Spain debt

ECB fuels recession, debt fears; dollar rally cools but stocks continue to struggle

  • Hawkish ECB pushes eurozone yields to multi-year highs but euro flounders
  • Dollar reclaims FX krone as all eyes now turn to US CPI report
  • Growth and inflation worry dog ​​stocks, but China bows despite new lockdowns

The ECB joins the global fight against inflation and shakes the markets

The European Central Bank charted a course to end all asset purchases and launch a series of rate hikes on Thursday as it raised its inflation forecast sharply. But although the move was widely expected and the Bank announced an initial rate hike of just 25 basis points in July, Chairwoman Christine Lagarde left the door wide open for a 50 basis point hike in September and beyond.

With no sign yet of a slowdown in the eurozone price spike as Lagarde had hoped, there now appears to be a sense of panic. The ECB is not only preparing to raise interest rates a few times, but is potentially on the verge of entering a longer tightening cycle than many investors had anticipated.

The hawkish turn triggered a further sell-off in eurozone sovereign bond yields. Peripheral yields such as Italy and Spain rose the most, but German and French yields also jumped substantially. The ECB has outlined plans to contain any fragmentation of the eurozone bond market, which would allow it to flexibly use its reinvestments in the PEPP. Lagarde even assured that policy makers are ready to introduce new tools if needed should fragmentation get out of control.

But investors clearly wanted more details and there were a few alarm bells ringing in the bond market amid some fears that highly indebted countries will struggle to meet their debt commitments if rates rise too high. The most telling part of it all, however, is the Euro’s tumble yesterday even as yields soared. The single currency came close to breaking above the $1.06 level as concerns over the ECB’s slowdown dominated any boost from the long-awaited shift towards policy normalization.

Stocks turn into a sea of ​​red

The mood has also deteriorated on the equity markets and the European indices are poised to extend the heavy losses of yesterday Friday. The ECB’s war on inflation comes as oil prices climb back towards March highs and the World Bank and OECD have just downgraded their growth forecasts for major economies.

With stagflation risks on the upside, equities have been hammered this week as optimism is in short supply at the moment. Stocks on Wall Street tumbled on Thursday, led by the Nasdaq, which fell 2.8%. Although long-term Treasury yields have stabilized a bit, the two-year yield is on the verge of hitting a new 3.5-year high, as traders are no longer so sure that the Fed will suspend its hikes. rates later in the year.

The latest CPI numbers due from the US later today could revive or weaken hopes of the Fed shifting into gear. Analysts are expecting an 8.3% print for May in the headline rate. There is a danger that a stronger than expected figure could accelerate the sale of shares.

The tightening of virus restrictions in China adds to today’s pessimism. Seven districts in Shanghai have been locked down so health officials can carry out mass testing, while in Beijing entertainment venues have been ordered to close. The latest restrictions weigh lightly on oil futures today, but stocks in China ignored them.

A drop in Chinese producer prices in May bolstered expectations of further monetary policy easing, while strong overseas demand also helped local equities buck the global trend, with the CSI 300 index closing lower. 1.5% increase.

A mixed picture in the foreign exchange markets

Persistent risk aversion sentiment is keeping the US dollar at three-week highs against a basket of currencies. The greenback was the main winner on Thursday from jitters about an economic slowdown. But the euro is resisting further declines and the Australian and New Zealand dollars are recouping some of yesterday’s losses.

However, the Canadian dollar slipped past the C$1.27 level despite more hawkish language from the Bank of Canada in the past 24 hours. Talk of the next BoC decision being a 75 basis point hike may add to concerns about excessive tightening.

The Japanese yen, meanwhile, was mixed on Friday as intervention speculation continued to swirl in the markets. The safe-haven currency was unable to hold its gains against the dollar yesterday, but at least in the short term, there seems to be a bit of resistance in the 134.50 yen area. The dollar/yen fell slightly today to settle around 133.80 in European trading.