Weekly View – Draghi tries to quit

Last week’s US CPI and PPI prints were both at record high levels, and yet the Michigan five-year consumer inflation expectations came in lower than expected at 2.8%, driving markets higher. There appears to be a discrepancy of expectations and the actual data. Despite the IMF and US sentiment indicating that recession is imminent, US retail sales were up 1% month-on-month and the control-group component at +0.8%, both better than expected. At the same time, commodities prices have corrected, with copper down 30% year to date and the price of wheat now below its pre-Ukraine war levels, signalling a recession ahead. We still see challenges to come, which is why we remain positive on oil. This week, we will be watching to see whether the Nord Stream gas pipeline reopens, especially given that a reopening of Libya’s oil fields will not compensate for a disruption of Russian gas. Elsewhere, Chinese Q2 2022 GDP was much lower than expected, implying that the authorities will have to increase stimulus efforts if they want to reach their yearly growth target of 5.5%. On a more positive note, China’s monthly retail sales and production figures point to a sequential improvement in economic conditions.

Following the resignations of the UK and Italian prime ministers Boris Johnson and Mario Draghi, new leaders must be chosen, with Italian elections to take place between now and May 2023. This will be critical, given Italy’s “take care” government has yet to implement the PNRR investment plan that was agreed with the EU and makes Italy the single biggest recipient of EU funds - EUR122 bn out of EUR750 bn. This week the ECB will meet with the objective of providing details around its tool to backstop periphery bonds in case of future market dislocation. The euro reached parity with the US dollar and in our view, the Swiss franc offers good diversification against the euro. We prefer US to European sovereign bonds. In the US, inflation remains the Fed’s main worry, especially after the CPI’s 9.1% was higher than forecasts. Markets are now pricing in a 100% chance of the Fed raising interest rates by 75 basis points (bps) at its next meeting.

As Q2 2022 earnings season US banks were the first to report, with mixed results. Investment bank results were weak but trading revenues strong. More and more US companies are indicating that they will reduce hiring. Banks are preparing for a recession by increasing provisions and stopping buybacks. We expect to see this in other sectors as pressure on margins rises. We prefer dividend growth strategies over buybacks given the latter may have passed their peak.