Stagflation is back in focus

(Danske Research Team – Danske Bank A/S)

Market movers today

There are only few economic releases today. The only number of relative importance is the US July durable goods orders, which are expected to slow due to the financial tightening taking place on the back of the Fed tightening.

The 60 second overview

August PMIs point to weakening growth momentum: In the euro area services activity seems to be stagnating and manufacturing slipped further into recession territory. New business was down in both the manufacturing and service sectors, suggesting little prospect of an improvement in production ahead. On a positive note, businesses continue to see less rises in their costs and in turn are increasing their selling prices at a softer pace. The post-pandemic employment recovery continues, although firms are increasingly reluctant to hire new staff in light of weakening order books. Overall, pent-up services spending that boosted growth in Southern Europe during Q2 is increasingly running out of steam as persistently high inflation and rising interest rates are weighing on consumers’ disposable income. Germany’s manufacturing progress is under strain from both lingering supply constraints, a weakening demand outlook and rising cost pressures in light of the worsening energy crisis. With the threat of rationing and production cuts later this year still looming large, the near-term outlook for the euro area economy remains challenging and we think a recession in H2 22 will be difficult to avoid.

In the US, the manufacturing index declined more than expected but remains above 50, as new orders remained near previous levels. However, service sector growth appears to be slowing faster than expected, as firms’ expectations of incoming new business and employment growth ticked lower. Overall price pressures continue easing, but input and output price growth remains at very elevated levels. All together the figures continue to support the ‘stagflationary’ narrative on both sides of the Atlantic. New home sales in the US were also disappointing. A downturn in homes sales is often an important leading indicator of a rise in unemployment rates in the US economy.

Equities proved surprisingly resilient despite poor macro data releases from the US. Equities admittedly drifted somewhat lower but with most cyclical sectors – materials, consumer discretionary, industrials – all higher. Real estate sector underperforming on the back of weak data combined with higher yields triggered some rotation out of growth/ quality stocks. Contrary to the mildly positive reaction from equities and bond investors, VIX continued to drift higher (currently 24) which to us marks the end of the positioning-driven rally over summer. S&P500 -0.2%, Dow -0.5%, Nasdaq -0.8% and Russell 2000 0.2% higher.

FI: After the European PMIs in the morning, rates traded mostly sideways through the day. Initially, the French PMI sent yields lower by 1-2bp, but the German manufacturing PMI just 15 minutes later – which was not as weak as expected – sent Bunds 4bp higher.

FX: US data-induced USD weakness proved short-lived in yesterday’s session. EUR/USD temporarily broke above parity but closed back below the important threshold level. NOK had a strong session supported by higher oil prices and better-than-feared European PMIs. Also, continued NOK demand from elevated natural gas prices (tax payments) is supportive. EUR/SEK moved back below 10.60.

Credit: Credit spreads moved largely sideways yesterday. ITraxx main widened by 0.5bp ending in 110.6bp while Xover grinded 2.4bp tighter ending in 549.4bp.

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