MARKET WRAPS

Stocks:

European stocks were slightly lower Tuesday, with precious-metal miners in the red as gold and silver prices dropped. However, gains for oil majors, as Brent crude edged up, limited overall losses.

Cautious trading is expected to continue, however, as investors look ahead to this week's meeting of the European Central Bank, which is expected to debate when to withdraw bond purchases and other stimulus measures.

"Data have been broadly in line with expectations, except for stronger inflation, and there is room for the ECB to spin a positive outlook in order to prepare markets for the inevitable tapering next year, a point clearly made by some hawkish ECB policymakers," said economists at Societe Generale led by Michel Martinez.

"Financing conditions are not tightening. Inflation forecasts are rising, both near term and medium term. As such, not reducing the pace of PEPP purchases, at least somewhat, would raise questions about the credibility of the ECB reaction function, and potentially undermine the power of the new rates guidance in the process," said economists at Deutsche Bank led by Mark Wall.

Shares on the move:

House-builders fell in London after downbeat industry data. The Halifax house-price index showed the annual rate of house-price inflation continuing to slow, hitting a five-month low of 7.1% in August versus 7.6% in July. Berkeley Group, Taylor Wimpey and Persimmon all fell.

"Much of the impact from the stamp-duty holiday has now left the market, as highlighted by the drop in industry transaction numbers compared to a year ago," Halifax managing director Russell Galley said.

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Shares in DS Smith rose 1.6% after the packaging company reported higher first-quarter volumes, although it said costs were still rising.

The update was reassuring, showing demand momentum continuing, Citigroup said. While input costs have continued to increase, Smith expects to offset this largely through prices, which should boost margins especially in the second half of the year, the bank said. "We're ahead of consensus estimates for FY22... and think consensus is likely to be revised slightly upward after today's trading update," Citigroup said.

Data in focus:

German industrial production increased in July, beating forecasts despite widespread supply shortages, statistics office Destatis said. Total industrial output--comprising production in manufacturing, energy and construction--rose 1.0% in July from June in calendar-adjusted terms. Economists had forecast a 0.7% increase, according to a poll by The Wall Street Journal.

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Economic expectations declined in Germany for the fourth consecutive month, the ZEW economic research institute said. The measure of economic expectations decreased to 26.5 in September from 40.4 in August. The reading missed economists' forecast of 57.5 points taken from a survey by The Wall Street Journal.

"Although financial market experts expect further improvements of the economic situation over the next six months, the expected magnitude and the dynamics of the improvements have decreased considerably," Achim Wambach, president of the ZEW institute, said.

Economic Outlook:

Spain's GDP growth is expected to accelerate to 3% in the third quarter, compared with the previous three-month period, driven by strong consumption, Pantheon Macroeconomics said.

Growth is expected to cool somewhat in the final quarter, though, with the economy forecast to register a 6.2% expansion overall in 2021. Despite the strong growth, GDP would remain around 3% below its pre-pandemic size at the end of 2021, a level that most other developed economies have already surpassed.

"With services trade accounting for a larger share of exports, and tourism taking longest to recover, we think growth will slow to 4.5% next year and that Spain will only regain its Covid-19 losses at the start of 2023, after Germany, France and Italy," Pantheon said.

U.S. Markets:

Stock futures wobbled, suggesting that the S&P 500 will hover close to its record at the opening bell following the long holiday weekend.

Stocks have ground higher in recent weeks, lifted by strong corporate earnings and the economic recovery. But investors say they are now waiting to see if the Federal Reserve may delay plans to begin scaling back easy-money policies because of the risks from fresh Covid-19 outbreaks and concerns that growth may cool.

"People are seeing the slowdown in the economy and the outlook becoming somewhat more opaque and therefore it is understandable that people wouldn't want to jump in and put money to work," said Willem Sels, global chief investment officer at HSBC Private Bank. "There are valid concerns about Delta, about Chinese and global growth and inflation, and it is natural that people want more visibility," he said.

Forex:

The ECB could indicate that it plans to end its main asset-purchase program earlier than anticipated, lifting the euro, Bank of America said.

