EMEA Morning Briefing: Fed Rate Bets Back in Play After Surprise BOC Rate Hike

MARKET WRAPS

Watch For:

E.U. GDP and main aggregates estimate, employment; France OECD Ministerial Council Meeting concludes, OECD harmonized unemployment rates, job creation; Italy German Chancellor Olaf Scholz meets Italian Prime Minister Georgia Meloni and Italian President Sergio Mattarella; trading updates from FirstGroup, SAS, M&G

Opening Call:

Shares could open mixed in Europe on Thursday, as investors recalibrate their expectations regarding the Fed rate decision next week. In Asia, stock benchmarks were broadly lower; Treasury yields broadly fell; the dollar weakened; oil dipped while gold gained.

Equities:

European stocks futures indicate a mixed open on Thursday, with the markets bracing for more volatility and as apprehension builds about the Federal Reserve's interest-rate decision next week.

U.S. stocks ended mostly lower on Wednesday after the Bank of Canada unexpectedly raised its benchmark interest rate by a quarter of a percentage point, resuming its monetary tightening after a four-month pause, which added to worries that the Fed could follow next week.

"I think there's a realization among central banks but also investors that the cost of capital wasn't yet at the tipping point. We're not sending the world economy into recession," said Phillip Colmar, partner and global strategist at MRB Partners.

"That means you price out the recession risk, and it's not bad for equities. But the flip side of it is that [central banks' tightening] policy may not be done," said Colmar.

"So you got a better growth backdrop, but you got higher interest rates, " noted Colmar. It takes off some of the profits off of big tech companies, which have been leading stocks gains so far this year, but it "broadens the rally out", Colmar said.

Bill Hench, portfolio manager of the First Eagle Small Cap Opportunity Fund, said small-cap stocks, which have been lagging behind its large-cap peers, are "logical places" to look now.

"If suddenly people think we are not going to get a recession," they would start looking at sectors that have underperformed their peers for the past two years, Hench said.

"We should be prepared for additional volatility," SEI's Jim Smigiel said and thinks are pricing too low inflation and interest rates.

"The challenge for [the Fed] is that the longer that they have to stay tighter, the longer that near-term inflation stays stubborn, the higher the potential that those longer-term expectations may change."

Investors betting on a Fed pause this month may be disappointed, according to Louis Navellier, who says a few clouds are emerging.

The Chairman of Navellier & Associates points to Canada and Australia raising rates in the face of slowing economies due to stubborn inflation trends.

"Stagflation is seen as worse than suffering through a recession to break inflation. Our Fed could reach the same conclusion and estimates are that it may take a 6% rate to slow things enough to actually reach a 2% inflation rate," Navellier said.

Forex:

The dollar weakened in Asia, as investors recalibrate their Fed rate bets.

The Bank of Canada's unexpected rate hike has reverberated well outside Canada, with markets now viewing a Fed June pause merely as a breather and pricing in more compelling odds of a rate increase in July, said Mizuho Bank.

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The euro is likely to remain weak versus the dollar even though the eurozone's high core inflation and tight labor markets leave no room for the European Central Bank to be complacent, Bank of America said.

"As long as global and particularly U.S. inflation remain high, we would expect EUR/USD to remain weak," BofA said.

Sticky inflation means a hard economic landing might be necessary for central banks to meet their inflation target soon enough to avoid entrenched inflation, it said.

EUR/USD could fall below BofA's 1.05 short-term forecast in a hard-landing scenario while stagflation--weak growth combined with high inflation--would lower it to parity, it added.

Bonds:

Treasury yields were broadly lower, as investors reassess Fed rate bets after the Bank of Canada's unexpected rate hike fueled bets that the Fed may still need to raise interest rates after its policy meeting next week.

While U.S. markets are pricing a relatively low probability of a hike in June, and putting more probability on a July hike, monetary policy elsewhere in the world illustrates both the economic peril of a premature pause and the potential for resurgent inflation to provoke "surprise" rate hikes, said Citigroup.

"The surprise nature of hikes shows that once it becomes clear policy rates are not sufficiently restrictive, central banks (including the Fed) may react by hiking sooner rather than later," it said.

"Our base case remains for a 25bp Fed rate hike next week," it added.

Treasury yields were likely to rise as markets adjust their outlook to the reality of Fed policy, Jim Smigiel, chief investment officer at SEI said.

