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European stocks slip back as ECB fluffs its lines

Eurosystem sign at ECB

We’ve seen sharp falls in the FTSEMib after Italian Prime Minister Mario Draghi resigned his position, after failing to get the support he needed from inside the Italian Parliament.

Europe

The initial boost prompted by the resumption of Russian gas flows through Nord Stream 1, has given way to concerns over political uncertainty in Italy which appears to be acting as a drag on wider risk sentiment, while worries over slowing growth are continuing to weigh on commodity prices.

The decision by the ECB to raise rates by a bigger than expected 50bps also caught markets off guard, but the central bank fluffed its messaging as ECB President Christine Lagarde tried and failed to offer clarity on how the new Transmission Protection Instrument (TPI) ant-fragmentation tool would work.  

On the FTSE100, JD Sports is amongst the better performers after it was being reported that it was in talks to sell Footasylum to private equity firm Aurelius as it looks to draw a line under its disagreements with the FCA. The sportswear company also appears to be getting a positive read across from the latest full year numbers from Frasers Group.

The company which owns the Sports Direct brand, has seen its shares surge after reporting a record-breaking year, with adjusted profit before tax of £344.8m, while upgrading its guidance for the next 12 months to between £450m to £500m.

Group revenues rose to £4.75bn, a rise of 30.9%, driven by outperformance from all its divisions, with a 31.2% rise in sports retail revenue, 43.6% revenue growth in Flannels stores, while in Europe revenues increased by 28.4%.

Another retailer doing well is Dunelm Group who reported a 16% rise in full year sales to £1.55bn, despite a disappointing showing in Q4, where sales fell 6% to £358m. The retailer said it expects profit before tax will be slightly ahead of consensus of £207m, while trading as we head into the new fiscal year has been solid. 

The rising cost of living doesn’t appear to be hurting Howden Joinery as the builders and kitchens company posted record results for H1. Group revenues rose 39.9% from 2019 levels to £913.1m, while profits before tax rose a similarly impressive 85.7% to £145m. The company was also able to improve its margins by 60bps, on an annualised basis, offsetting rising costs with the ability to pass on price increases, as it reiterated its full year outlook.

Hospitality has also been a sector hit hard by the pandemic with All Bar One owner Mitchell and Butlers shares falling sharply despite reporting a 0.9% improvement in Q3 sales, although year on year sales were still down by -1.5%. The pub chain went on to say that inflationary pressure was likely to persist at or above current levels prolonging the impact on margins well into next year.

Ocado shares have also slipped back after strong gains yesterday after reporting that Ocado Retail revenue fell 8.3% to £1.1bn in H1. Group revenue as a while fell 4% to £1.3bn, as improvements in the International Solutions business saw a doubling of revenues. The Group slid to an EBITDA loss of £14m, largely driven by lower sales and higher costs in its retail division.

We’re also seeing weakness in airlines after US carriers United and American Airlines cut their capacity outlook for the rest of the year, with IAG, easyJet and Ryanair all retreating from three-week highs.

Carnival shares have dropped sharply after the cruise company announced a $1bn equity raising as it looks to try and keep its head above water, and fund various balance sheet issues in 2023.

US

US markets opened slightly higher after outperforming European markets yesterday, however they have started to roll over as the US dollar starts to push higher again, after the ECB underwhelmed on its anti-fragmentation tool.

Can Tesla deliver a record H2 as it looks to increase maximum output at all four of its factories, so that it is able to easily pass the 1m mark by the end of this year for vehicle deliveries? While Q2 profits surprised to the upside, revenues slipped back below the last two quarters, while operating margins also declined. This will be the key challenge for the electric car company as Musk himself acknowledged when he said that production was the main issue facing the business.

United Airlines shares hit an air pocket in early trading despite returning to profit in Q2. The shares have fallen after the airline cut its forecasts for the rest of the year, citing soaring costs as well as disruptions caused by a lack of capacity at airports. United said it plans to constrain its capacity expansion to no more than 8% over 2019 levels, below the previous 20%.