The risk, most likely at the December meeting, is that the ECB signals it wants to end the APP too soon after the Pandemic Emergency Purchase Programme ends in March 2022, BofA analysts said. Ideally, quantitative easing will end just before the ECB starts raising interest rates but recent comments from policymakers suggest it could end earlier, they said.

"Such communication/forward guidance could lead to a tightening of financing conditions and supporting the EUR."

The dollar will likely tread water in the near-term before strengthening in 2022 ahead of the Fed's first post-pandemic interest rate rise, ING said.

"A Fed happy to go slow with the taper--and break the link between tapering and tightening--means the dollar can tread water," ING analysts said.

An orderly tapering of asset purchases, which won't be announced until November, should still set the stage for a stronger dollar in 2022 before the first rate rise later that year, they said. ING expects EUR/USD to trade in a range of 1.17-1.20 for the rest of the year.

The U.K. government's plans to increase national insurance to help fund care reforms and clear backlogs in the national health system could weigh on sterling, RBC Capital Markets said.

"We would guess the combination of fiscal tightening and party backlash may weigh on GBP," analysts at the bank said. Prime Minister Boris Johnson's parliamentary majority suggests he can pass the tax increase despite breaching manifesto pledges and facing backlash from members of his Conservative Party, they added.

In the near-term, however, sterling is likely to benefit from the extension of Northern Ireland's Brexit grace period expiring next month as "it removes an imminent flashpoint for GBP."

Bonds:

Market expectations regarding the ECB's delivery on asset purchases at Thursday's monetary policy meeting are torn between two close call scenarios, JPMorgan's analysts said.

One is that the ECB will retain the "significantly higher" purchase pace of the Pandemic Emergency Purchase Programme and the other is that it will remove the "significantly higher" element but will offset this by a strong "dovish" commentary.

JPMorgan expects the "significantly higher" part to be removed, with the monthly pandemic emergency asset purchases to be reduced to EUR60 billion in the coming quarter from around EUR80 billion currently.

Separately, JPMorgan said it holds a short position in 10-year Portuguese government bonds versus Spanish peers as a risk-off hedge to its portfolio.

Strategists Aditya Chordia and Elisabetta Ferrara consider the dynamics of supply versus ECB purchases favorable for both countries for the remainder of the year, but trading more than 10 basis points below Spanish bond yields, Portuguese government bonds are "quite dear" and the strategists find it hard to justify given relative fundamentals, liquidity and skewed supply versus ECB purchase dynamics considerations.

However, the trade is expected to perform well in a potential risk-off dynamic if the ECB delivers a "hawkish" message, given Portugal's smaller and relatively less liquid bond market compared with Spain's, JPM said.

Pimco expects the ECB to signal a somewhat lower pace in pandemic bond purchases over the coming quarter on the back of lower yields and improved economic data.

Pimco forecasts a cut in the PEPP pace to EUR60 billion a month--from around EUR80 billion currently--to align with earlier in the year, according to portfolio manager and executive vice president Konstantin Veit.

Pimco expects the PEPP to end next year, potentially as early as March 2022--the currently envisaged end--and expects the regular Asset Purchase Programme to be upsized to EUR60 billion from EUR20 billion, as progress toward the 2% medium-term inflation aim remains meager.

Oxford Economics expects government bond yields to grind higher as the ECB is likely to start reducing asset purchases, but 10-year German Bund yields will turn positive only by mid-2022, said chief German economist Oliver Rakau.

Oxford Economics forecasts a cut in the pandemic emergency bond purchases to EUR70 billion a month in 4Q from around EUR80 billion, "but even at that reduced pace, PEPP purchases along with the bonds bought under the Asset Purchase Programme would more than suffice to soak up governments' expected bond issuance in 4Q." Spread widening for riskier sovereigns should remain limited and gradual.

Slowing but still above-trend economic growth should support euro-denominated cyclical investment-grade corporate bonds, said Mizuho.

"Although developed markets growth is decelerating, it is still well above trend," analysts at the bank said, adding that this environment is supportive for euro investment-grade cyclicals. These bonds have underperformed throughout the third quarter of this year, as sovereign bonds rallied and a more defensive mindset took hold, they said.

"We see good value in overweighting cyclicals in European equities and in IG credit," as risk assets continue doing well.

Commodities:

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09-07-21 0559ET