15 August 2022 Equities | Europe | FX | Global | Monetary Policy & Inflation

Markets to Watch This Week: Markets Are Incorrectly Pricing Fed and BoE

We standardise WoW price changes across different markets to allow for cross-market comparisons.

Market Moves

US inflation took the market by surprise. And, for the first time since January 2021, it was to the downside. That is, prices rose 8.5% YoY (versus 8.7% YoY expected) while they remained flat MoM (versus 0.2% MoM expected). It helped reignite the risk-on attitude investors had previously adopted, with US equities extending their rally from June lows (Chart 1). It also benefitted risk-sensitive currencies, and Euro and US HY credit spreads.

Dominique and Henry, however, warn to not get too optimistic too soon because the dip in inflation was almost entirely energy related, and core inflation remains strong. Dominique continues to expect core inflation around 5.5% YoY at year-end. As a result, she thinks the Federal Reserve (Fed) hikes more than is priced (175bp by YE). Our network largely agrees.

Elsewhere, China 2Y yields moved higher despite misses in CPI and PPI data likely over worries about tighter liquidity or some profit taking in long rates trades. Yields, however, fell back when the PBoC surprisingly cut rates today. Also, ethereum attempted its return above $2,000. While likely helped by the above, focus is on the merge. We are bullish ethereum.

The Week Ahead

The US remains in focus this week with the second half of the week likely to see the most action. First, there will be retail sales (Wednesday). Dominique is expecting a positive surprise relative to consensus of 0.1% MoM, as the recent stronger-than-expected labour market, PMI, and consumer confidence data suggest economic growth could be picking up. Fed minutes follow later that same day. She expects them to reinforce the message that rate hikes will continue into 2023. Three Fed speakers are due Thursday (Kansas Fed President Esther George and Minneapolis Fed President Neel Kashkari) and Friday (Richmond Fed President Tom Barkin) where a similar message will likely follow.

Across the pond, it will be busy in the UK. Labour market data (Tuesday) will continue to show that hiring difficulties remain strong, and wages continue to rise significantly above pre-COVID rates. The market is looking for headline wage growth of 4.5% YoY, while Henry sees some upside risk. Either way, purchasing power for UK consumers will continue to decline. UK CPI (Wednesday) is expected to come in at 0.4% MoM, leaving the YoY continuing on an upward trajectory. However, there is nothing that the Bank of England can do about the surge in energy costs. It is another reason why he thinks the BoE will underdeliver on market pricing.

Elsewhere across the continent, it is a holiday-shortened week, with much of Europe out for the Feast of the Assumption. The focus will remain on water levels. A drought was declared in the UK last week. For Europe, it is a largely similar story. It means Europe manufacturing is at risk while nuclear power plants are restricted on the amount of power they can produce. Meanwhile, low river levels, such as on the Rhine, will restrict transit for energy and goods meaning growing supply disruptions. At the same time, Russia may be able to further tighten its stranglehold on Europe’s energy supply. By our calculations, if Russian gas to Germany is restricted further, the 15% EU suggested reduction in gas usage will not be sufficient to avoid a shortage.

For further analysis, see our week-ahead preview, and watch Andrew and Dominique discuss topics such as: why the market rallied, whether a 2% inflation target is viable, and what to expect from retail sales.