Uh oh! Inflation in Europe took the wrong direction in February. The data released yesterday printed a record inflation of 7.2% in France and ticked higher to 6.1% in Spain. Both were higher than expected, of course, and cranked up the hawkish European Central Bank (ECB) rate expectations.
For the first time, the market pricing pointed out that the ECB’s deposit rate would reach 4%, 150bp higher than where it stands right now. That means more 50bp hike will be on the mene after the next ECB meeting’s almost certain 50bp hike.
What does that mean for investors?
First, it means higher bond yields, as the hawkish ECB expectations directly impact the bond yields, sending them higher. As such, German, French, Italian and Spanish 10-year yields are now at the highest levels in more than a decade. They are at levels reached during the European debt crisis at the start of 2010s.
Higher yields are good for the euro – even if it won’t necessarily reverse the negative trend against the dollar, it should at least slow the selloff.
But hotter-than-expected inflation is not necessarily good for the European stocks, as higher inflation means higher ECB rates, higher ECB rates mean higher bond yields, higher bond yields mean more expensive financing for companies, more expensive financing for companies means less projects, less manufacturing, less services, and that, in return, means lower revenues for companies.
Though a stronger euro helps companies eke out better profits as a stronger currency makes raw material and energy costs more affordable for European businesses, higher yields could weigh more on the balance than a stronger euro. Therefore, what’s probably next for the Stoxx 600 is a downside correction, following a 23% rally between last October and this February.
Today, we will get hold of the German inflation figures along with the final manufacturing PMI data for the Eurozone countries, and tomorrow morning, the Italian CPI numbers will fall in before the Eurozone flash CPI estimate for February. The expectation is that inflation in the Eurozone may have slowed to 8.2% from 8.6% printed a month ago. Or it may have not slowed as much.
Higher inflation combined with soft growth is the worst possible scenario for stocks.
Slower Aussie inflation, stronger China PMI
Inflation in Australia eased more than expected in January, from last month’s record 8.4% to 7.4% versus 8% expected by analysts. But growth also slowed in Q4.
The Aussie-dollar first dipped then rebounded. The better-than-expected PMI data from China boosted iron ore prices, and helped throw a floor under the Aussie’s selloff, at around the 100-DMA, 0.6740. But clearing support at this level would only take another wave of hawkish Federal Reserve (Fed) pricing, which would boost the dollar appetite and send the pair below the 100-DMA. The downside risks prevail.
Speaking of the Fed expectations
Cooling US house prices for a seventh straight month, and ugly Richmond manufacturing index cooled the hawkish Fed pressures yesterday, but the S&P500 couldn’t hold on to its gains above the 50-DMA, and closed yesterday’s session below this level. As a result, the month of February ended with a 2.7% loss for the S&P500, and with mounting pressure from the bears.
The key support to watch in S&P500 is the 200-DMA, near 3940. There are warnings that a fall below this level could trigger a $50 billion selloff, according to JP Morgan.
Elsewhere, well crude oil jumped yesterday, although the latest API data showed another 6.2 million barrel build last week in the US crude inventories. The strong PMI data from China certainly helped keeping the oil bulls alert, but the 50-DMA offers, a touch below the $78pb, may be hard to clear defying the massive builds in US crude inventories week after week. The more official EIA data is due today, and remember last week, the EIA data was even bigger than the API.
