Musings on Markets (Dated 31/07/2022)

25th – 31st July

Competing narratives between the need to scale back rate hikes to bolster a slowing economy & the need to continue raising rates to control inflation continued to battle this week. 

The key event of the week was Wednesday’s FED meeting. The boring part is the FED raising rates from 1.75% to 2.5% as expected (75bps). The interesting part which has spurred a rally in the SPX, were comments made by Powell that “recent indicators of spending and production have softened” & a move to becoming data dependent in taking decisions going forward. One of the reasons is the market participants revised downward expectations of peak rates while maintaining their views of 75Bps of Fed Rate cuts next year.

Taken together, these statements acknowledge the possibility for the FED to scale back the pace of monetary tightening. The market is looking well into ‘23 and ignoring the weakening economic data.

By becoming data dependent the Fed will rely more on backward looking/ lagging indicators that may cause them to overshoot in their tightening. Indeed, inflation is still running hot with June Core PCE (the Fed’s preferred inflation indicator) printing hotter than expected at +0.6% MoM v +0.5% exp. and +4.8% YoY v +4.7%. exp.

On a technical note, the US printed -0.9% for Q2 GDP, chiming with the general melancholy tone surrounding economic fundamentals in western economies and kicking off a debate as to what does and does not constitute a recession.

In Europe we CPI inflation beat expectations at 9.6% (est. 8.7%), while GDP growth also beat expectations 0.7% vs 0.2% expected. Taken together this may help the ECB maintain a more hawkish tone over the coming months. 

However, the ECB faces a particularly acute challenge with regards to energy on the supply side as Russia announced this week that it was cutting gas flows through Nord Stream 1 to 20% of capacity – citing ‘equipment repairs’. 

While European leaders have agreed in principle to reduce gas consumption by c.15%, it remains to be seen how German manufacturing will sustain production with gas flows from Russia greatly reduced in the coming winter.

In terms of Credit GBP, HY Corporates returned 65 basis points (bps) on the week, with Financials out-performing Non-Financials each returning 80 bps, and 62 bps respectively. In terms of rating, Double BBs returned 61 bps, whilst Single Bs and CCCs returned 65bps and 172 bps respectively.

At time of writing (Fri 29th, Afternoon) The FTSE is up 1.7% on the week. GBP / USD is down 1% on the week at c.1.2173. The spread on the iTraxx Crossover (XOVER) – a proxy for the market’s assessment of credit risk (the greater the spread, the greater the perceived risk) decreased by c.20ps over the week to 510. 

Reporting

This week we had Vodafone 1Q23, EDF 2Q22, Vodafone 2Q22, Petrobras 2Q22, and Virgin Media 2Q22.

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