European equities are mostly lower at the start of the week, as key themes including nerves around earnings season and concerns that the Federal Reserve will be under more pressure to hike rates after last week’s stronger than expected payrolls report from the US, dominate sentiment. The “good news is bad news” theme remains strong for now. Markets are falling at the start of a new week, after concerns mount that China will go back into lockdown. While these concerns are preoccupying sentiment, there are some fundamentals that are worth looking out for as they could determine the longer-term direction of markets after this summer madness quietens down. Below we take a look at three themes that will drive market direction in the coming days and weeks: 1, EUR/USD parity As we start a new week, the risk off theme is driving EUR/USD below the 1.01 handle and the sell off in the euro is gathering pace. The lack of upward momentum suggests a break below parity is now inevitable. But what would it actually mean? A weaker euro is surely good for the large German exporters, including the automotive industry and the large manufacturing sector? However, it’s not as simple as this and there are many moving parts and unintended consequences when you see historical moves in the world’s most important currencies. As you can see in the chart below, the Dax and EUR/USD have typically had a strong correlation so far in 2022, however, the relentless pressure on the euro is causing a divergence with the Dax. As EUR/USD reaches two-decade lows, the Dax is starting to outperform the euro. We will be watching this closely to see if this is maintained. While a weak euro should be good news for German exporters, it has a dark side that could spell bad news for the future of the Eurozone. It increases the cost base for German companies, as energy, which is priced in dollars, becomes ever more expensive. The reliance of large Eurozone economies on energy imports is the Achilles heel of the European economy. Coupled with the restrictions of energy imports from Russia, and the threat from Russia that it will cut off natural gas supplies, Europe’s energy position already looks weak. The currency decline is exacerbating this problem, as Europe looks to secure energy from other suppliers, but needs to pay more because of the declining euro. Thus, the Dax’s divergence from EUR/USD may not persist, or it will be a reflection of more people selling the euro, rather than favouring the Dax. Thus, a weak euro is a threat to Europe’s largest economy. Graphical user interface, chart Description automatically generated. However, another impact of EUR/USD parity is what it means for central banks. Will it trigger a more aggressive stance from the ECB, or could it cause the Fed to hold back on large rate hikes per meeting due to the impact they have on the FX market? As we move into the second half of this year, we believe that central banks may be more attentive to currency moves, with an increasing chance that the ECB and BOE will have to adjust their current policy stances and start matching Fed rate hikes to prop up their currencies. This could limit dollar strength in the long term. Also, as the euro reaches a multi-decade low vs. the USD, we will be watching to see if the single curtrency will fall further, or if it will bounce back. We predict a 75% chance that there could be more weakness for the euro if EUR/USD breaks parity. 2, Economic data watch Key economic releases this week include US inflation data for June. The market expects another rise in the inflation rate to 8.7%, up from 8.6% in May. The market will trade off the monthly inflation figures, and these are likely to make grim reading from the Fed. The monthly rate of US inflation is expected to come in at 1%, driven by higher energy prices. The key drivers of inflation for June are expected to be energy prices, food costs, airline fares and shelter costs. Hence the rate of core inflation, without food and energy, is also expected to rise by 0.5% last month. While this is a slightly lower rate than the 0.6% rise in core inflation for May, it remains uncomfortably high for the Fed who embarked on a 75bp rate hike at its last meeting. We are unlikely to have reached peak inflation yet, which could keep markets nervous as we move through this week. It is worth noting that the June figures are unlikely to reflect the current slowdown in consumption that is expected after a record decline in consumer confidence in the US and rising US interest rates eating into consumer...

