European Midday Briefing: Mounting Recession Fears Hold Back Stocks Again

MARKET WRAPS

Stocks:

Stocks in Europe struggled for momentum once again on mounting recession fears, as investors continued to worry that stronger-than-expected economic data will prompt central banks to hold interest rates higher for longer.

"[U.S.] stocks fell for a fifth day, but sovereign bonds gained, a hint that the market catalyst shifted from the hawkish Fed pricing--where stocks and bonds fall at the same time--to recession fears, where stocks remain under pressure, while investors seek refuge in safer sovereign assets," Swissquote Bank said.

Stocks to Watch

Swiss Re has an increasingly attractive risk-reward profile into 2023, especially as the stock has lagged the European insurance sector overall, JPMorgan said.

The reinsurer is better geared to pricing momentum, given its portfolio mix, and the company has been making positive noise around pricing and structure changes as well. While concerns continue around reserving trends, Swiss Re has reduced the issues at its problematic U.S. liability book in recent years.

JPM has upgraded Swiss Re stock to overweight from neutral, and lifted the target price to CHF100 from CHF85.

European Central Bank

The ECB is expected to raise interest rates by 50 basis points next week and start quantitative tightening of the Asset Purchase Programme in March 2023, Morgan Stanley said.

Its base case is a 2.5% terminal rate--where the ECB stops raising rates--but stronger economic growth and a later inflation peak would lead to a higher terminal rate.

Eurozone HICP has peaked in October at 10.6% and should fall, but policy-induced volatility near term and sticky core inflation should nonetheless keep the pressure on the ECB, Morgan Stanley said.

U.S. Markets:

Stock futures were little changed, putting the S&P 500 at risk of extending its recent losing streak, as recession fears remain top of mind for many investors.

In bonds, the yield on the benchmark 10-year Treasury note rose to 3.458%, from 3.407% Wednesday. The yield on the two-year Treasury note, which reflects short-term interest-rate expectations, rose to 4.283%.

"A sharp decline in Treasury yields and a deepening inversion across the yield curve suggest that recession risks have started to overshadow inflation in the eyes of investors, something corroborated by a range of leading economic indicators and the latest breakdown in oil prices," XM said.

Forex:

The euro rose after ECB chief economist Philip Lane said interest rates will need to rise several more times to tame inflation, but any gains should prove limited due to renewed energy concerns, ING said.

Overnight index swap pricing for the ECB's December 15 meeting increased to a 67 basis points rate rise on Wednesday from 54bp on Tuesday, ING said. However, a likely rise in gas prices due to northern Europe's current cold snap could cause EUR/USD's rally to stall around 1.05-1.06 this month.

"Higher gas prices are one of the key reasons we are not more bullish on EUR/USD next year," ING said.

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December is normally a weak month for the dollar but it's likely to recover in the new year, ING said.

Preventing a larger correction is the fact the market's Fed interest-rate rise expectations haven't crumbled yet with the peak rate priced above 4.9% for next spring, keeping two-year Treasury yields above 4.25%.

"Short-end yields holding up here and the ongoing inversion of the U.S. curve is key to our call that the dollar can hold gains/bounce back into the first quarter of 2023."

Bonds:

Spread-widener positions in eurozone government bonds are increasingly attractive but year-end dynamics suggest holding off until the first quarter of 2023, Mizuho said.

Thursday's trading could be dominated by several ECB speakers, albeit possibly without fresh market-moving information, and by U.S. jobless claims.

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The year-end rally in eurozone rates has come to an end, and heavy government bond supply at the start of 2023 should drive 10-year Bund yields back above 2%, Morgan Stanley said.

"As we approach January's heavy issuance we foresee a retracement on the 10y Bund [yield] to the 2.10-2.15% region."

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Metzler said the recent performance of the U.S. and eurozone government bond markets is somewhat exaggerated by now.

"In particular, 10-year Treasury yields below 3.5% no longer really fit the picture, in our view. While we don't know exactly where the bottom of this move is, we foresee ably expect a counter-reaction that should bring the overall U.S. curve back up at least around 20bp."

Prior to that, however, the market has to wait for next week's central bank meetings where once again it is not so much the decision per se, but the accompanying wording that is likely to be the deciding factor, Metzler said.

Energy:

Crude oil futures held solid gains on China reopening hopes, while higher stockpiles continued to keep prices below $80 a barrel.

"OPEC's unchanged production targets and larger-than-expected U.S. fuel stock builds have weighed on energy markets this week," Peak Trading Research said.

Brent is down 9% so far this week on the higher stock levels, but some impetus is coming from the fact that "China is officially relaxing its Covid policies, and the Chinese yuan is gaining versus the dollar, which helps U.S. export prospects."

Coal Outlook

Read Barrons.com Coal's Rally May Soon Burn Out. This Is What Could End It.

Metals:

Prices for base metals and gold wavered, with China's reopening likely to provide a boost for demand, though rising Covid-19 cases remain a concern, while U.S. PPI data could move bullion.

Meanwhile, nickel surged 3.2% to $31,630, the highest level since May 2 as low liquidity remains a key concern driving volatile in LME-nickel. Traders are looking at other methods of pricing outside of the LME for battery grades because of the issues around pricing, according to an analysis from Fastmarkets.

Gold Outlook

Gold is on track to post a loss for the year--and the precious metal's performance in 2023 will greatly hinge on where the global economy is headed, according to a report from the World Gold Council.

Gold's performance in the new year will be "shaped by the intertwining effects of economic growth, inflation and monetary policy, with additional support from geopolitics and a likely softening U.S. dollar."

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