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No Christmas cheer from Lagarde as markets dive on bleak outlook

ECB President Christine Lagarde

European markets have seen big falls in the aftermath of today’s European Central Bank rate meeting, where President Christine Lagarde delivered the market equivalent of a “Bah Humbug” moment to all of that pre-market Christmas optimism, that the ECB wouldn’t dare risk a melt up in rates heading into 2023.

Europe

Those expectations got a reality check today with a 50bps rate hike and a bleak economic assessment of what was likely to come next year, and what the ECB intended to do about it in the coming months.

While the rate hike of 50bps was widely expected, what came next was not, as Madam Lagarde adopted an almost Bundesbank assessment of what was going to come in respect of monetary policy next year. Not only did she outline the prospect of at least another 100bps of rate hikes between now and March, but the economic forecasts also made for grim reading.

Inflation forecasts were pushed higher, with CPI not expected to come back to target before 2025, but GDP forecasts where revised lower, meaning that not only is Europe having to contend with the prospect of higher inflation, but also much higher rates, with all the risks that could present to Italy’s bond markets, where 10 yields surged by over 25bps.

The German DAX fell below the 14,000 level for the first time since early November, while the FTSE100 slipped back, although the losses in the UK benchmark have been more modest, due to its slightly more defensive bias.

The big miss in Chinese retail sales this morning as well as concern about the pace of any reopening has seen some big falls in the likes of Burberry, Adidas, Hermes and LVMH, with the German auto sector also getting hit hard with losses for Volkswagen, Mercedes-Benz and Porsche.

European banks are also feeling the pinch due to the sharp spike in yields, as well as concerns over the economic outlook, with Deutsche Bank sharply lower.     

US

US markets have taken their cues from today’s price action in European markets, plunging sharply, although it is notable that while European yields are surging, US yields are not.  

This would suggest that equity markets in the US are reacting more to concerns over the economic outlook than they are to what’s happening with US yields. The bleak outlook from this morning’s Chinese data, along with the bleak outlook painted in Europe by the ECB has seen US stocks fall sharply as investors look at rerating earnings expectations for next year.

In a regulatory filing it’s been reported that Tesla CE Elon Musk offloaded another $3.6bn worth of Tesla shares, which saw the shares briefly slip to their lowest levels in over 2 years before recovering.

Tech shares are bearing the brunt of today’s market weakness led by the likes of Nvidia, while consumer discretionary is also under pressure led by Ralph Lauren and Estee Lauder.

Netflix is also sharply lower over concerns that its ad-based business model is falling short on subscriber numbers prompting the business to refund advertisers due to falling short on viewer numbers.

FX

In another big day for central bank rate decisions, and in the aftermath of yesterday’s decision to raise rates by the Federal Reserve, the US dollar is back on the front foot as we get more rate increases today from the Swiss National Bank, Bank of England and the European Central Bank.

The biggest losses have been in the likes of the commodity currencies as poor Chinese economic data and increasing concerns that co-ordinated monetary tightening is likely to usher in a sharp global slowdown. This perhaps explains why US yields haven’t spiked higher and equity markets are under pressure.

The euro briefly pushed above 1.0700 against the US dollar, before slipping back mostly due to an unexpectedly hawkish outlook from the European Central Bank. While rates were raised as expected by 50bps, the inflation forecasts for this year, 2023 and 2024 were all pushed higher to 8.4%, 6.3% and 3.4%, with the ECB saying that further rate increases will become necessary, with at least another 100bps by March.

As messaging goes this suggests that monetary policy is likely to remain restrictive for much longer than anticipated with little prospect of a rate cut much before 2025. This hawkish tilt appears to be an attempt to appease the hawks on the governing council who are arguing for a tougher monetary policy response to high rates of inflation.

Quantitative tightening is also due to start in March 2023 at €15bn a month.

The Bank of England also raised rates by 50bps, however in contrast to the Federal Reserve and the ECB there was a three-way split on the MPC between two who wanted no change to rates, external MPC member Catherine Mann who wanted to hike rates by 75bps and the rest who wanted 50bps. The clear lack of consensus while welcome as it implies a lack of groupthink, also suggests that the MPC is struggling to navigate a line between dealing with a clear long term inflation problem and concerns over the impact higher rates will have on economic growth.

This is certainly a valid concern; however, it does beg the question how anyone can think that a 3% base rate is enough to help pull inflation down from 10.7% on a sustainable basis, and let’s not even start on where RPI is. Today’s splits on the MPC have seen the pound get crushed against the euro on an expectation that the ECB may well start to outpace the Bank of England when it comes to rate rises next year.

While the Bank of England does have to be cautious when it comes to pushing hard on the rate hike button given the fragility of the UK housing market, the ECB doesn’t exactly have a free hit given the fragility of some parts of the European bond market, which could come crashing down if it pushes too hard, with even starker consequences for the region.   

Commodities

Crude oil prices rolled over as first the Bank of England, and then the European Central Bank painted a bleak outlook for economic growth over the next couple of years. The raising of inflation forecasts and downgrading of growth forecasts with interest rates remaining higher for longer appear to be re-rating market expectations of the demand outlook over the course of the next few months.  

Gold prices have taken a battering on the back of the strength of the US dollar, dropping below the $1,800 an ounce level as well as the 200-day SMA

Volatility

Last night’s FOMC meeting has been instrumental in providing direction across many asset classes, with the Fed’s stance being seen as perhaps a little more hawkish than had been previously predicted. Rates are now at their highest in 15 years and are expected to peak just above 5%. That served to rattle confidence across all US equity indices although the tech-heavy NASDAQ was the one seeing the highest levels of price action. Losses over the day were limited but the reaction to the Fed news saw a 300 point sell off, followed by a meaningful reversion. One day vol here hit 42.42% against 26.44% for the month.

In fiat currencies, it was the Aussie Dollar against the greenback that proved to be the most active on the day. The pair found meaningful support ahead of the Fed’s statement although gains proved difficult to sustain with that more hawkish than expected tone. One day vol here printed 17.58% compared to 14.73% for the month.

CMC’s proprietary basket of stocks involved in the US Big Tech industry saw an active session, with direction coming from a number of angles. One of the constituents here - Apple - shrugged off that news from the Fed whilst a demand that they also allow rivals into the app store in Europe is adding further downside here.  Other tech firms as noted above in the NASDAQ comment also struggled, leaving one day vol on the basket to come in at 80.48% against 42.8% on the month.

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