By Jane Foley, head of FX strategy at Rabobank
Looking on the bright side
Despite the weakness of China’s Q2 GDP report, stock market rallied on Friday as investors choose to look on the bright-side. The market reined back some of Thursday’s dogmatism about the prospects of a 100 bps rate hike from the Fed on July 27, welcomed some positive earnings reports and decided that the refusal of President Mattarella to accept PM Draghi’s resignation was a good outcome – despite the fact that Italy’s political situation remains precarious. The better tone has been in extended in Asia overnight, though Japan is closed for a holiday. According to Refinitiv, of the 35 companies in the S&P 500 that have reported for Q2, 80% have beaten analysts’ expectations.
Thursday’s comments from Fed hawks Bullard and Waller appearing to favor a 75 bps July rate hike over a 100 bps move, allowed the market to view the combination of Friday’s US data releases as also less likely to trigger the larger sized announcement. US retail sales data were solid, consumer confidence improved slightly, but inflation expectation gauges slowed while the industrial production data were weaker than expected. Treasury yields dropped, though notably the curve remained inverted.
Since mid-June, recession fears have weighed heavily on crude oil prices and on commodities such as copper. By the end of last week crude oil had given up all of the gains made since the Russian invasion of Ukraine on February 24. Following last week’s visit by President Biden to the Middle-East, a senior US energy envoy stated that major oil producers had spare capacity and are likely to boost supplies, though it was not specified which regional supplier this referred to. Despite this, oil has ticked higher this morning in tune with the better tone in equites.
For the markets, Draghi remaining as Italy’s PM for as long as possible is the best possible outcome for Europe. Even though he is an unelected technocrat, trust was won during his tenure as ECB President. Elections were always due in 2023, and it is still possible that they may be brought forward. Draghi is due to address parliament on Wednesday, when his position, and that of Italy, will become clearer. Italian politics are characteristically volatile and the recent calm would undoubtedly have been broken sooner or later. However, a crisis in Italy now would coincide with the war in Ukraine and could emphasis a lack of strong coherence in parts of Europe since it would come at a time when Macron has no parliamentary majority in France and when the UK is saddled with a lame duck PM.
A more intense crisis has been playing out in Sri Lanka for some months. Over the weekend the IMF warned that other developing nations have also been experiencing sustained capital outflows for four consecutive months and that currency depreciation, high levels of debt and dwindling FX reserves could also bring crisis to other nations in the Asian region.
USD strength is a contributing factor to the pressure being felt in various EM economies.
Last week Chile announced a USD25 bln FX intervention to support the peso. A drop in copper prices (a key export) in addition to USD strength have been exerting pressure on its economy. The IMF warned on Saturday that it will cut its global growth outlook “substantially” in its next update.