Another week of earnings, another week on banking. On the earnings side, good news, especially for technological companies. On the banking part, some bad news surged back again as First Republic suffered significant turbulence. But if you have been following this column, you don’t want to read on this topic all over again. So, allow me to start already focusing on next week, laying the table for the Fed’s and, especially, the ECB’s monetary policy gatherings on Wednesday the 3rd and on Thursday the 4th, respectively, by analysing the economic data reported by the Eurozone over the last couple of days.
The outlook around our old continent has been, during the last months, brighter than what we had been used to. The problems that were to hit us – on energy, restrictive credit conditions, and their consequences on weaker member countries – didn’t hurt that much. Call it on the post-pandemic conditions of households and of overall integration, on the ability of policymakers to manage all these headwinds, or even on the weather. Yes, the weather, that brought us a pleasant yet dangerous (in some known aspects) winter, made us less vulnerable to a certain extent to the consequences of the war on the energy supply front. The truth is that we’re in better shape than predicted.
Even the consequences that the restrictiveness would expectedly have on the sovereign yields of the weaker or more indebted countries (I’m referring to Italy specifically) were stunningly averted. The Financial Times reported on Saturday that we’re even starting to see hedge funds taking a step back and unwinding their short positions on Italian treasury bonds, given that the size of the sell-off that would be expected did not actually materialize.
The clearest indicator from which we could confirm this strength was in the foreign exchange market, specifically in the currency pair with the dollar. After having significantly fallen since the beginning of this long-lasting stagflationary-like cycle, breaking parity during the summer, we breached a 1.10-ish mark in the EUR-USD. Actually, a yearly high was hit at 1.1095.
The rationale behind this tendency was clear: a juncture of (1) a Federal Reserve that is way ahead on the tightening cycle, hence very close to the stop raising further the Fed Funds Rate, and (2) the projected recession-avoidance combined with still alarming price indicators, specifically the core measure, that would have the European Central Bank set to continue its ride on restricting policy for longer than its counterpart on the other side of the Atlantic. But while FX currency pair quotations reflect both sides’ part of the story, this trend was being driven more by Europe’s performance rather than by the dollar weakening, as the upward movement (as per the below graph) on the trade-weighted Euro implied.
Data from: https://www.ecb.europa.eu/stats/balance_of_payments_and_external/eer/html/index.en.html
Not only in the FX market did we see this force playing, but also in the equity market we witnessed Europe outpacing the US. This is remarkable, to say the least. The pinnacle of this came at the beginning of the week. LVMH, the owner of well-known luxury brands such as Louis Vuitton, Moët & Chandon, and Christian Dior, hit a market capitalization of 500 billion dollars (i.e., around 454 billion €). The number per se is not the most relevant part of this story. What stands out is the fact that this is the very first European-listed company to do so.
Mixing this all up, prior to this week, while we still had the most recently available GDP figures showing a flat-lining trend, these sets of good news were coming out. Sentiment surveys were another source of optimism, suggesting a possible return to growth in this year’s first quarter. Did it materialize? Well, yes. But not in the most convincing way.
On Friday, the Eurozone reported its gross domestic product figures, showing an increase in the output of a tiny ten basis points: 0.1%. Though marking a return to positive figures, as the sentiment surveys had hinted, the expectations that had been building up were not matched by these numbers. Despite positive contributions from Italy, Spain, and France, Germany failed to deliver any growth.
It made it look like that feeling that most (or at least some) of us have had, where we get out of an exam classroom celebrating the idea that the exam went (apparently) pretty well, and then, a couple of weeks later, we receive the great surprise of an 18. I mean, you still pass, but the expectation hurts the feelings.
After all, the market kind of re-shaped out of this report. Some of its tone to embrace not only next week, in which the ECB will deliver its benchmark rates policy decision, but more incisively the next months, which will determine the future path of the monetary tightening, shifted. The dominant hawkishness got hit and the tables turned to have market analysts starting to talk about the end of the period in which the central bank increases its reference rates. Also, the consensus got split between predicting a 25 or 50 basis point hike next Thursday.
Now the table is laid for next week. No kind of surprise is expected to come from any side of the Atlantic. Nevertheless, a hot print on the Euro Area’s inflation, whose report is due on Tuesday, may shift the tone back to where it was prior to Friday. And Tra i Leoni will be here to break it down for you.