European equities are mostly lower at the start of the week, as key themes including nerves around earnings season and concerns that the Federal Reserve will be under more pressure to hike rates after last week’s stronger than expected payrolls report from the US, dominate sentiment. The “good news is bad news” theme remains strong for now. Markets are falling at the start of a new week, after concerns mount that China will go back into lockdown. While these concerns are preoccupying sentiment, there are some fundamentals that are worth looking out for as they could determine the longer-term direction of markets after this summer madness quietens down. Below we take a look at three themes that will drive market direction in the coming days and weeks: 1, EUR/USD parity As we start a new week, the risk off theme is driving EUR/USD below the 1.01 handle and the sell off in the euro is gathering pace. The lack of upward momentum suggests a break below parity is now inevitable. But what would it actually mean? A weaker euro is surely good for the large German exporters, including the automotive industry and the large manufacturing sector? However, it’s not as simple as this and there are many moving parts and unintended consequences when you see historical moves in the world’s most important currencies. As you can see in the chart below, the Dax and EUR/USD have typically had a strong correlation so far in 2022, however, the relentless pressure on the euro is causing a divergence with the Dax. As EUR/USD reaches two-decade lows, the Dax is starting to outperform the euro. We will be watching this closely to see if this is maintained. While a weak euro should be good news for German exporters, it has a dark side that could spell bad news for the future of the Eurozone. It increases the cost base for German companies, as energy, which is priced in dollars, becomes ever more expensive. The reliance of large Eurozone economies on energy imports is the Achilles heel of the European economy. Coupled with the restrictions of energy imports from Russia, and the threat from Russia that it will cut off natural gas supplies, Europe’s energy position already looks weak. The currency decline is exacerbating this problem, as Europe looks to secure energy from other suppliers, but needs to pay more because of the declining euro. Thus, the Dax’s divergence from EUR/USD may not persist, or it will be a reflection of more people selling the euro, rather than favouring the Dax. Thus, a weak euro is a threat to Europe’s largest economy. Graphical user interface, chart Description automatically generated. However, another impact of EUR/USD parity is what it means for central banks. Will it trigger a more aggressive stance from the ECB, or could it cause the Fed to hold back on large rate hikes per meeting due to the impact they have on the FX market? As we move into the second half of this year, we believe that central banks may be more attentive to currency moves, with an increasing chance that the ECB and BOE will have to adjust their current policy stances and start matching Fed rate hikes to prop up their currencies. This could limit dollar strength in the long term. Also, as the euro reaches a multi-decade low vs. the USD, we will be watching to see if the single curtrency will fall further, or if it will bounce back. We predict a 75% chance that there could be more weakness for the euro if EUR/USD breaks parity. 2, Economic data watch Key economic releases this week include US inflation data for June. The market expects another rise in the inflation rate to 8.7%, up from 8.6% in May. The market will trade off the monthly inflation figures, and these are likely to make grim reading from the Fed. The monthly rate of US inflation is expected to come in at 1%, driven by higher energy prices. The key drivers of inflation for June are expected to be energy prices, food costs, airline fares and shelter costs. Hence the rate of core inflation, without food and energy, is also expected to rise by 0.5% last month. While this is a slightly lower rate than the 0.6% rise in core inflation for May, it remains uncomfortably high for the Fed who embarked on a 75bp rate hike at its last meeting. We are unlikely to have reached peak inflation yet, which could keep markets nervous as we move through this week. It is worth noting that the June figures are unlikely to reflect the current slowdown in consumption that is expected after a record decline in consumer confidence in the US and rising US interest rates eating into consumer...

Markets US equities were a touch softer Friday, S&P down 0.1% to be 2% higher over the week. Bonds sold off after payrolls beat, US10yr yields up 9bps to 3.08%, 2yrs up 9bps to 3.1%, leaving the curve still inverted. Over the week, 10yr yields are up 20bps as recession concerns ease. While the MSCI World rose 1.7% last week, in another attempt at a growth-led bear market rally, Chinese benchmarks were down slightly below 1%.  Covid numbers are ticking higher again; on Sunday, Shanghai reported the first case of the highly-contagious BA.5 sub-variant. The latter is creating some negative chop at the open, with China beta getting slightly tarnished but no worse for the wear as investors could be increasingly desensitized to Omicron risk in China.  In the wake of solid Payroll data, US recession risks are getting nudged into the corner. Still, this week's focus pivots back to inflation, particularly the US CPI and the inherent hawkish Fed policy implications. Given the recent developments in the Ukraine war, markets are struggling to have high conviction on the Nord Stream 1 gas flow resumption; risk could start teetering on the edge of a dumpster again, And while we are putting the June inflation data to one side, it is still the marquee number in the market's eyes with the search for peak Fed hawkishness continuing. Because the government data doesn't capture the gasoline and freight shipping price slide, markets could look through a slightly hot CPI number; hence we think the focus should be on US activity numbers. Both the big ones come on Friday: the Empire Manufacturing Survey and Retail Sales. Central banks don't care about what people say but what people do. Hence, retail sales could be a market mover. More importantly, the Q2 earnings season will kick off next week, starting with the big banks. Do not forget that the forward guidance revision from retailers fueled recession concerns in the last quarter. Oil In the wake of solid economic data, US recession risks are getting nudged into the corner. So oil has rebounded as investors seemingly put more emphasis on supply issues over recession concerns in the US. However, with Covid numbers ticking higher again in China on Sunday, Shanghai itself reported the first case of the highly-contagious BA.5 sub-variant; the news could be a bit of a downbeat Monday morning rally capper.  Although the possible demand impact of a recession continues to weigh on sentiment, with desks de-risking the inevitable recession clunker and likely limiting a full-on recovery rally, the prevailing view, at least for now, is that the longer-term structural issues facing the oil market will support prices through any near-term uncertainty.

