European stocks managed to edge higher on Monday but with gains capped in reaction to some underwhelming Chinese data, while the ongoing drought conditions across much of Europe continued to impact logistics and energy costs.
A raft of data released Monday showed economic activity in China slowed across the board in July, highlighting the breadth of the economic challenge facing policy makers and prompting the country's central bank to unexpectedly cut two key interest rates.
"Of course, bad data from China also weighs on recession worries for the rest of the world," wrote Ipek Ozkardeskaya, Senior Analyst at Swissquote Bank.
Eurozone inflation will likely settle modestly above the European Central Bank's 2% target in the long run, Berenberg said. This will be a return to the old normal of the 1990s with inflation above the 2% targets of central banks.
Inflation surged to 8.9% year-on-year in July, the highest level in more than 40 years. In the short term, Berenberg expects inflation to rise to 10% in October and stay close to that level for the remainder of 2022 before declining substantially from early 2023 onward.
It sees the inflation decline culminating in a temporary drop below 2% in early 2024 if prices for food and energy recede from their current elevated levels.
Read: Eurozone Is Seen Falling Into Recession in 4Q
Read: European Consumer Confidence Continued to Plunge in July
Stock futures fell as the fresh evidence of a slowdown in China adds to the headwinds facing the global economy.
The major stock indexes notched another week of gains on Friday but many investors continue to have their doubts about the staying power of the rally.
The dollar should remain strong in the near-term as the Federal Reserve is likely to continue raising interest rates even after data showed inflation slowed more than expected in July, Danske Bank said.
"Monetary conditions are not restrictive enough to ensure a return of inflation to 2%. Hence, we do not think it is time to reverse course on our bullish USD view."
It may take a couple of weeks when key U.S. data are published, or a decent rebound in oil prices, before dollar sentiment finds a renewed tailwind, Danske Bank said. It expects EUR/USD to fall below parity in the second half of the year.
ING said eurozone economic releases this week, including German ZEW investor expectations on Tuesday and eurozone gross domestic product data on Wednesday, are likely to add to concerns about a weak economy and push the euro lower.
"Neither should provide much lasting support for EUR/USD, which can sink back into the 1.0150/0200 area."
Concerns are growing about the ongoing rise in gas prices in Europe, compounded by drought across much of Europe and low levels of the Rhine disrupting raw material transport networks and pushing up costs on other routes, ING said.
Sterling's reaction to key U.K. data this week--including unemployment and inflation figures--may be modest, as they're unlikely to change interest-rate expectations for the BOE, ING said.
"That should mean EUR/GBP is able to hold below Friday's highs near 0.8485/90. Cable [GBP/USD], however, looks vulnerable to dollar strength and could quite easily make a return visit to 1.2000."
German 10-year Bund yields have moved to the upper end of the recently established 0.75%-1% range, but they aren't expected to sustainably settle above the 1% mark in the next few weeks, Landesbank Baden-Wuerttemberg said.
"A key factor here is that economic downside risks continue to dominate at the global level, but particularly for Germany and the eurozone."
LBBW retains bias for further decline in yield levels.
Meantime, Morgan Stanley said Bund yields could rise sharply in the second half of August as market expectations of policy easing by the Fed next year are fading, while government bond issuance in the eurozone picks up in September.
"The market narrative of a recession leading to a Fed easing as soon as early-2023 is gradually fading, following Fed members' hawkish comments and the stronger non-farm payrolls data."
Morgan Stanley expects a seasonal selloff from late August for roughly three weeks--a pattern observed 80% of the time for Bunds, Gilts and USTs from 2007 to 2021.
J.P.Morgan Asset Management said technical data suggests that investors are repositioning portfolios to prepare for a recession, which is helping to create a more favorable backdrop for bond markets.
This is evident by a pick up in demand for Treasuries and investment-grade fixed income assets, particularly among retail clients, JPM said, adding that positioning surveys suggest that investors are beginning to move toward being overweight duration.
"These recent moves indicate that investors are seeking to insulate their portfolios against future bumps that might occur as a recession looms large while central bank policy remains restrictive."
Danske Bank said it was too early to go long Italian government bonds, with uncertainties ahead of snap elections in September.
"Given that we are uncertain regarding the new government and the reform process begun by [Mario] Draghi is likely to slow down, we do not recommend buying Italy even at this very elevated spread."
If the BTP-Bund spread widens on the back of internal Italian political problems, the European Central Bank's antifragmentation tool isn't expected to be used to support Italian bonds in this case, Danske added.
Crude futures were almost 2% lower after a raft of Chinese data showed that economic activity in the world's largest importer of oil slowed last month.
Beyond China, traders are on the lookout for news on the Iran nuclear deal, which, if revived, could boost global oil production by about a million barrels a day inside a year. The European Union has told Iran it wants a yes or no response to a draft proposal it circulated last week by today, The Wall Street Journal has reported.
In other news, water levels in Germany's Rhine river continue to fall, hampering industrial flows through the country as the continent battles an ongoing drought.
With barges unable to pass, the flow of industrial goods has suffered as logistics costs rise, particularly for coal-powered plants which have traditionally imported coal via the river.
Read: Rhine Water Levels Drop Further as European Drought Continues
Base metals and gold were down in early trading as weaker-than-expected industrial data from China pressured the global economic outlook.
"Macro looks poor especially with this morning's China data overlapping with news of continued strikes in the U.K. as rising cost-of-living continues to be a sore point," Marex said, adding that the rising dollar was adding further pressure.
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