MARKET WRAPS
Stocks:
European equities were mixed as investors parse the latest earnings reports and sentiment wobbles amid geopolitical tensions over Taiwan and the Federal Reserve's pathway on monetary policy.
Fed officials said they expect to keep lifting borrowing costs through at least early next year to slow the economy and bring down high inflation, pushing back against some investors' hopes of a milder rate path.
Geopolitical tensions make for a break from the most dominant macro forces moving markets of late--inflation at a four-decade high and the risk of recession from the Fed's shift to fight red-hot prices with much tighter monetary policy.
In early European trading, French bank Société Générale rose 3% after reporting a narrower loss than analysts expected, despite its exit from Russia. German healthcare firm Siemens Healthineers fell nearly 8% after saying its earnings were hit by higher costs and lower sales of Covid-related products.
Stocks to Watch:
Serco Group's potential to benefit from accelerating growth in U.S. defense spending and the expansion of the U.S. Navy is underappreciated by the market, Citi said, ahead of the company's first-half results on Thursday.
The U.K. outsourcing company's vast majority of contracts provide some kind of inflation protection, and with inflationary increases applying on the anniversary of contracts being signed, it is reasonable to expect results to benefit from at least a mid-single-digit inflation tailwind, Citi said.
"We expect Serco to highlight improved [foreign exchange] and inflationary tailwinds across its business," the bank said. Citi retains a buy rating on the stock and 244 pence price target.
Economic Insight:
The Bank of England is likely to act more forcefully against high inflation at Thursday's meeting with a 50-basis-point interest rate increase, Goldman Sachs Asset Management said.
The central bank will also likely signal the beginning of active quantitative tightening in October at a quarterly pace of GBP10 billion, it said.
The BOE will probably raise its short-term and medium-term inflation forecasts while cutting its 2022 economic-growth forecasts, Goldman Sachs Asset Management said.
The BOE will remain data-dependent with its policy decisions and willing to act aggressively if high inflation persists, it said.
"Despite the risks to growth, firm inflation and a tight labor market are supportive of further tightening beyond this month's meeting."
U.S. Markets:
Stock futures edged up ahead of services-sector data and corporate earnings, while Treasury yields pushed higher as investors continued to look ahead to the Fed's pathway on monetary policy.
Investor sentiment has wobbled since House Speaker Nancy Pelosi arrived on her historic visit to Taiwan --an island at the heart of the global chip-making industry that China considers part of its territory.
Mrs. Pelosi's landing on Tuesday was met with Chinese military aggression, with the world's second-largest economy planning drills around Taiwan that will be among the most significant in almost 30 years.
After falling on Tuesday, stocks were poised to make somewhat of a rebound in the day ahead.
"Risk assets are attempting to shake off the recent spike in U.S.-China tensions, with ...U.S. futures looking to have found a more solid footing after a wobbly start to August," broker Exinity said.
"Amid persistent uncertainty over the pace of U.S. rate hikes and global recession risks, markets now also have to contend with the resurgence in U.S.-China tensions," Exinity added.
"The aggressive tone emanating out of Beijing in response to Pelosi's visit to Taiwan has made for a classic safe haven play in recent sessions, with gold and Treasuries rising in tandem with the U.S. dollar and the Japanese Yen."
Forex:
The dollar rose in early trade after Fed officials damped speculation that the central bank could shift away from raising interest rates amid U.S. recession fears.
Fed officials Mary Daly, Loretta Mester and Charles Evans on Tuesday signaled the Fed was committed to lifting rates further to tame inflation.
"Expect similar rhetoric to emerge from Fed speakers today from the likes of James Bullard (1330CET), Patrick Harker (1630), Mary Daly (1715) and Tom Barkin (1745)," ING said.
However, the bigger focus may be the OPEC+ supply meeting, the Dutch bank said. Any surprise increase in crude supplies would hit oil prices, weakening the dollar on reduced safe-haven flows, ING said.
