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EUROPEAN MIDDAY BRIEFING - Stocks Steady But Inflation, Recession Fears Continue to Cloud Markets

07/01/2022 | 05:41am EDT

MARKET WRAPS

Stocks:

European stock markets managed to claw back early losses to trade just in positive territory, although economic worries continued to weigh on investor sentiment.

At the heart of investor concerns is the fact that inflation remains at a multi-decade high, which makes the Federal Reserve and other central bank poised to continue aggressively boosting interest rates and tightening monetary policy. The risk is that raising borrowing costs to dent economic demand could spur a global recession.

"If you want the good news this morning it's that [the first half of the year] is now finally over," said Jim Reid, a strategist at Deutsche Bank.

"If you want the bad news it's that there's not much good news around as we start [the second half] and U.S. equity futures are already down...in the first few hours of the new half year."

Economic Insight:

Credit Suisse has forecast eurozone GDP growth of 2.4% in 2022 and 0.7% in 2023, well below the consensus of 2.8% and 2%, respectively.

Inflation is likely to combine with rapid European Central Bank tightening and deteriorating external demand to weaken consumption and investment growth, Credit Suisse said, adding that inflation is likely to rise further and surprise on the upside, forecasting the headline figure to average 7.5% this year and 3% next.

"A recession is now a clear possibility, although still not a given."

Credit Suisse said high excess savings and easier fiscal policy should help prevent a recession but there are still potential triggers such as Russian gas cuts that would lead to rationing.

U.S. Markets:

Stock futures were sliding as investors entered the second half of 2022 with the same fears that made the first half the worst start to a year since 1970: Higher inflation, higher interest rates, and a higher risk of a U.S. recession.

In bond markets, the yield on the benchmark 10-year Treasury note ticked up to 2.989% from 2.973% Thursday.

Shares of Kohl's fell more than 17% in premarket trading after CNBC reported the company terminated talks with Franchise Group, owner of The Vitamin Shoppe. CNBC's report cited two people familiar with the matter.

Barron's has reached out to Kohl's and Franchise for comment on the CNBC report.

Forex:

The dollar, recently 0.3% higher against a basket of currencies, will continue to outperform as widespread risk aversion drives investors toward safe havens, said MUFG Bank. It said the dollar's strength has intensified as fears over weaker global growth mount.

"It is difficult to envisage any turn to more favorable market conditions."

The upcoming earnings season could show worse profits and guidance as companies may no longer see recently robust margins as sustainable, said MUFG. Rising natural gas prices due to the war in Ukraine could also worsen investor sentiment.

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Sterling will remain highly sensitive to global investor risk appetite as the U.K.'s external deficit is worsening, said MUFG Bank.

Sterling tends to perform poorly during periods of risk aversion and data on Thursday that showed the U.K. had a record current account deficit in the first quarter suggest the currency's underperformance could continue as financial market conditions will remain challenging in coming months, said MUFG.

"The overall external position is worsening which leaves the U.K. more vulnerable at times when risk aversion becomes elevated and capital flows can diminish as investors pull back from financing."

Bonds:

Bond yields were slightly lower in early trading and Citi is leaning to the view they may have peaked. "It feels like yields may have peaked but we've been here before and there are reasons to be anxious."

German Bunds remain very sensitive to spot inflation data but have now overshot softening medium-term inflation anchors by a distance, Cit said. It finds a trading range of 1%-1.5% for the 10-year Bund yield fairer than a range between 1.5%-2%.

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Societe Generale remain bearish on German Bunds, targeting the 10-year yield at 2% in the second half of the year, on assumption that the European Central Bank's hawkishness hasn't peaked yet.

Furthermore, if fiscal policy in the eurozone continues to stimulate demand instead of prioritizing targeted and supply-side measures, "the ECB eventually may be forced to hike rates above the neutral level."

SocGen added that this isn't priced in by the market currently.

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The narrowing of the 10-year Italian BTP-German Bund yield spread by more than 40 basis points and the more-than 80bp drop in the 10-year BTP yield since the ECB's ad hoc meeting without the central bank buying yet more BTPs seems encouraging, said Commerzbank.

This tightening, however, also underscores the risk of setbacks if the ECB fails to meet high expectations about its planned anti-fragmentation tool at the July meeting, they add.

