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EUROPEAN MIDDAY BRIEFING - Stocks Mostly Drift Lower as Inflation Fears Dominate

MARKET WRAPS

Stocks:

Most European benchmarks suffered modest losses Wednesday, as worries about a possible recession, surging inflation and rising interest rates continue to hamper markets.

Concerns around inflation at a multidecade high remain in focus--especially how high prices will inform the Federal Reserve's path of tightening monetary policy. The risk as the central bank is expected to keep raising interest rates and start unwinding its bondholdings is that this could dent economic demand so much as to cause a recession.

"After some respite over the last couple of weeks, the last 24 hours have seen equities and bonds sell off in tandem once again as inflation fears cranked up another notch," said Jim Reid, a strategist at Deutsche Bank.

Stocks to Watch:

According to press reports, Germany's national agency for digital medicine has agreed on a new soft rollout strategy for electronic prescriptions.

The soft rollout would be in contrast with a previously expected time-bound, nationwide adoption of e-prescriptions, and also depends on some opposition from physicians, Citi said.

Overall, the share prices of online pharmacies Zur Rose and Shop Apotheke are expected to continue to show volatility, according to Citi, as there remains uncertainty around a nationwide adoption of e-prescriptions in Germany.

Economic Insight:

The European Central Bank's message at the June 9 meeting is expected to be very clear, amid significantly higher inflation projections, that policy normalization starts, said Generali Investment's senior economist Martin Wolburg.

Beyond July, when the ECB's first interest rate rise is expected, "much will depend on the change in the growth and inflation mix," Wolburg added.

Generali expects the ECB to lift the deposit rate by a cumulative 75 basis points to 0.25% this year. Market expectations of 100bps ECB interest rate rises this year are overdone, Wolburg said, as Generali looks for a significant slowing of activity in the second half.

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Retail sales in Germany plunged by 5.4% month-on-month in April. The headline was constrained by a whopping 7.7% month-to-month slide in food spending, the biggest fall since this series began in 1994, said Pantheon Macroeconomics' chief eurozone economist Claus Vistesen.

The carry-over for the second quarter--growth assuming sales are unchanged in May and June--is now minus 4.8%, according to Pantheon. This suggests the German economy could be sliding into recession quicker than expected in Pantheon' baseline scenario, which currently expects a technical recession in third and fourth quarters.

U.S. Markets:

Stock futures wavered into the new month, with June trading set to start against the backdrop of familiar themes, including inflation and the pace of tightening monetary policy from the Federal Reserve.

With inflation firmly on the radar, bond yields pushed higher, with the yield on the benchmark 10-year Treasury note nearing 2.9%, up from 2.75% at the end of last week.

Higher yields add pressure to tech stocks in particular, because they discount the present value of future cash flows, and many tech stocks have valuations banking on profits years into the future. This in part explains the relative underperformance in Nasdaq futures Wednesday.

Investors will get more detail on the growth picture in the day ahead with global manufacturing purchasing managers index data, as well as the ISM manufacturing reading for May. The Fed will also release its Beige Book.

Forex:

A selloff in bonds has helped to lift the dollar slightly, alongside concerns about the effect of the EU oil embargo on Russia and Tuesday's better-than-expected U.S. consumer confidence data, said ING.

Speculation the Federal Reserve could pause raising interest rates in September is being kept at bay for now, which is "laying the basis for a period of gradual re-strengthening in the dollar."

ING said the DXY Dollar Index could advance to the 103.00 area in the run-up to the June 15 Fed meeting. However, firmer equity markets on Wednesday might help lift riskier currencies against the dollar, ING added.

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Fears about the risks to eurozone growth after the EU announced a plan to ban Russian oil imports are weighing on the euro, which could fall to $1.05 by the end of the month, said ING.

Growth concerns offset Tuesday's news that eurozone annual inflation jumped to a record 8.1% in May, which failed to lift the euro despite confirming the likelihood of interest-rate increases by the ECB.

"While high inflation is keeping the ECB tightening expectations supported, the euro--which is already embedding a good deal of monetary tightening--is struggling to find any solid bullish driver," ING said.

Bonds:

Generali Investments said the general trend of bond yields should point upward in the near term, both in the U.S. and the eurozone.

The backdrop is an inflation outlook which remains bleak, while uncertainty remains elevated with lockdowns in China and the continuing war in Ukraine, said senior bond strategist Florian Spaete.

In addition, inflation in the eurozone still has to peak, while U.S. inflation has probably already reached its highest point, even as deceleration will be slow, Spaete added. He continued that these inflation worries as well as growth concerns are expected to increasingly affect international bond markets.

Markets are pricing a more realistic path for the Federal Reserve, with the peak of cycle unlikely to exceed 3% significantly, while in contrast, key rate expectations for the European Central have moved further up, Spaete said.

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Gross government bond issuance in the eurozone is expected to amount to EUR106 billion in June, according to Citi, in line with the issuance in May, but would exceed the anticipated monthly gross issuance of EUR94 billion in 2022 by EUR12 billion.

Net cash requirement--gross supply minus free-float coupons, total redemptions and assumed net purchases by the European Central Bank--is likely to be nonsupportive for eurozone government bonds at EUR60 billion, Citi forecast.

Energy:

Oil futures added almost 2%, boosted by the EU's plan to ban Russian crude imports and despite reports that OPEC was considering suspending Russia from its quotas.

"Russian crude imports are likely to stay supported in the near term, with a phased reduction of Russian barrels by Europe offset by strong demand for discounted Russian barrels from India and China," said UBS.

Metals:

Gold extended its retreat as higher oil prices triggered by the EU's ban on most Russian crude added more headaches for policymakers seeking to control inflation, while the dollar and Treasury yields rose. Both have been the preferred inflationary hedge for investors over gold in recent weeks.

Base metal prices were also lower.

"The pullback in oil [Tuesday] was quite significant for aluminum, putting pressure on prices, given oil typically equates to energy and energy in turn is the biggest cost factor of the production of refined aluminum," said Marex's Asian metals team.

And copper prices falling against a rising dollar further highlights the recession risks faced by the global economy, Marex added.

Other News:

Fitch said iron ore has performed better than expected through the worst of China's recent Covid-19 lockdowns, as it raised its 2022 price forecast to $130/ton from $120/ton.

"While we expect iron-ore prices to see some continued weakness for spot prices in the coming days from continuing lockdown restrictions in China, we believe that there is now primarily upside for iron ore demand in the months ahead."

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June 01, 2022 05:53 ET (09:53 GMT)

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