Please see today’s Daily Investment Bulletin from Brooks Macdonald received this morning:
What has happened
Both US and European equities fell on Wednesday, marking for both a fourth consecutive session of declines, and ending August at month lows. Mirroring equity falls, bond prices were also lower, as markets pushed bond yields higher on the expectation that central banks are increasingly in a corner over having to raise rates to tackle current energy-led inflation pressures. Also knocking sentiment overnight is the news of a new COVID lockdown in the Chinese city of Chengdu, making it the largest city to be locked down since Shanghai earlier in the year.
Eurozone inflation heaps pressure on ECB ahead of rate decision
Wednesday saw the flash estimate of Eurozone CPI for August, coming in at 9.1% Year on Year (YoY), a new record high, up from July’s 8.9% and ahead of the 9% estimate expected by the market. While energy prices were a predictably large component, core CPI (excluding food and energy) was 4.3% YoY, ahead of 4.1% expected. Services inflation rose 3.8% YoY. The data heaps more pressure on the ECB ahead of their next monetary policy meeting due next Thursday (8 September), with some ECB members in recent days seemingly opening the door to considering a larger 75bp move. In terms of what markets are expecting, overnight index swaps are now pricing in a 69bps hike for the next meeting, so closer to 75 than 50.
US dollar currency strength continues
The US dollar index (DXY) saw a third month in a row of gains in August, holding close to 20 year highs. The latest boost for the Dollar came on the back of a hawkish rebuke from Fed Chair Powell at Jackson Hole last week, as markets factored in higher US interest rates for longer. Of course, with currency pairs, the strength of the Dollar and the DXY index owes just as much to weakness in other currencies, including notably the Euro. Currency movements are often multi-faceted, but a key factor behind currency pairs this year has been energy. Versus relative US energy independence, Eurozone countries have been much more exposed to higher energy prices, forced to switch from buying previously relatively cheap Russian gas priced in Euros, to currently more expensive international LNG cargoes priced in US Dollars. Impacting broader terms of trade, this has fed into mounting Eurozone economic growth concerns, putting downward pressure on the Euro relative to the Dollar,
What does Brooks Macdonald think
A stronger outlook for US interest rates and the dollar continues to be a headwind for many countries globally, in particular, some emerging market economies. First, a stronger dollar and US interest rate outlook can impact and even reverse capital flows into emerging markets which are often reliant on foreign investor inflows in order to fund local government funding. Second, a stronger dollar can impact the relative cost of dollar denominated debt where emerging market economies have historically taken advantage of relatively low-cost dollar finance to support government financing.
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Andrew Lloyd DipPFS
01/09/2022