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This is a shorter trading week for the Easter public holiday, however, there are some key data releases to watch out for and as we have mentioned in recent notes, the markets are being driven by fundamentals at this stage of the cycle, so keeping up to date with political and economic data is critical. The main event that the markets are digesting at the start of this week is news that incumbent French President Macron won the largest share of votes in the first round of the Presidential election on Sunday. He will now face the second-round run-off with the far-right candidate Marine Le Pen, who made a stunning comeback, winning a decent 23% of the vote. The question for French and European asset prices, will the anti-EU, anti-NATO candidate become the French version of Donald Trump, and how will the euro react?
Euro’s hopes rest with Macron
While Le Pen has won a large share of the French vote, the last time she had a run-off with President Macron in 2017, the gap between them was narrower, thus, the markets are pricing in for another Macron victory. This is good news for the euro and European stock prices, as Le Pen is seen as a disruptive political and economic force for the currency bloc. The euro is leading the G10 pack higher today, and the Cac 40 is outperforming the FTSE 100 and the Dax, as markets believe that although it will be close, Macron will still win on 24th April and remain as President. A snap poll taken after Sunday’s vote, suggest that Macron will narrowly beat Le Pen. The poll by Elabe, which interviewed 1,500 people, found 52% would vote for Macron in the second round, vs. 48% for Ms Le Pen. While this is within the margin of error, another poll by IPSOS found that Macron would win by 54% vs. 46%, which is a more comfortable margin of victory and one that the markets are running with. Of course, there are still nearly 2 weeks to go, and Macron will need to hit the campaign trail hard and try to ameliorate the cost-of-living crisis, which is his weak spot that has been expertly exploited by Ms Le Pen. Overall, the market reaction to Sunday’s vote suggests that a win for Macron is positive for the euro and for markets, while a win for Ms Le Pen is negative. If we see polls showing the race narrowing, or moving in Le Pen’s favour, then expect the euro and French assets to sell-off.
UK growth and stagflation risks
Stagflation is being mentioned in relation to the UK economy, after February GDP, which was released early on Monday, came in below expectations at 0.1%. Considering that inflation is continuing to rise, and the cost of living is surging, the market is now fearful that UK could be entering a period of low growth and high prices, a la 1970s, which is particularly corrosive for economic growth and asset prices. The decline in output in February came after a stronger bounce in GDP in January, where the economy expanded by 0.8%. Growth in February was dragged lower by industrial production (down 0.6% vs. Jan), and manufacturing, which fell by 0.4% compared to Jan. Growth was boosted by services and tourism, although the service sector’s 0.8% expansion, was slightly lower than the 0.9% expected. The non-EU trade balance also weighed on growth as it widened. Unsurprisingly, due to Brexit red tape and the war in Ukraine, our EU trade balance narrowed. While services continue to grow at a decent clip, the decline in short-term manufacturing rates are of a concern, even if annual growth looks decent.
Brighter skies ahead for the UK economy?
The surging cost of raw materials and energy along with the supply chain crunch, could hurt this sector further and it is one of many economic consequences of the Russian invasion of Ukraine that are impacting the UK’s manufacturing and industrial economy. This won’t be unique to the UK, we expect Europe, especially Germany, to also be impacted. However, after taking a long time to recover post the Covid pandemic, the risk is that another weak month of growth could set the UK’s economic recovery plans back again. For now, the market may put this month’s weak growth report behind it and look to a brighter future and this is why GBP/USD has started the week on a bright note and is back above the $1.30 level, although after a weak start to 2022, the pound is looking extremely vulnerable against a resurgent dollar. As one would expect, EUR/GBP is mostly trading sideways, although the euro has a bid at the start of the week. While there are reasons to short the pound, we would note that the short pound trade, particularly against those currencies less impacted by the war in Ukraine, are looking stretched right now. GBP/AUD fell to its lowest level since late 2020 earlier this month, however, it bounced back at the start of this week, and GBP is also improving vs. the NOK, and we could see the pound start to make a comeback if the commodity currencies stay under pressure, on the back of a weaker oil price.
Why the oil price is falling
Brent crude fell 1.8% at the start of the week and is now close to $100. A breach of this key psychological level would be important and the reason that oil is falling is twofold. On the one hand, the market is normalising the war in Ukraine and looking past it now that Russia has not secured a quick victory in Ukraine and does not appear, for now, to be invading any other sovereign territory. Secondly, the EIA has reported on a descent energy crude inventory of 2.4 mn barrels for the week before last, which is expected to build further in the coming months due to the release of the US’s Strategic Petroleum Reserves. The American Petroleum Institute also revealed a build-up of stock to the tune of 1.5 mn barrels for last week. While this is welcome news, supply still remains tight, so we could see oil prices remain volatile in the coming weeks.
US price growth: Headline vs. core is a headache for the Fed
Elsewhere, we have mentioned above the importance of fundamentals in the current market environment. This week sees the release of US inflation data in March, and YoY CPI growth is expected to rise to 8.4%, up from 7.9% in February, and the highest level since 1981. Core CPI is expected to rise at a slower pace, inching up to 6.6% from 6.4% in February. We expect the focus to shift to diverging rates of headline and core inflation, with headline prices impacted by volatile food and energy prices. The risk is that central banks target headline inflation, which is difficult for them to control and may require a larger policy response, and thus a larger risk of an economic slowdown/ recession. This is bad news for equities. Thus, if we see headline prices surge more than expected, this could keep equities subdued for the medium term.
UK price pressures could weigh on broader FTSE indices
Elsewhere, UK price data is also released this week. Headline price growth is expected to rise to 6.7% in March, however the focus is on April’s figures, released next month as that is when the national insurance increase and the end of the energy price cap both came into effect. Prices are expected to rise to 8% this month, just as growth looks like it came off the boil. For now, excess demand means that most price pressures are being passed on to consumers, however, if growth continues to weaken, especially if the consumer shows signs of strain, then we could see businesses come under pressure, which would add to concern about the outlook for the FTSE, especially the domestically focussed companies in the ex-FTSE 100 space.
Bank earnings: Forward guidance is key
We will round up the latest ECB meeting later this week, and also the US bank earnings for Q1. Regarding the latter, US banks are expected to see a sharp drop in earnings and large right downs on their Russian businesses/ assets. However, US banks saw their share prices rise at the end of last week as the markets looked through short term pain, such as a slowdown in deal-making since February due to the Russian invasion of Ukraine, and to long-term gain, such as a normalisation in interest rates that could boost lending income for banks with large retail units. Overall, forward guidance is key!
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