Market jitters as ECB fails to deliver sweet Easter for markets

The markets are quiet on this Good Friday, which is the perfect time to reflect on recent price action and try to determine what will be the key drivers and direction of markets in the coming weeks. As we have mentioned, fundamentals are the dominant force in markets, and inflation data continue to drive price action. Thus, as we look towards the summer months, we need to ask ourselves two questions: 1, will inflation remain elevated, 2, when will inflation start to fall back, what signs do we need to look out for and how will this be reflected in price action? Overall, the inflation data in the US and UK and the ensuing rise in Treasury yields has weighed on market sentiment this week. Global benchmark indices have had another down week, with the Treasury sell off in full swing and the dollar index once again remains king after it breached the 100.00 level on Thursday. 

There are three topics that we will focus on today. 

1, Inflation, could it fall? 

UK and US price data both surpassed expectations, US prices rose to another 40-year high, surging to 8.5% last month. In the UK, CPI rose to 7%. Both headline rates were enormous, however, there were glimmers of hope that inflation in the US and UK could be nearing its peak. For example, in the US, core CPI rose by 0.3%, its slowest rise since September, while in the UK, the price of used cars decelerated, which is positive since this was one of the largest upward contributors to price rises. This does not mean that inflation will plunge. Price rises are here to stay, and you won’t see your favourite items in the supermarket fall anytime soon. Inflation is merely the rate of change in prices, so if inflation growth slows it means that price increases will start to slow/ stall and thus won’t be rising further. Signs that this is happening would make central banks’ jobs easier and it may boost stock market prices since it would give some certainty about where inflation will go next. In the UK, there are some signs that inflation could fall to the 2% target rate sooner than some people think. This is because of the following: the decline in used car prices as mentioned above, the modest rise in new car prices, the fall in shipping costs, the future price curves of natural gas and electricity are currently downward sloping, which means that Ofgem should be able to reduce the energy price cap next year. Lastly, wage growth is not responding to the sharp rise in prices, this is because wages are no longer linked as closely to inflation, due to the decline in unions etc. This means that inflation could be more manageable for households in the next 12 months, and the UK economy could avoid a recession. This is another reason why stock markets have not fallen off a cliff over 40-year high inflation rates. The FTSE 250 has had an undeniably bad start to the year, but it has picked up in recent weeks. 

However, it is worth noting that in the US both inflation expectations and the 5-year Treasury note yield are all higher this week. The 10-year 10-year forward rate, which is a good indicator of medium-term inflation expectations, rose to their highest ever level since the data was collected by the St Louis Fed. Thus, the era of high inflation is far from over. 

2, US consumer confidence 

There are small signs of hope in the US that consumer sentiment is managing to hold up in the face of surging prices. The University of Michigan survey of consumers jumped by 10.6% in April, although it remains below the January reading, and is still one of the lowest readings for a decade. However, expectations about the future of the economy are improving, up nearly 30% in a month, with a 17% improvement in personal financial expectations. Other points to note about this survey was that a strong labour market has bolstered wage expectations among the under 45s, with the expected gain in wages to be 5.3%, the largest increase in 30 years. The other surprising news in this report was that consumers expect barely any increase in the price of gasoline over the next year. The fall in gas prices in the US during March also contributed to improved sentiment from the US consumer. The surveys authors warned that the April survey only offers tentative signs that the US consumer is in recovery mode, although prior to this survey US retail sales had picked up by 0.5% in March. The survey’s authors also warned that the level of sentiment remains close to recession lows, and significant sources of uncertainty, namely the war in Ukraine, could reverse April’s gains. So, this data suggests that the US consumer is resilient, but remains in a weakened state. Thus, if you trade consumer discretionary stocks, you need to watch out for the oil price, Brent crude surged another 1% on Friday and remains above $111 per barrel. As you can see in the chart below, consumer discretionary stocks have sold off, but they remain significantly elevated compared to their 2020 lows. Thus, another inflation shock could weigh further on this sector that relies on the strength of the US consumer to survive. 

Chart 1: S&P 500 consumer discretionary sector and the S&P 500 financial sector.  

3, The ECB weighs on euro 

It was a tale of two central banks this week. The People’s Bank of China failed to raise rates this morning in response to ongoing lockdowns in Shanghai. This sent Asian stocks lower. However, this came after the ECB meeting failed to be as hawkish as expected, which sent EUR/USD lower by 1%, to its lowest level since 2020. While the ECB remains concerned about inflation, covid-stricken Christine Lagarde stated the risks to the Eurozone economy from the war in Ukraine and said that it would be the worst region effected by the conflict. This has reduced expectations that the ECB will raise rates in July, however, the bank remains data dependent, so this makes the ECB’s meeting in June the next big focus for euro traders. Until we get the march round of economic data, including GDP for Q1, retail sales and the latest confidence data, it is hard to see the euro recovering from here. However, it may trade sideways after steep declines in recent sessions.