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The Bank of England may prefer a stronger pound to aid its battle against high inflation, ING said.
"Some BOE speakers have said that the pound has a role to play in monetary policy settings and indeed the trade-weighted pound has rallied 3% from its lows in July, largely on the back of the weaker euro," Dutch bank said.
With gas prices remaining high and the dollar likely to stay firm--adding to inflationary pressures--arguably the BOE wants a stronger pound, ING said.
Also read: Sterling Unlikely to Be Affected by UK Leadership Race
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The Swiss National Bank is feeling the pain of its foreign -exchange interventions, Commerzbank said. The SNB recorded a loss of CHF95.2 billion in the first half, largely due to losses on forex positions, the bank said.
Increased spending on foreign currencies to curb the franc's rise inflated the SNB's balance sheet, which raised the risk of losses in case of fluctuating markets, Commerzbank said.
"In the end the SNB was unable to prevent the franc's appreciation; if at all it was merely able to dampen it--at a high cost as it turns out now," it said.
Bonds:
Government bond yields are unlikely to rise much from current levels in the second half of the year as investors' concerns over an economic slowdown take over inflation fears, Threadneedle Investments said.
"As we go into the second half and people start to look more at the potential slowdown in economies, that's when we reckon that actually bond yields are not going to rise further from where we are right now," the asset manager said.
10-year U.S. Treasury yields are likely to be at or below 3% 2H 2022 and the big yield increases seen in 1H won't be repeated in 2H, Threadneedle Investments said.
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Government bonds seem to have already priced in much of the looming deterioration in economic growth, leaving a little room for bond yields to rise slightly in the coming weeks, Generali Investments said.
"With the peak in inflation still to come and further key rate hikes still in the offing, we expect yields to trend moderately upward again in the weeks to come," it said.
As both the ECB and the Fed have effectively abolished their forward guidance and turned to a data-dependent, meeting-by-meeting approach, "yield uncertainty is set to rather increase and will keep bond market volatility on a high level," Generali Investments said.
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Italian 10-year government bond, or BTP, yields are a key gauge of investors' approach toward Italy's snap elections in September, Metzler said.
"The struggle of the 10-year Italian yield with the 3% mark is currently a good gauge of how nervous investors are with regard to the upcoming new elections in Rome," the German bank said.
Recent data from the European Central Bank indicates that the ECB has used Pandemic Emergency Purchase Programme reinvestments to support eurozone peripheral government bonds, Metzler said.
Energy:
Oil prices edged lower ahead of the OPEC+ meeting. The cartel is set to decide on future production plans as its course of supply hikes comes to an end.
President Biden, following his visit to Saudi Arabia last month, has hinted that the group could continue to raise its supply quotas.
OPEC delegates told the Wall Street Journal that the cartel is undecided between a modest increase or keeping quotas unchanged. The virtual meeting is set to begin at 1130 GMT.
The former could be challenging seeing as the group has fallen short of its earlier targets. It also raises questions about whether extra supply quotas would translate into actual barrels of oil reaching the market.
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Recession fears make OPEC members less likely to agree to raise production levels when they meet later Wednesday, DNB Markets said.
The cartel is caught between U.S demands to raise output further and its ally Russia, which is likely to oppose additional supply. Since President Biden's visit to Saudi Arabia last month, concerns about the global economy have grown, which could dampen the cartel's appetite to pump more.
"The weakening macro backdrop and rising risk of recession are weighing on OPEC+ confidence to add more production," DNB said. "With spare production capacity largely exhausted outside Saudi and U.A.E., it might prove difficult to line up full support for a production increase."
Metals:
Metals markets remained mixed, with trading houses noting limited buying in Asian markets amid Nancy Pelosi's visit to Taiwan.
Mrs. Pelosi's statement of not abandoning Taiwan injects uncertainty to markets, helping to lower trading activity, according to Marex.
However, analysts are starting to discount the likelihood of China coming back with a military response despite drills being conducted in the South China Sea, it said.
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08-03-22 0700ET
