Risk assets rose worldwide last week as the backdrop turned more supportive. Recession fears seem to be easing worldwide, particularly in the Eurozone, but interest rates are not rising in tandem, the best combination possible for stock markets, credit, and commodity currencies. The dollar underperformed against every currency in G10, and the biggest winners were Latin American currencies. The major exception was the Brazilian real, which continues to be hobbled by fears that the Lula administration will undo the economic stabilisation achieved over the last year in Brazil. As this is written, news of the anti-lockdown protests in China are dominating headlines and risk assets are opening softer in Asian early morning trading. In addition to the headlines from China, this should be a very busy week for markets. The flash inflation report out of the Eurozone (Wednesday) is expected to remain at record highs, especially in the core indicator, a stark contrast to the wishful thinking we see in the ECB and elsewhere that inflation will somehow go away on its own. The latter part of the week will be dominated by US macro news, including the PCE inflation report (Thursday) and the critical November payrolls report (Friday).
The pound continues to benefit from the sense of stability brought to UK finances by Prime Minister Sunak. It’s also helpful that market expectations for the terminal rate in the UK continue to creep up towards 5%. A handful of MPC members spoke last week, and there appears a general consensus among policymakers that additional interest rate hikes are required. Last week’s High Court ruling, which deemed that another Scottish Independence referendum cannot take place without Westminster consent, had little impact on sterling. This week is extremely light in terms of UK data, so risk appetite among investors and a couple of speeches by MPC members (Tuesday and Wednesday respectively) will be the main drivers of trading in the pound.
While sentiment in the Eurozone economy remains negative, key surveys last week all came out stronger than expected. This includes the PMI survey of business activity, but also consumer and investor confidence. For now, the weakness in the surveys has not fully shown up in the actual economic numbers, which continue to hold up rather well under the circumstances. This week, the focus will be on the flash inflation numbers for November, out on Wednesday. The excitement around the possibility that headline inflation may retreat slightly, while remaining in double digits, should be tempered by the absence of any sign of a pullback in the more persistent core number. The latter will likely remain above 5%, a dizzying and unsustainable 4% above overnight rates in the Eurozone.
The holiday-shortened week in the US had little economic or policy news to drive markets, aside from the publication of the somewhat stale minutes of the last Fed meeting. The minutes reinforced the notion that the Fed is likely to revert back to a 50 bp hike in December but told us little about the more important question of what to expect next year. While the payrolls report on Friday should dominate headlines, we think markets are not paying enough attention to the PCE inflation report for October, the Fed’s preferred inflation measure, released the day before. It will be interesting to see whether it confirms the softness of the CPI report that gave so much encouragement to markets, thanks partly to some technical quirks in the report. Should it come out higher than expected we could see some sharp retracement in expectations for the Fed’s terminal rate.