Risk outlook – Reading through the fog

Risk-off sentiment was everywhere you looked this morning; UK and European stocks moved 2% lower while the S&P 500 ended last week with a similar loss, gold and Japanese Yen both moved higher, and oil prices are heading towards $100 a barrel. What we’re clearly seeing ripple through markets are mounting geopolitical risks from the Russia-Ukraine situation; for the most part, we expect a game of headline tennis to dominate all week. This leaves both the Pound and the Euro exposed on the downside until tensions begin to subside—if they do. Looking into the FX options market, we’ve seen short-dated volatility metrics in both currencies rise against the US Dollar—further evidence of the uncertainty at play.

Over the weekend, German Chancellor Olaf Scholz prepared another attempt to deter Vladimir Putin from a fresh incursion into Ukraine, just as US officials warned that an attack was imminent. Scholz is due to travel to Kyiv today before heading to Moscow on Tuesday in what’s been described as a decisive week in the conflict. An escalation risks worsening Europe’s energy crunch, with the potential for supplies of natural gas and oil to be cut off. Just this morning, benchmark European gas prices jumped as much as 14% as energy prices took another leg higher.

Moving past the immediate geopolitical risks, on Friday we saw University of Michigan Consumer Sentiment crash to an 11-year low as Americans expect an inflation rate of over 5% for the next 12 months–the highest since 2008. This puts the Federal Reserve in a difficult spot, with markets pricing in almost 100bps of interest rate hikes by June. Meanwhile, we’ve seen the yield spread between the US two and ten-year Treasuries narrow to its lowest since August 2020, a growing indication of economic slowdown and a potential driver of US Dollar weakness in the mid-term horizon.

Bottom line: Markets are susceptible to outsized moves on fresh Russia-Ukraine headlines, but let’s not forget central banks. European Central Bank President Christine Lagarde is talking today at 4:15PM after three ECB officials played down the prospect of rate hikes over the weekend. More dovish rhetoric could see a meaningful break below 1.13 for EUR/USD, and GBP/EUR head back above 1.20.
 

The week ahead
 

GBP 

It was a mixed bag last week for the Pound, rising 1.0% against the Euro and closing marginally higher against the US Dollar after a choppy week of price action. Inflation will be in focus yet again this week, with UK Consumer Price Index data due on Wednesday; current forecasts suggest no change since December. Rates markets are pricing in five interest rate hikes for the Bank of England in 2022, with a 25 basis-point hike fully priced in for the March meeting. Bank of England Chief Economist Huw Pill’s recent dovish comments and calls for a more measured approach could indicate a surprise similar to the November meeting, as aggressive market pricing continues. Russia-Ukraine talks are ongoing, with the UK armed forces minister stating that this is the closest Europe has been to war for 70 years and stressing the need for diplomacy and compromise.     

  • The UK Unemployment Rate for December will be released on Tuesday. Forecasts indicate a 4.1% print.
  • UK CPI and Core CPI y/y data for January is expected to read 5.4% and 4.3%, respectively, compared with 5.4% and 4.2% in December.
  • House prices in the UK are projected to increase 9.3% in December versus 10.0% in November, with the House Price Index released on Wednesday.
  • On Friday, analysts are expecting UK Retail Sales m/m for January to read 0.6% versus -3.7% in December.

 

EUR

The Euro faced selling pressure last week as Russia-Ukraine tensions increased. Citizens of Ukraine began fleeing the country as the US expressed concern over possible aerial bombardments if an invasion was enacted. European markets have sold off sharply this morning in response, with the Euro Stoxx 50 falling 3.0%. The latest CPI print out of the US added to the selling pressure in the common currency as markets priced in further divergence between the European Central Bank and Federal Reserve. Irish Central Bank Governor Gabriel Makhlouf has criticised the markets’ pricing of an ECB rate hike in June, suggesting it's unrealistic, as the likelihood of killing the recovery from the pandemic remains.

  • European Central Bank President Christine Lagarde is due to speak before the European Parliament today at 4:15PM.
  • Eurozone and German ZEW Economic Sentiment data will be released on Tuesday, with forecasts pointing to 54.4 and 55.1 readings, respectively.
  • Euro Area Industrial Production m/m for December is expected at 0.3% versus a 2.3% print in November.
  • The latest G20 meetings are scheduled to take place over Thursday and Friday this week.

 

USD

The US Dollar Index climbed 0.9% since the start of last week as markets priced in a 50 basis-point rate hike and inflation hit a 40-year high of 7.5%. Shorter-dated Treasury yields climbed as a result, with the two-year reaching levels not seen since January 2020. Across the curve, the ten-year yield also hit a multi-year high of 2.0%. US President Joe Biden is planning to roll out new Covid-19 guidance in the coming month as the country prepares to roll back restrictions ahead of the midterms in November. Mask mandates have already been scrapped in states such as California, New York, and Connecticut.    

  • US Producer Price Index and Core PPI m/m are forecast to come in at 0.5% and 0.4% for January versus the December readings of 0.2% and 0.5%, respectively.
  • Analysts are expecting Retail and Core Retail Sales m/m to read 1.8% and 1.0% in the month of January versus -1.9% and -2.3% in December.
  • The latest Federal Open Market Committee meeting minutes will be published this Wednesday at 7:00PM.
  • Federal Open Market Committee member James Bullard speaks today and Thursday, with Loretta Mester and Lael Brainard also speaking towards the end of the week.

 

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