Eurozone Long Term Interest Rates; Germany ZEW Indicator, WPI; U.K. Unemployment; OECD Composite Leading Indicators; IMF World Economic Outlook; G20 Trade Ministers Meeting; updates from Air France-KLM, Infineon, Petrofac, Entain
Fears about elevated inflation stoked by spiralling energy costs will likely hit European markets on Tuesday. In Asia, most shares dropped, the safe-haven dollar gained, as did gold, while oil futures stabilized.
European shares face steep opening losses on Tuesday, as worries persist about slowing growth and mounting inflation, punctuated by a rally in oil prices.
On Wall Street, all three major stock indexes finished lower Monday, posting their largest one-day point drops in a week, as investors remained focused on the release of fresh inflation data and third-quarter earnings this week.
“Sentiment is fairly negative,” said Matthew Tuttle, chief executive and chief investment officer of Tuttle Capital Management. “Buyers came in and tried to rally the market and that failed miserably.”
In addition to the prospect of the Federal Reserve tapering bond purchases and then raising rates down the road, “there are a whole bunch of inflation numbers this week and people aren’t expecting that to be good news in any way, shape or form.” Moreover, the S&P 500 is below its 50-day moving average and “if you’re trying to sit out there and be a buyer, there’s not a whole lot to grab onto.”
Stocks to Watch: The outlook for Rio Tinto’s stock is buttressed by strong base-metals prices as iron ore, its main product, weakens in price, said JPMorgan. Rio Tinto is net cash and offers a dividend yield above 10%, JPM said. “We believe investors will be well rewarded owning the stock, particularly once we see China growth sentiment improve [likely after the Winter Olympics in February 2022].”
Still, the bank trimmed its target on Rio Tinto’s Australian stock to A$144 from A$150, after downgrading its iron-ore price forecasts but kept an overweight recommendation.
The dollar added to gains in Asia on rising worries about whether inflation will be transitory, said IG.
Recent strength in commodities prices, together with wage increases, seem to be fueling more persistent price pressures, challenging expectations the Fed’s tapering timeline may be postponed due to lackluster jobs gains, IG added.
Capital Economics said the dollar is likely to remain strong thanks to a hawkish Fed and uncertain global recovery.
“We think that for the dollar to rise substantially from here would take a further significant shift from the Fed and/or a more significant slowdown in the global economy; our central forecast does not suggest that the greenback’s recent rally will turn into a major dollar bull market.”
JPMorgan polled clients on fourth-quarter growth and 68% of them expect the dollar to appreciate by year end from current levels. “Central bank hikes have finally injected some carry into FX, but it is premature to call this a comeback,” said JPMorgan.
“Yields have increased in nominal terms but rising inflation has left real yields near two-decade lows. At a minimum, growth stability is required for FX carry to deliver positive returns. In G10, we note that the September FOMC was comprehensively hawkish and there remains ample room for further move in U.S. rates to continue to support the dollar versus low-yielders.”
The pound will likely depreciate versus the euro next year as the Bank of England will raise interest rates later than the market expects, said Commerzbank. It sees EUR/GBP rising to 0.88 by September 2022.
The market has fully priced in the first U.K. rate rise for February 2022, with some even expecting an increase this year but such a move is unlikely until the second quarter of 2022, said Commerzbank’s currency analyst You-Na Park-Heger.
“After all, the recent labor shortage and supply problems, which are due not only to the corona pandemic but also to a large extent to Brexit, harbor risks for the economic recovery.”
Treasury yields were unchanged in Asia, with U.S. bond markets closed on Monday for Columbus Day.
JPMorgan Asset Management said that while the recent uptick in inflation is likely transitory as the Fed has argued, with high prices themselves providing a strong incentive to producers and distributors to get goods to market thus relieving price pressures, it appears increasingly likely that some of this higher inflation will linger.
“In particular, the effects of fast-rising wages, fast-rising rents and, most of all, higher inflation expectations should keep inflation well above the Fed’s long-run 2% target through 2022 and into 2023,” said David Kelly, chief global strategist.
“Policy makers would undoubtedly like to see stronger growth and cooler inflation…this is simply not the economy we have and we expect the Fed to bow to this reality by announcing a plan to taper bond purchases at its meeting next month and to start raising short-term interest rates before the end of next year.”
Soaring expectations of a looming interest rate rise in the U.K. will widen the yield gap, or spread, between 10-year gilts and the equivalent German Bund by 20 basis points, said Saxo Bank.
“We expect this spread to widen [to] as much as 150bps as the market prepares for the BOE’s interest rate hikes,” said Saxo Bank’s fixed income strategist Althea Spinozzi.
By the end of the year, however, the 10-year Gilt-Bund spread is likely to narrow to current levels of about 130 bps as inflation expectations, the German election aftermath and higher yields in the U.S. force Bund yields higher, Spinozzi added.
Traders are likely to pay special attention to this week’s U.K. data releases as higher interest rate expectations deepen the selloff in gilts.
“The British economy is slowing down while inflation expectations rise due to supply chain disruptions and staff shortages,” said Spinozzi.
The market’s focus will be on Tuesday’s unemployment and wage data as well as Wednesday’s GDP, industrial and manufacturing data. “As inflationary pressures become more pronounced, we anticipate yields to continue to soar and the yield curve to flatten as investors price early interest rate hikes,” Spinozzi said.
Crude futures were little changed in Asia after their strong gains on Monday which saw U.S. oil book its first settlement above $80 in almost seven years and Brent hit its highest settle value in three years.
Increasing tightness in the physical market is likely to put further upward pressure on prices in the fourth quarter, said ANZ, which has raised its short-term target for oil prices to $90.00/bbl.
“From a fundamental standpoint, the story remains virtually unchanged,” said Brian Steinkamp, commodity analyst at Schneider Electric, in a daily note.
“Supply is tight as the world holds steady against Covid and economic activity continues to recover, sending fuel prices across the board higher throughout the year and surging as of late” with the approach of winter in the Northern Hemisphere.
Gold edged higher in Asia as investors looked ahead to this week’s U.S. inflation data. The precious metal could be forming a base as risks to the U.S. economic outlook continue to grow, said OANDA. Also, gold is beginning to attract some safe-haven flows, owing to factors such as supply-chain issues showing no major signs of easing.
Gold futures on Monday settled with a loss for a third straight session, marking the longest period of declines for bullion in nearly a month and extending last week’s slump following a weaker-than-expected September jobs report.
Aluminum was lower in a likely technical correction after prices earlier crossed the $3,000/ton level, the highest level since 2008, supported by expectations of supply shortages, said Marex.
The broker said European production of the metal could come to a complete stop by the end of December as current magnesium inventories–used to make aluminum–are expected to last only to the end of November.
It’s “not all about power, lower demand may weigh, with auto makers possibly lowering vehicle production due to input shortages, said Marex.
JPMorgan said iron-ore prices are likely to remain under pressure, cutting its 2022 price forecast for the steelmaking commodity to $105/ton from $125/ton.
Chinese steel production has plunged following a directive from Beijing that 2021 output be similar to 2020. There could be some support for prices in the first quarter of 2022 as policy easing improves activity in China’s steel industry, said JPM.
“Average daily steel production levels for China in 2022 should be higher than in August 2021…however, additional supply from Vale threatens to put the market into surplus again,” said JPM.
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