While Italy could still afford higher yields, investor sentiment will be crucial as Italy will have to attract new investors again next year, said Commerzbank.

---

The ECB will start applying flexibility in PEPP reinvestment allocations as of July 1, but this flexibility might not be sufficient to prevent a continued widening of country spreads, said Societe Generale.

It considers a frontloading of reinvestments unlikely, while reallocating all redemptions from core countries to peripheral countries seems difficult to implement in practice.

The ECB's planned anti-fragmentation tool, details of which are expected to be unveiled at the July policy meeting, is likely to slow down spread widening and help control spread volatility, which is a pre-condition before raising interest rates, SocGen said.

Energy:

Oil futures were lower and remained on course for their third consecutive weekly loss, as recession fears continued to weigh on demand.

Concerns are rising that central bank tightening and soaring inflation will weigh on global growth and push the U.S. and other major economies into recessions, reducing demand for oil.

"The inter-week collapse in oil price reflects growing recessionary concerns," said SPI Asset Management. Oil prices have risen too quickly and mounting risk of a recession is putting a cap on prices, SPI said.

Read: Putin Orders Sakhalin Energy to be Transferred to New Russian Company

Read Barrons.com: Putin Steps Up Natural Gas Restrictions for Europe

Metals:

Copper and gold prices were weaker, with safe-havens such as the dollar and bonds boosted, as markets remained risk off.

Copper prices were at their lowest level since February 2021, as recession fears continued to hit demand for the red metal.

"Recession concerns have gained the upper hand and weighed on metals prices," said Commerzbank. "The LME base metals index has plunged by 25% in the past three months and finds itself at its lowest level since April of last year. This was also the most pronounced quarterly loss in nearly 14 years."

Silver prices remained down over 13% from the start of the year and at their lowest level since July 2020 and UBS expects the metal to test pre-pandemic lows amid "rising U.S. rates, a stronger dollar and increasing U.S. recession risks."

UBS said: "We think fundamental conditions are also falling into place for silver prices to reach pre-pandemic levels. In short, we expect prices to test $19 an ounce."

UBS advised against adding silver exposure and "to hedge their long silver positions over the next six months."

Other News:

Fitch said iron ore prices may moderate in the second half as steel inventories have been building up.

"The longer it takes for construction and manufacturing sectors in China to reopen, the more likely it is that steel margins will come under pressure and some capacity is curtailed, putting pressure on iron ore prices."

DOW JONES NEWSPLUS


EMEA HEADLINES

EU Targets Foreign Subsidies, Aiming at China but Worrying U.S. Companies

BRUSSELS-European Union lawmakers struck a political agreement on new rules for companies that reap financial benefits from governments outside the bloc, pushing forward a proposal that sparked concern from some U.S. business groups.

The regulation, under a deal reached late Thursday, primarily targets companies from China and elsewhere with government backing. It would allow the European Commission, the EU's executive body, to block such businesses from making certain acquisitions or winning large public contracts if they previously benefited from foreign subsidies that regulators deem to be distortive.


Siemens Investment in Siemens Energy Could Hurt 3Q Earnings by EUR2.8B

Siemens AG said Thursday it could see a non-cash impairment of about EUR2.8 billion ($2.92 billion) on its investment in Siemens Energy AG.

Siemens AG said that, with the closing share price of Siemens Energy on Germany's Xetra, the market value of Siemens AG's 35% investment in Siemens Energy is significantly below the book value. Siemens Energy shares Thursday closed at EUR13.99, down about 4.3%.


Sodexo Backs Full-Year Guidance After Strong 3Q

Sodexo SA on Friday backed its guidance for the financial year after reporting a strong third quarter.

The French food-services and facilities company posted revenue of 5.52 billion euros ($5.79 billion) for the quarter, up from EUR4.48 billion the year prior. It said that a minus 1.7% hit from acquisition and disposals was more than compensated by a strong positive currency impact of 6.6%, through the strength of the US dollar and the Brazilian Real.


Julius Baer Agrees to Settlement in Long-Running Litigation Case

Julius Baer Gruppe AG said it agreed to settle a litigation case dating back more than a decade that sought hundreds of millions of euros in compensation.

The Swiss private banking group said Friday that it would pay 105 million euros ($110.1 million) through existing provisions, while the remaining amount will be charged against its first-half results.


Aston Martin Lagonda Regularly Monitors Funding Options; Trading in Line

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