13 June 2022 - The ECB joins the party as US inflation hits a new record.



US equity markets registered their 10th negative week in the last 11, taking with them Europe and the rest of the world. The only bright spot was Chinese equities, which posted a weekly gain of about 4%. It is impressive that the S&P500 rallied 7% in the week before and dropped 5% last week, driving investors crazy. The S&P500 is on track to test its recent lows, with the first line of support being at aroun 3850 , where the "20%-drop-from-the-peak" bear market signal resides. A level to also watch is the intraday low of the S&P500 at 3810, on the 20th of May. If we do get to test the recent lows and there is a rebound again, it sets up a technical environmet of a "double bottom", which is considered a positive development.


The ECB announced pretty much what everyone was expecting, but failed to provide details on a burning issue. And that is whether they can tackle the widening of the spreads (increasing difference) of the periphery bond yields (Italy, Spain, Greece etc) vs the German ones, which could lead to a new crisis in the region. Mrs. Lagarde said that they are aware of the situation and there are tools in place to help, but when asked, she did not provide any details. The bank announced the end of the Quantitative Easing program as well as a 25bps increase in interest rates taking place in the July meeting. Mrs. Lagarde left the door wide open for a 50bps increase in September and painted a picture of almost consecutive interest rate increases for the meetings to come. Which means that in the Fall of 2022, we are going to have positive interest rates again in the Eurozone, after almost a decade. And the market has discounted that the ECB rate at the end of next year will be close to 2% ! It is tempting to think that this is not going to finally happen, as a recession might be around the corner and a significant investment opportunity in high quality, short-term EUR bonds might be forming again, after many years of negative rates.


The central bank of Australia (RBA) suprised markets with a 50bps rate increase, as there seems to be a competition among them of who is going to appear more hawkish, or in other words who will demonstrate to be more aggressive in the fight against inflation. It is the turn of the Bank of England to meet this week, with expectations calling for a 25bps increase to 1.25%. Of course, members of the voting committee might opt for a 50bps hike, which is becoming a trend among central banks after the FED did so last month. And of course, we also have the FED on Wednesday who they are simply going to announce what we already know, another 50bps increase.


US headline inflation kept rising in May, despite expectations that we might have seen the worst. The CPI rose by 8.6% vs the expectations for 8.3%, dashing hopes that we could start seeing a lower annual growth this month. The Core CPI, which excludes food & energy items rose also higher than expectations but only slightly ( 6.0% vs 5.9%). More importantly it slowed down compared to April (6.2%), but the market has chosen to ignore it for now.


Credit growth in May in China expanded much more than expected. Chinese banks extended 1.9 trillion yuan (280bn$) in new loans, nearly triple the figure of April and much higher than the expected 1.3trillion. There is no better leading indicator of future stock performance in China than its credit impulse, i.e. the rate of growth of new loans. It has been moving up in recent months.


Mixed news from China's Covid19 situation. Beijing looks like it has re-opened for most of its parts, but Shanghai reported 11 new cases on Thursday and proceeded with targeted lockdowns and testing. There is no desire whatsoever from the government to walk away from the zero-Covid strategy, which means episodes such as this will keep happening.


In corporate news, Target Co. , one of the US's largest retail store operator provided a profit warning for the current quarter, which however has broader implications. The company said that it will cut prices significantly in order to get rid of its balooning inventories of certain goods. On one hand, cutting prices is good for inflation. On the other hand, demand might have already started hurting and perhaps we got one more sign that an economic slowdown is coming. However, a lot of damage has been done in specific sectors already (consumer discretionary for example) without even knowing how deep this slowdown will be. We should be looking at opportunites of stocks that are discounting a really bad scenario, which might not finally materialize.


Bond yields spiked to new highs, after the ECB and the inflation data in the US. The 10-year US Treasury rose to 3.17%, but remains lower of the 3.20% registered a few weeks ago. The biggest move however was seen on the 2-year, which rose to 3.15% from only 2.50% a few days ago. The German 10-year yield rose to 1.50%, the highest since 2014.


The EURUSD rallied initially closer to 1.0800 after the ECB, only to crash to 1.0500 shortly thereafter, as the market realized that Italy, Spain, Greece are starting to face again high financing costs.


Gold is trying move higher, with an attempt towards 1870$.


Equities: Weekly Performance



 

Charts of the Week


Chinese equities' technical background improves

This is the chart of the Chinese CSI300 index of local shares (blue line). This past week it has moved above its 50-day moving average line (green dotted line) registering a positive technical improvement for the short term. Essentially, it has returned back to levels right before the news about the Shanghai lockdowns in March. The 12% rally from the April lows is indicative of the improvement of the market's sentiment towards Chinese equities in the last few weeks as the country seems to be gradually lifting some restrictions and new measures to stimulate the economy have been announced. There is also hope that the regulatory crackdown on monopolistic behavior (e-commerce), on business models favoring elitism (private after-school education) and on extreme speculation (real estate) has come to an end.


The Japanese Yen (JPY) at the lowest levels in 25 years

One has to go back to 2002 to find the JPY trading at 135 vs the USD, as the chart shows. The reason of the steep sell-off in the value of the japanese currency (and equivalent rise in the USDJPY, as the blue line shows) is the significant divergence of the Central Bank's monetary policies and the huge gap between the bond yields of the two countries that this has created. The FED is starting an aggressive interest rate hike campaign which has already caused the US bond yields to spike to multi-year highs, while the Japanese Central Bank is sticking to its zero-rate policy and continuing its quantitative easing by maintaining a "ceiling" for its own yields, beyond which it intervenes. Those of us in the investment community have been brought up knowing that one of the best hedges/protection for equity market sell-offs is owning the Japanese currency, which usually rallies during trouble. This year, this has not worked for the first time in decades. But are current levels a "once-in-a decade opportunity" to buy the JPY as a protection from a potential recession in the US and further equity weakness ? Time will tell.


 

Disclaimer

• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

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• Sources: Equity performace: Factshet, Chart 1: Kepler Chevreux & Chart 2: Factshet