Markets US equities were a touch softer Friday, S&P down 0.1% to be 2% higher over the week. Bonds sold off after payrolls beat, US10yr yields up 9bps to 3.08%, 2yrs up 9bps to 3.1%, leaving the curve still inverted. Over the week, 10yr yields are up 20bps as recession concerns ease. While the MSCI World rose 1.7% last week, in another attempt at a growth-led bear market rally, Chinese benchmarks were down slightly below 1%.  Covid numbers are ticking higher again; on Sunday, Shanghai reported the first case of the highly-contagious BA.5 sub-variant. The latter is creating some negative chop at the open, with China beta getting slightly tarnished but no worse for the wear as investors could be increasingly desensitized to Omicron risk in China.  In the wake of solid Payroll data, US recession risks are getting nudged into the corner. Still, this week's focus pivots back to inflation, particularly the US CPI and the inherent hawkish Fed policy implications. Given the recent developments in the Ukraine war, markets are struggling to have high conviction on the Nord Stream 1 gas flow resumption; risk could start teetering on the edge of a dumpster again, And while we are putting the June inflation data to one side, it is still the marquee number in the market's eyes with the search for peak Fed hawkishness continuing. Because the government data doesn't capture the gasoline and freight shipping price slide, markets could look through a slightly hot CPI number; hence we think the focus should be on US activity numbers. Both the big ones come on Friday: the Empire Manufacturing Survey and Retail Sales. Central banks don't care about what people say but what people do. Hence, retail sales could be a market mover. More importantly, the Q2 earnings season will kick off next week, starting with the big banks. Do not forget that the forward guidance revision from retailers fueled recession concerns in the last quarter. Oil In the wake of solid economic data, US recession risks are getting nudged into the corner. So oil has rebounded as investors seemingly put more emphasis on supply issues over recession concerns in the US. However, with Covid numbers ticking higher again in China on Sunday, Shanghai itself reported the first case of the highly-contagious BA.5 sub-variant; the news could be a bit of a downbeat Monday morning rally capper.  Although the possible demand impact of a recession continues to weigh on sentiment, with desks de-risking the inevitable recession clunker and likely limiting a full-on recovery rally, the prevailing view, at least for now, is that the longer-term structural issues facing the oil market will support prices through any near-term uncertainty.

The day's best news for risk was Germany confirming that the government had received a positive signal from Canada regarding delivering a turbine needed to maintain the Nord Stream 1 gas pipeline to Germany. If it is confirmed it was received, I would expect a sharper correction in EU natural gas prices, the bleeding to temporarily stop on the Euro and a general recovery in European and global risk sentiment.  Friday's solid US non-farm payroll should keep the Fed on the path of a 75bp hike. But with aggressive Fed pricing already in the books, the strong print had less of a "good was bad" vibe. Last month, good was bad for a solid non-farm payrolls number, as good data gave a green light for aggressive hikes. I think that narrative has shifted.  A 75bp hike is almost entirely priced for July, and the market is moving closer to a 50/50 split between 50bp and 75bp in September July: 72.6bp September: 57bp (50/50 split between 50bp/75bp would be 62.5bp) November: 39.4bp December: 19.3bp Even though this week's CPI is the marquee data point with expectations for it to come in hot - the disinflationary forces of late, specifically lower commodity prices, will not be in the government data yet, which may complicate the market's reaction function to another hot print. But we think the market may look past the June data, given the recent pullback in crude and gasoline prices and the slowdown in freight data. Also, UMich inflation expectations still matter, but the Fed's weight on the data should be lower after last month's revision – especially given 5y5y breaks staying grounded. Just like the NFP number would have needed to be vastly different from the consensus to trigger a real market reaction, we think even more so for this week's CPI. Although an unexpected  downswing would be stellar for risk  I am putting the inflation data slightly to one side and am more interested in the US activity numbers. Both big ones come on Friday: the Empire Manufacturing Survey and Retail Sales. Ultimately central banks do not care about what people say but what people do. Hence, I think retail sales could be a market mover. More importantly, the Q2 earnings season will kick off next week, starting with the big banks. Do not forget that the forward guidance revision from retailers fueled recession concerns in the last quarter.

