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- Global equities ended the week higher buoyed by a “peak inflation” narrative and Europe’s policy response to the energy crisis. Performance was balanced across defensive and cyclical sectors although Energy lagged as oil prices fell.
- US and euro government bond yields tracked higher last week, with the euro area underperforming. Record gas prices in the region forced the European Central Bank (ECB) to take stronger action to try to tame the inflationary impact. For the US market, better economic data and continued hawkish signals from the US Federal Reserve maintain the pressure there.
- Financial conditions continue to tighten around the globe in an effort to stave off inflation and now there are signs that this is beginning to work. Prices for globally-traded commodities, such as oil, are well off their yearly highs and there is evidence of some easing of global supply chains. While there are undoubtedly challenges in Europe, the economic data in the US continues to suggest no imminent recession there. China is forecast to bounce back from its lockdowns next year. Therefore, we maintain our late cycle view that keeps us neutral on equities, but we have a bias towards defensive and quality styles. Bonds look attractive in fixed income.
- Despite concerns in Europe about the impact of record gas prices on consumers and businesses, as well as some softer economic data coming from the region early last week (notably, euro area Services PMI, and German Factory Orders, Construction PMI and Industrial Production), the ECB raised interest rates by 75bps to combat the threat of inflation. This was expected, and it is clear that taming inflation is the priority for the central bank, even at the expense of growth.
- The fiscal response to higher gas prices in Europe will also maintain the pressure on the ECB and the Bank of England to increase interest rates further. Growth is expected to slow sharply in Europe (including the UK) with recession now a strong probability.
- In the US, the economy appears more resilient. ISM non-manufacturing data for August rose from 56.7 to 56.9 and was better than forecast. This comes on the back of the previous week’s strong labour market data.
- Chinese trade data (exports and imports) were lower than expected and this reflects the impact of the country’s COVID lockdowns. However, a gradual reopening of the economy after the Communist Party Congress in October would see a rebound in growth there. Cooler China inflation readings late in the week were seen as a positive.
Chart of the week: Europe's energy crisis
Last week’s decision by Gazprom to indefinitely suspend gas flows from the Nord Stream 1 pipeline has sharply escalated tensions with its largest customer – the EU. The impact on gas prices – locally and to a lesser extent globally – is clear but the focus of the markets in Europe is turning to Summer/Winter 2023. The Winter 2022 market looks well balanced, for now, and risks of a gas shortage leading to blackouts in the the near term appear manageable. The bad news is that barring any resolution with Russia, high gas prices are needed for longer to reduce demand and divert liquified natural gas supplies from elsewhere.
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