ECB downer for the euro

Risky assets are moving in unison on Thursday after the much-anticipated ARM IPO set the market alight. Its initial IPO price was $51, however, it traded up to $63.59 where it closed. In after-market trading on the Nasdaq late on Thursday, the stock price had moderated and was down nearly 2% at the time of writing, however, large fluctuations in the price of ARM shares are to be expected after a 25% jump on the first day of trading. Thus, if we see the current after hours sell off continue into Friday, it is not a sign that the bottom is falling out of the market. Stocks were broadly higher on the S&P 500 with strong gains for the utility, energy, materials, real estate, and communications sectors. Stocks are in recovery mode this week, bucking the trend for September, the S&P 500 is currently up 1.59% so far this week, and the monthly gain for September so far is 0.59%. While we are only halfway through the month, this is certainly a good start.

EUR dumped after “dovish” ECB

One asset that struggled on Thursday was the euro, after the market decided that the ECB has finished hiking interest rates.   Christine Lagarde and Co’s statement after today’s ECB decision to hike interest rates to 4%, a record high for the currency bloc, included the comment that the ECB believes that “interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” This was the catalyst for a sharp drop in the euro, along with a sharp decline in bond yields across the currency bloc and across the entire yield curve. German 10-year yields were down some 5 basis points on Thursday, and even the UK 10-year yield fell 6 basis points. The shorter end of the curve, which is more closely linked to interest rate expectations, also saw declines in yield. This filtered through to the UK 2-year yield, which also saw its yield retreat, the 2-year Gilt yield is now at 4.71%. Market based interest rate expectations for the ECB fell after Thursday’s ECB rate decision. The market is now expecting 4% to be the peak for interest rates, with 33 basis points of cuts from the ECB currently expected by June 2024.

Does the ECB’s dovish hike set the tone for the Fed and the BOE next week?

We mentioned earlier this week that the ECB could set the tone for other central banks through to the end of this year. So far, the ECB’s message could be distilled down to a dovish hike and then a hawkish pause. The ECB statement also highlighted its continued fears about inflation, it said that “underlying price pressures remain high”, and that it will take a data-dependent approach to its future monetary policy decisions. This could be problematic for those who believe that this is the peak for Eurozone interest rates. The ECB’s target inflation rate of 2% is based on headline inflation, which is expected to trend upwards due to the rise in the oil price since July. Thus, while this ECB meeting is arguably less important than the meetings from 2022, when the ECB was in the thick of tightening monetary policy, we still don’t have final clarity on whether Thursday’s hike was the final one from the ECB. From a market perspective, this could mean bond market volatility for the currency bloc, and a higher level of FX vol, particularly for EUR/USD. It could also mean that EUR/USD creates a floor above $1.06, with $1.0630 acting as a decent floor during Thursday’s sell off.

Headline inflation pressures are building

The rise in commodity prices is also worth watching. Cattle, sugar, and coffee futures all jumped by more than 1% on Thursday, while crude oil futures were up more than 2%. The price of WTI rose above $90 per barrel for the first time this year. There were gains also for copper, although gold’s gains were muted, which is surprising due to the concern that rising commodity prices will prove to be inflationary. The rise in the price of oil and some food stuffs does not seem to get in the way of stronger risk sentiment and a strong performance for stocks. The relationship between oil and stocks has historically been mildly positive, although the correlation is not particularly strong. Thus, beware using changes in the oil price to determine your trading strategies, especially when there are still unknowns around the future path for monetary policy.

A touch of inflation pressure in the data should not sway the Fed

Elsewhere, US retail sales grew by more than forecast in August, although that was mostly down to stronger petrol prices. After stripping out petrol sales, the rate of retail sales growth was a mere 0.1% for August, which does not suggest that the US consumer is firing on all cylinders, with rising interest rates and high levels of credit starting to chip away at the edges of consumption as we move towards the end of Q3. The rising oil price has claimed another victim, this time Delta Airlines who cut its Q3 earnings forecast due to the surging cost of jet fuel. American Airlines cut its Q3 profit forecast earlier this week. US producer prices also came in higher than expected for August, rising 0.7% last month. However, the core rate of PPI showed signs of stabilisation. Since the Fed does not target headline inflation rates, and instead focusses on the core PCE rate of inflation when it sets monetary policy, a temporary jump in headline inflation pressures should not stop the Fed from remaining on pause this month, and potentially for the rest of the year, especially if the consumer is showing signs of weakness. However, the question remains just how temporary the spike in oil prices will be, as momentum, and supply constraints are biased to the upside.

As we move into the end of this week, a few themes are developing: will we get more dovish commentary from the Bank of England and the Fed when they meet next week? Just how dovish was the ECB really, and will some members of the ECB try to shift the tone to a more hawkish narrative in the coming days and weeks? Also, how long can risk sentiment, and stock performance, continue to hold up with Brent and WTI above $90, and showing no signs of retreating? These are the questions that will determine the outcome of markets through to year end.