European Midday Briefing: Markets Steady But Investors Remain Cautious

MARKET WRAPS

Stocks:

European equities made modest gains on Tuesday after the U.K. Treasury and Bank of England attempted to calm the market turmoil following last week's U.K. budget statement.

Berenberg said the negative market reaction over the government's economic growth plan looks overdone.

It said higher deficits justify higher yields and a lower exchange rate, but the U.K. remains a solid advanced economy, doesn't have large external liabilities in a foreign currency and will almost certainly be able repay its debt.

However, the U.K. has damaged its once strong credibility with a poorly managed Brexit and threats of a U.K.-EU trade war, Berenberg added.

"Once upon a time, markets may have been excited by the prospect of the U.K. cutting taxes and deregulating. Today, markets just see a government...pursuing a last-ditch attempt to try and rescue its election chances."

Stocks to Watch:

Shares in Porsche are expected to trade higher following its stock-market listing Thursday thanks to "the appetite for Europe's largest IPO this year, Porsche-driving retail investors, as well as Porsche's potential fast-track entry into indices," Bernstein said.

Parent company Volkswagen set a placement price range for Porsche's preferred shares of EUR76.50-EUR82.50. While the price could exceed EUR82.50 if the book-building process is stronger than expected and the companies agree, "we have to note that the Porsche-Piech family is paying a 7.5% premium on top of the offer price and is taking on a significant amount of long-term debt to pay the bill," Bernstein said.

Economic Insight:

Eurozone inflation will continue its upward trend in September, partly due to Germany's decision to end cheap public transport tickets as of Aug. 31, ING said.

"The key will be to see how much [prices in] other categories have continued to rise."

ING expects eurozone inflation to rise to 9.6% from 9.1% in August, while economists polled by The Wall Street Journal see inflation accelerating to 9.7%.

Regarding unemployment data, ING expects the labor market to have remained very tight with the unemployment rate stable at a historic low of 6.6% in August. Economists polled by The Wall Street Journal also see the unemployment rate unchanged. Eurozone inflation and unemployment data will be published on Friday.

U.S. Markets:

Stock futures were firmer following a five-day losing streak on Wall Street that saw the Dow tumble into a bear market on Monday and the S&P 500 hit a new 2022 low.

Following Monday's retreat, investors and analysts said sentiment continued to be negative as traders worry about the outlook for interest rates and the possibility that stress from the second extended period of declines this year will spill over into unexpected areas.

Forex:

Sterling looks vulnerable after the BOE said it would assess the impact of new fiscal policy at its next meeting instead of delivering an emergency interest rate rise as some market participants expected, ING said.

GBP/USD hit a record low of 1.0349 on Monday following last week's U.K. mini-budget statement, prompting the BOE to signal it could take action at its next scheduled meeting in November.

"But six-to-nine weeks is a long time in FX markets," ING said. "We had felt that the BOE would prefer to avoid getting sucked into defending the pound with rate hikes."

Pantheon Macroeconomics said the BOE is expected to accelerate its interest-rate hiking cycle as financial markets have lost confidence in the U.K.'s macro policy regime.

Raising interest rates to near 6%--the level markets are currently pricing in--would crush inflation but lead to a sharp increase in mortgage defaults, Pantheon said.

Hiking more slowly would weigh on sterling and boost imported inflation, allowing it to stay above target for longer, Pantheon said. This option is one that the BOE is likely to see as the lesser of two evils, though a recession is unavoidable as many households and businesses will cut spending immediately knowing that higher interest rates and further price increases are in the pipeline.

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The Hungarian forint rose ahead of another expected interest rate rise by the National Bank of Hungary in a policy decision due at 1200 GMT on Tuesday.

The NBH is likely to raise its benchmark interest rate 75 basis points to 12.50%, ING said.

NBH officials have recently signalled that the rate-rise cycle is coming to an end, which could make a 75bp move look aggressive, ING added.

"Our call for today's NBH decision should mean positive support for the forint."

Bonds:

Bond yields worldwide stabilized after extending the biggest gains in seven decades.

The 10-year Treasury yield, along with German and Japanese bonds, were all little changed. The 10-year gilt yield, which has skyrocketed since Friday when the new British government announced a series of big tax cuts, pulled back to 4.052%, down from as high as 4.282% on Monday.

The pause comes as bonds cope with their first bear market in more than 70 years, as defined by prices falling 20% from their recent peak. More than a decade of global bond returns have been erased for the first time since the 1950s, according to Deutsche Bank analyst Jim Reid.

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