and uncertainties remain, he said. BNP Paribas Markets 360 continues to see an interest-rate rise from the ECB in 2022 as unlikely. It expects the liftoff in March 2023.

U.K. borrowing costs were rising in lockstep with U.S. Treasury yields as investors continue to price in a steeper policy-tightening outlook. The yield on two-year benchmark U.K. government bonds, or gilts, is up eight basis points to 0.985% from Wednesday's close, driven by a sharp rise in its U.S. counterpart.

The 10-year Italian BTP-German Bund yield spread remains on a widening track as the Italian presidential election process continues, analysts said.

After the Fed, "focus will also shift to Italy today where BTP spreads trade on cyclical highs in light of the yet fruitless election process," Christoph Rieger, head of rates and credit research, and Michael Leister, head of interest rate strategy, at Commerzbank said.

Commodities:

Oil prices ticked lower as hopes for a deal over Iran's nuclear ambitions rise. Russia's envoy to the negotiations taking place in Vienna said that world powers and Iran might reach an agreement next month. The deal would likely involve lifting sanctions on Iran's oil by April, said Mikhail Ulyanov.

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01-27-22 0654ET

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