Hawkish central bankers: Fed chair Powell struck a fairly hawkish tone in his Jackson Hole speech, signalling that Fed is committed to bringing inflation down even if it requires an extended period of below-trend growth and some weakening in labour market conditions – a message which was also echoed by other FOMC members. ECB seems increasingly ready to follow in the footsteps of the Fed, with discussion of a 75bp rate hike in September gathering pace. Various Governing Council members (including Klaas Knot at our Danske Talks) spoke out in favour of such a move and notably influential ECB member Schnabel gave a hawkish presentation at the Jackson Hole conference, where she argued that a recession and higher unemployment may be needed to bring inflation lower. We have changed our call and now expect a 75bp hike ECB from next week, as inflation risks take precedence over the deteriorating growth outlook (see also Research: New ECB call – We expect 75bp at the meeting next week, 29 August). Both euro area HICP and core inflation rose to new record highs of 9.1% and 4.3%, respectively, in August and with the latest rise in energy commodity prices yet to feed through, an inflation peak is not yet in sight.
Markets roller-coaster: Yields rose across the curve as markets priced in more frontloaded central bank tightening on the back of the coordinated hawkish messages from Jackson Hole, while risk assets saw a setback this week as recession fears intensified. After the surge last week, European gas and electricity prices plunged after the EU said it will intervene in power markets to curtail the strong rise in prices. An emergency meeting of energy ministers on Friday 9 September could bring further clarity on how such a reform, including price caps could look like, although details may take weeks to hash out. EUR/USD started the week by falling below parity, but hawkish ECB comments and the drop in energy prices lent some temporary support to the EUR. We continue to see further downside ahead with a 12M target at 0.95.
The Europe-US divide: The US July JOLTs report provided further evidence of strong labour markets, as job openings rose against expectations to 11.2 million. Consumer confidence rebounded, while near-term inflation expectations eased slightly and ISM manufacturing new orders rebounded back above 50. So far we see little signs of the US being near recession, but we think Fed will be forced to hike the economy into a recession in 2023 (see Research US – Fed continues to guide US economy towards a recession, 1 September). While US data surprised on the upside, the same cannot be said about Europe. Economic sentiment, business climate, service sentiment and industrial sentiment all took a big step lower in August, underscoring the high risk of recession in Europe. Weak PMI readings from Asia during August also suggest challenging times ahead for the European (and global) manufacturing cycle.
Next week: Apart from the ECB meeting on Thursday, energy price developments will remain in focus, in the run up to the EU energy minister meeting on Friday. We will also get clarity whether gas supply through the North Stream 1 pipeline has indeed resumed after the 3 day maintenance period. The final round of the Conservative Party leadership election takes place on Monday with polls largely favouring Liz Truss to become the UKs next Prime Minister (see Research UK – Truss vs Sunak – and why it matters, 2 September).