"Our bias is for higher yields. We don't see any rational in the near-term why the Fed would be turning course, cutting rates."

Investors are also bracing for an estimated $1 trillion deluge of Treasury issuance to start flowing later this week and continue in the coming months as part of the latest debt-ceiling resolution.

Heavy supply of fresh Treasury debt will refill government coffers run low by another protracted fight in Washington over the U.S. borrowing limit. But it won't necessarily derail stocks, or the broader market, according to strategists.

"In our view, broad market concerns about T-bill issuance are overblown, " CreditSights said.

Energy:

Oil prices slipped early Thursday after being supported by data showing higher China crude imports in May.

"Demand slowdown from China has been a major concern for the crude oil market recently, and a recovery in oil imports is likely to provide some comfort to the oil market," ING said.

Prices have likely stabilized after traders digested recent news of further voluntary production cuts by Saudi Arabia, said https://urldefense.com/v3/__http://DailyFX.com__;!!F0Stn7g!HsgzC6OQCdaQdnVUG2pkAzLVXiOq7fzh7ts55zdjC68RnpdOhHuexNG5I9MePkrGv93rOftVu2FHLtaIlUKlLRguQ05cSM7XMA1-JxGJRI8$ .

"For crude oil, the lack of follow-through from the OPEC+ production cut announced over the weekend may reveal the underlying weakness in global demand," it said.

Still, for now, Manish Raj, managing director at Velandera Energy Partners, said "smart money is staying on the sidelines until more convincing data emerges on either demand picking up, or supply actually going down."

"So far, both stories have been elusive, with no sign of demand pickup, or of supply actually going down," he said.

Metals:

Gold prices gained in Asia as investors await further clues on the Federal Reserve's interest rate path.

The price of the yellow metal fell Wednesday after a surprise decision from the Bank of Canada to resume its monetary tightening policy after brief pause, Oanda said.

"The Bank of Canada rate decision sent a shiver down the spine of most gold bulls as they are the leading central bank when it comes to action since Covid-19," it added.

The question is whether the Fed is "going to stick to its guns or try to shoot down inflation further," said Naeem Aslam, chief investment officer at Zaye Capital Markets.

"The dollar index is certainly suggesting that there is a large possibility for this, and the strength in the dollar index is keeping old traders somewhat worried."

Still, the price level that puts the bulls on the higher ground is $2,000, and gold currently trades below this key mark, said Aslam.

"This means that there is some hallucination among gold traders who think that the odds are stacked in their favour."

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Aluminum prices were lower amid downbeat commentary from producers.

ANZ analysts noted that companies don't think there will be an upside for the metal's demand, citing comments made at an industry panel where Century Aluminum, Novelis and Hydro, among others participated.

Producers have also been struggling with commitments from customers amid an uncertain economic backdrop, ANZ added.

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Chinese iron ore prices were higher in early trading, extending a multiday rally.

The steelmaking raw material has rebounded from an earlier selloff as analysts have signaled optimism of trough valuations and expected improvement in real-estate construction activities, a major source of iron ore and steel demand in China.

The momentum will likely be sustained over the coming months, SDIC Essence Futures analysts said.

They particularly like a local city government's recent move to offer more property purchase support measures, a sign of potential further policy easing in the housing market.

TODAY'S TOP HEADLINES

A deluge of Treasury bill issuance is coming. How it could impact stocks and the broader market

Investors are bracing for an estimated $1 trillion deluge of Treasury issuance to start flowing later this week and continue in the coming months as part of the latest debt-ceiling resolution.

Heavy supply of fresh Treasury debt will refill government coffers run low by another protracted fight in Washington over the U.S. borrowing limit. But it won't necessarily derail stocks, or the broader market, according to strategists.

Why U.S. stock-market investors are rattled by the Bank of Canada's surprise rate hike

The Bank of Canada delivered another reminder to U.S. investors Wednesday that pressing "pause" on interest rate hikes doesn't necessarily mean the monetary tightening cycle is over.

The Bank of Canada somewhat surprised traders by delivering a quarter percentage point hike in interest rates, ending a four-month pause. An uptick in the April inflation reading and still strong consumer spending convinced policy makers to resume hikes. The Reserve Bank of Australia on Tuesday delivered a second straight rate hike after having ended a short pause of its own.

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