HomeContributorsFundamental AnalysisLower Inflation Expectations Support Risk Sentiment

Lower Inflation Expectations Support Risk Sentiment

Market movers today

The ECB’s Sintra Forum kicks off today, but key speeches from policymakers will probably not come until tomorrow. We’ll also look out for more headlines from the G7 summit in Germany amid ongoing discussions on how to resolve the global food crisis and a possible “price cap” on Russian oil.

Norwegian retail sales should show a moderate decrease in May amid high energy prices eroding purchasing power.

Later this week, the Riksbank meeting and Chinese PMIs on Thursday and euro area inflation figures on Friday will be in focus.

The 60 second overview

Lower inflation expectations: University of Michigan long-term inflation expectations were revised down to 3.1% from earlier 3.3% in the final report released on Friday. The big jump in the preliminary report from 3.0% to 3.3% was a key reason why the Fed hiked by 75bp and not 50bp, so the probability of another 75bp in July has probably declined on the back of the downward revision. Currently, the market is pricing a 50/50 probability of another 75bp hike next month relative to a 50bp hike. That said, inflation is still key for the Fed and the problem is that there are upside risks to long-term inflation expectations as long as actual inflation stays high given that economic agents often have adaptive inflation expectations.

Risk appetite: The incipient signs that the inflation picture is improving supported risk appetite on Friday with equities higher, cyclical currencies higher, tighter credit spreads, and higher crypto.

Russia default on foreign debt: Russia defaulted on their foreign-currency sovereign debt Sunday, as due to the financial sanctions Russia did not manage to pay the USD 100m in delayed interest payments. Yesterday, the 30 days grace period expired for the interest payments originally due May 27. We should expect a formal declaration from the rating agencies this morning. However, Russia has already been transformed into a financial, political and economic pariah state and as such the expected default will only have symbolic importance and will not impact sentiment in global financial markets today.

Oil: Oil prices reversed some of the recent declines on Friday as risk appetite improved. The leaders at the G7 meeting discussed over the weekend how to impose a price cap on Russian oil. However, that it probably easier said than done. But apparently the G7 will try to link the cap to shipping and insurance of Russian oil. Note that Russian Ural oil is already trading with a 30 USD a barrel discount to Brent.

This week the oil market report from the EIA might attract some market attention. There is some tentative evidence that demand is slowing (e.g. PMIs around 50 now) and some tentative evidence that oil inventories may be on the rise. In light of this, should the key market report show oil inventories (incl. SPR) are still being drawn down, we may very well see a new upward move in oil.

Equities: The gloomy week ended with a bear market rally, as inflation worries faded (yet replaced by increasing recession worries). Bond- and equity markets in tune once again, with yields and equities higher. However, real yields have dropped continuously over the last week which has fuelled the outperformance in growth-, quality- and defensive stocks. The gain was broad based on Friday but long duration cyclicals such as tech, consumer discretionary and communication services best performing. Hence, defensives and cyclicals traded on par last week, despite the dreadful PMI reading. S&P500 surged by 3.1%, Nasdaq 3.3%, Russell 2000 3.2% and Dow 2.7%.

FI: Friday’s trading session was rather choppy but in the end, markets were broadly unchanged on the day across the board, amid a noteworthy revision of the University of Michigan inflation expectations to 3.1% from 3.3%, which we believe was a key reason why Fed hiked 75bp. The choppy session briefly pushed BTPs-Bund spread above 200bp, before settling around 196bp, as markets naturally still focus on how an anti-fragmentation could be structured.

FX: Cyclically sensitive currencies ended last week on a very strong footing with most notably NOK and ZAR gaining more than 1% vs the USD in Friday’s session. USD and JPY were among the underperformers while EUR was in the middle of the pack leaving EUR/USD north of the 1.05 mark.

Danske Bank
Danske Bankhttp://www.danskebank.com/danskeresearch
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