Its rival American Airlines also posted a Q2 profit on record revenues of $13.33bn, however rising costs have also constrained its ability to scale up its operations, and it plans to limit its plans to expand its capacity over the rest of the year, limiting its expansion by a similar amount to United.

Snap is reporting its latest Q2 numbers after the bell, which could offer an insight into advertising trends ahead of next week’s Facebook and Google numbers.

Carnival’s equity raise has also seen rivals Norwegian and Royal Caribbean also come under pressure

FX

Despite weakness in Italian markets the ECB raised interest rates for the first time in over a decade, lifting all three main rates by 50bps, surprising the markets in the process, initially sending the single currency sharply higher.

We also got another acronym, the TPI, or the Transmission Protection Instrument, which it said it would use to deal with any issues with fragmentation which could be used ex ante to deal with “unwarranted, disorderly market dynamics”.

The central bank also said that all future rate decisions would be decided on a meeting-by-meeting basis, thus signalling the end of forward guidance.

This is all well and good, however we still don’t know TPI will work, and whether the ex-ante steps could be challenged on a legal basis, especially if the ECB is required to buy a significantly large amount of Italian or other challenged bonds to keep spreads manageable.

When President Lagarde was challenged on this, she said that the governing council would decide on the eligibility of each member country on an individual basis for TPI implementation, and that conditions contained an element of discretion and judgement. We did manage to establish that any country must comply with EU fiscal rules, fiscal and debt sustainability, sound and sustainable macro policies, and an absence of severe macro imbalances. On any measure there is no way Italy complies with all of these, which is a problem, because if it did it wouldn’t need to use TPI.

For any tool to be effective the market must believe it will work. If the ECB were to follow the criteria above, they would probably have to bend the rules for it to work. The reaction of the euro in the aftermath of this is telling, as it gave up its post rate hike gains.

The pound has slipped back after the latest public sector borrowing numbers rose in June to £22.1bn, largely driven by big increase in debt interest payments to new record highs, due to the continued increase in headline RPI. The continued rise in headline inflation, and the Bank of England’s ambivalence towards it certainly isn’t helping in this regard.  

Commodities

The ability of oil prices to consolidate rebounds off recent lows continues to be constrained by worries over demand as US oil prices slide back below $100 a barrel once again. Rising gasoline inventories appear to be raising concern about demand destruction, while the surprise decision by the ECB to raise rates by 50bps 

UK August Natural Gas prices have fallen back after it was confirmed that Nord Stream 1 had resumed gas flows, after its recent maintenance shutdown.

Gold prices slipped to fresh 15-month lows, falling below the $1,700 level yesterday, and have chopped around today after the ECB surprised the markets by hiking by 50bps. For now, we’re holding above the August lows at $1,675, which if broken, could open further weakness. 

Volatility

The cannabis producer Sundial Growers saw its shares advance as much as 10% yesterday ahead of an investor meeting scheduled for today. This will include the idea of a stock consolidation, ensuring the company remains aligned with NASDAQ listing rules and as such avoids the risk of delisting. The accompanying liquidity issues this would present have the potential to erode value sharply. Daily vol sat at 208% against 153% on the month.

Amongst equity indices, Italy’s MIB saw elevated levels of price action yesterday amidst political woes in the country compounded by the idea that the ECB will today hike interest rates by 50 basis points. The underlying fell by 1.6% during Wednesday’s trade, driving daily volatility to 41.76% against 31.15% on the month.

The US Dollar regained a little ground against the Forint after recent declines from all-time highs on the pair. That continues to see USD/HUF looking active, with daily vol reaching 24.37% against 20.35% on the month. Gains for EUR/USD ahead of that anticipated rate hike today are also resulting in elevated levels of action. Daily vol here printed 11.94% against 10.34%, which is notable given the depth of liquidity on the trade.

Finally interest in cryptocurrencies remains elevated although has retreated a little from what was seen at the start of the week. Ethereum Classic, which saw its price close on double over the last week, remains at the top of the list although has been giving back some of those gains in recent days. Daily vol on ETCUSD came in at 159% against 99% on the month.

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