Sentiment towards equities remained bullish at the start of the new week. Investors are looking forward to the release of important macro data, central bank meetings and earnings reports from Wall Street banks this week.
The markets started quietly on Monday with European indices initially pulling back after Friday’s rally. But as has been the trend over the past several weeks, once US investors entered the fray, the dip was once again bought, causing the likes of the German DAX and S&P 500 indices to hit fresh record highs.
Crude oil also bounced off its lows, along with precious and base metals. In FX, the pound regained its poise, although it didn’t break out as it held near Friday’s highs when the currency had shot higher. PM Boris Johnson outlined the end of England’s social-distancing rules on 19 July. But the news was expected, and some UK investors were undoubtedly feeling a little deflated because of the result of the Euros final on Sunday night.
On a more serious note, the hesitation for the pound was probably due to the fact we have US CPI coming up on Tuesday and retail sales on Friday, which will sandwich UK CPI and jobs data on Wednesday and Thursday respectively. We will also have several other major global data releases to look forward to this week, including Chinese GDP on Thursday.
Delta variant could hurt oil but probably not stock markets
Monday’s overall risk-on session means the bulls remain in control. The market has been able to shrug off concerns over the rising delta variant of Covid-19. Though this may not be a major concern for the markets yet, it is something to keep a close eye on nevertheless, even as the UK’s full re-opening plan is going ahead. The rising cases do raise questions over how the summer holidays will be impacted and by extension the global recovery. It is more of a concern for emerging markets than developed economies. Vaccinations in EM economies are still moving slowly relative to the more advanced economies. Thus, it could dampen demand for crude oil.
As for stock markets, they rely so much on central bank support which means the rising cases of the delta variant could see the tapering QE purchases by major central banks pushed further back, keeping the stock market bulls happy. Friday’s decision by the People’s Bank of China to reduce the amount of cash lenders must hold in reserve has eased concerns over major central banks tapering their emergency stimulus measures in the coming months. European markets have been boosted by the ECB’s decision to change its inflation target to 2% from “close but below 2%,” which means the central bank will tolerate an inflation overshoot and thus keep its policy loose for even longer.
US inflation report: devil in the detail (Tuesday)
On Tuesday, we will get the latest inflation data from the US with expectations centred around 4.9% on the headline CPI, a touch weaker than 5.0% from the previous month, while a 4.0% reading is expected on the core front, which would be up from 3.8% previously and the highest reading since 1991.
On a month-on-month basis, CPI is seen rising 0.5% and 0.4% for the core print. If actual inflation turns out to be hotter than these readings then this could revive taper talks again, potentially leading to renewed strength for the dollar and weakness for stock markets. But given how the market has shrugged off inflationary concerns in the past, don’t be surprised if this is the case again.
The devil will be in the detail. It will be interesting to find out what the main drivers for inflation will be. So far, much of the rise in prices have been concentrated in categories impacted by the effects of supply chain bottlenecks and economic reopening. If it is again the same drivers, this wouldn’t worry the Fed – and Fed watchers – too much, for the US central bank has repeatedly indicated it is happy to allow this type of an overshoot in prices.
Worryingly for the Fed though, consumer inflation expectations are on the rise. A closely-watched survey from the New York Fed showed an increase to a record high 4.8% in the median inflation expectations at the short-term horizon of 1-year ahead, although inflation expectations at the medium-term horizon have remained unchanged at 3.6%. Households have reported improvement in their expectations about the labour market while the perceived likelihood of job losses reached a new series of lows as their year-ahead income and spending growth expectations rose further.
Inflation in emerging markets
Elsewhere, high levels of inflation are already impacting many people’s lives in poorer regions of the world and in emerging markets. In South Africa, for example, people have been protesting with stores in the Jabulani Mall near Johannesburg having been looted on Monday. There were reports and videos emerging of riots at more malls in other parts of South Africa. The rand took a near 2% drop on Monday as a result. Although the protests have started because of the jailing of former President Jacob Zuma, there is little doubt that rising costs of living and unemployment have made the situation worse. The nation’s unemployment rate has shot up to 32.6%, with the lockdowns and high cost of food inflation exacerbating the economic woes.
It is worth keeping a close eye on the situation in South Africa, as well as some of the other emerging markets such as Turkey, where the lira has been holding near its recent and record lows. The pressure on emerging markets could increase if inflation heats up further. People taking to the streets in South Africa could be a sign of things to come unfortunately.
Wall Street banks in focus
Meanwhile the focus for some investors will undoubtedly turn to earnings as they gauge whether the corporate profitability can support equity valuations at these levels before taking on more risk. US banks will kick off the reporting season this week. While the S&P may be at a record high, it remains to be seen how strongly banks have performed in Q2. It probably won’t be a repeat of Q1 and Wall Street analysts are not expecting banks to top those numbers. After all, the quieter market conditions in Q2 means profits from trading operations will probably be lower.
That being said, vaccinations have been ramped up and the US economy has recovered strongly. It is quite possible that more banks might still be able to beat than miss the (lowered) expectations, sending their shares higher. We are expecting to see the release of more reserves that some lenders had put away for loan losses that didn’t materialize during the height of the pandemic and in the subsequent wave of Covid spikes and lockdowns.