We got lots of trade and current account data this past week: German trade balance (Mon), the  Australia trade balance,  US trade balance (merchandise & services), Canadian merchandise trade (Thu), and Japan current account data (Fri).. Trade used to be the key for foreign exchange markets many many years ago, when financial flows were largely to finance trade. But now financial flows dominate the global economy and determine trade flows.  How does that work? Most people think of trade surpluses & deficits in the following way. The hard-working Germans who make excellent cars are the source of that country’s trade surplus (which we learned on Monday has disappeared, but never mind) while the spendthrift Americans, borrowing and spending money they don’t have, are the source of the perennial US trade deficit. This is the logic that says tariffs, market access agreements, and urging Americans to work harder and save more are the way to rectify these global imbalances.  That may have been the way the global economy worked many years ago, but not anymore. On the contrary, trade flows nowadays are the result of financial flows. Financial flows in turn are the result of political decisions to favor one group of people (normally the wealthy elite) over another group (the workers).  For example in a country like Germany, the workers don’t get paid enough to buy everything that they produce, a direct result of the Hartz Reforms of 2003/05 and the decision to focus on “competitiveness.”  The country therefore has to export its excess production. Furthermore, the profits of these companies go to people with a low propensity to consume (the wealthy), who save much of their income rather than spending it. But with domestic demand suppressed, there aren’t enough investment opportunities in Germany. They therefore have to put their savings abroad instead. That money flooding into other countries affects interest rates and the willingness of banks to lend in those countries and thereby distorts their economies.  That’s why although Germans may criticize the spendthrift ways of Spanish homebuilders and the Greek government, the bubbles that inflated and then popped, wreaking havoc on those countries, would never have been possible if excess German savings hadn’t pushed real interest rates in those countries down dramatically and made it so cheap to borrow.  In this global system, where one country’s surplus is another’s deficit, the US winds up as the “borrower of last resort” for countries with excessive savings. Its position as the major reserve currency forces it into the position of having a perennial current account deficit (the counterpart of its constant financial account surplus). What former French President Valery Giscard D'Estaing described as an “exorbitant privilege” is really an “extraordinary burden.” In other words, while the trade account used to be the dog that wagged the financial account tail, now the financial account is (generally speaking) the dog that wags the trade tail. For anyone who wants to understand this process, I strongly recommend reading Trade Wars Are Class Wars: How Rising Inequality Distorts the Global Economy and Threatens International Peace, by Prof. Michael Pettis and Matthew C. Klein. It will revolutionize how you think of trade and global economics.  In any case, what should we make of the German merchandise trade deficit in May, the first since 1991? Having said all of the above…sometimes the trade account is the dog and the financial accounts are the tail. Today may be one such time as the surge in energy prices combined with the slowdown in the global economy throws the German trade account into deficit.  This spells some danger for the euro. Germany has usually accounted for all if not more than all of the Eurozone’s trade surplus – it generally offsets the trade deficits of the other countries. (The chart only goes up to April and does not include May’s German trade deficit.)  Of course, that’s only the merchandise trade account. We have to know what’s happening with services and the various income accounts that make up the current account balance. Lo and behold, that’s a deficit too (this chart shows a 3-month moving average and so it hasn’t yet dipped into deficit, but the Eurozone current account was in deficit by EUR 5.4bn in April.) Looking at what’s happening recently with Germany’s trade in goods, the Eurozone current account deficit is bound to widen as higher energy prices push the trade account further into deficit. Now as we all know, the balance of payments has to balance. The money coming in always equals the money going out. If there’s a current account deficit (= Europeans spending more money abroad than they receive) then the country has to run a financial account surplus (= more money coming into European financial assets, such as stocks, bonds, land, etc.) than is...