Good inflation news in Europe; negative surprises in US

In the UK the FTSE 100 had a great week out performing its European peers with a rise of 1.84%, due to a greater fall in inflation than expected.

Data on the week was mixed for the UK however, after a preliminary estimate of gross domestic product (GDP) showed a greater-than-expected contraction of 0.3% in the three months through December. The economy shrank 0.1% between July and September meaning the UK fell into what many term as a ‘technical recession', although as we mentioned earlier in the week, no such official term exists.

On the positive side, annual consumer price growth undershot consensus forecasts, coming in at 4.0%, the same as in December. However, don't let this fool you, as the month over month number actually came in -0.6% below November. This is is great news for consumers and great news for the Bank of England.

Core inflation, excluding volatile food and energy prices, was also unchanged at 5.1%. But services inflation accelerated to 6.5%.

BoE Governor Andrew Bailey sought to downplay the GDP data before the figures had been released, asserting that any recession would be “very shallow” and that more emphasis should be placed on recent indicators, which “have shown some signs of an upturn.”

He later told a parliamentary committee that the inflation data was “good news,” with the caveat that services inflation was still too high and more clear evidence was required that wage growth was slowing. Wages, excluding bonuses, grew 6.2% in the three months through December, down from 6.7% in September to November, the slowest pace in over a year.

It seems the BoE will continue to downplay rate cuts until they are upon us. Not even they can continue to ignore the inflation data as it falls to the 2% target and below over the next 4 months.

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In Europe

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In Europe the pan-European STOXX Europe 600 Index ended the week 1.39% higher as signs of cooling inflation and a better outlook for interest rate cuts cheered investors. Germany’s DAX gained 1.13%, and France’s CAC 40 Index advanced 1.58% on upbeat corporate earnings, hitting new highs during the week. Italy’s FTSE MIB climbed 1.85%.

Core eurozone government bond yields rose modestly after the higher-than-expected U.S. inflation print. European Central BankPresident Christine Lagarde expressed concern over “making a hasty decision” to ease policy in case inflation rebounds, adding to the upward pressure on short-dated bond yields. Peripheral eurozone bond yields fell, however, particularly those of longer-dated Italian debt.

The European Commission cut its forecast for eurozone economic growth in 2024 to 0.8% from the 1.2% predicted in November. This downward revision reflected inflation, which has eroded purchasing power, and higher interest rates, which curbed credit.

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In the US

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In the US, benchmarks were mixed as small-caps and value shares outperformed.

Some favourable earnings surprises balanced against discouraging inflation data left the major benchmarks mixed, with the S&P500 Index recording its first weekly decline since the start of the year. The declines were concentrated in large-cap growth stocks, however, with an equally weighted version of the S&P 500 reaching a record intraday high on Thursday.

After suffering its biggest daily drop since June on Tuesday, the small-cap Russell 2000 Index rebounded to lead the gains for the week. Trading volumes also picked up later in the week, after a very quiet start on Monday following the Super Bowl weekend and with multiple markets shut for holidays, including the Chinese New Year and Carnival celebrations on the eve of the start of Lent on Wednesday.

Investors digested several upside inflation surprises during the week. On Tuesday, the major indexes sold off after the Labour Department reported that consumer prices had risen 0.3% in January, a tick above consensus expectations of around 0.2%. More concerning may have been the0.4% rise in core consumer prices, keeping the year-over-year rise at 3.9%,nearly double the Federal Reserve’s 2.0% target.

Stock futures fell again after some more substantial upside inflation surprise as producer prices, which are typically more volatile, had increased 0.3% in January — the most in five months — after falling0.1% in December. Core prices rose 0.5%, well above expectations of around 0.1%.

Much of the rest of the week’s economic data were also arguably disappointing—although signs of weaker growth seemed to help calm inflation concerns. On Thursday, the Commerce Department reported that retail sales had plummeted 0.8% in January. While many economists pointed to seasonal factors and harsher weather in January as a reason for the weakness, typically weather-sensitive sales at restaurants and bars rose 0.7%. Initial jobless claims also came in below consensus, while continuing claims were slightly above. While housing starts, reported Friday, came in lower than expected, a gauge of homebuilder confidence surprised on the upside.

The inflation data caused investors to lower their expectations for potential rate cuts considerably. According to the CME FedWatch Tool, the futures market ended the week pricing in only a 10.5% chance of a rate cut in March compared with a 65.1% chance a month earlier. The yield on the benchmark 10-year U.S. Treasury note also surged to an intraday high of 4.33% on Friday, its highest level since December 1.

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In Asia

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Japan’s stock markets rose over the week, with the Nikkei 225 Index gaining 4.3% and the broader TOPIX Index up 2.6%. The Nikkei hovered around its highest level in 34 years, continuing its strong performance in the year-to-date period and in 2023. Yen weakness and positive corporate earnings releases lent support. On the economic front, weak fourth-quarter growth data added to uncertainty about the future path of the Bank of Japan’s monetary policy, which the central bank deems dependent on sustainably achieving its 2% inflation target.

Financial markets in mainland China were closed, and no official indicators were released due to the weeklong Lunar New Year holiday, which began Saturday, February 10. Early data showed a pickup in consumer spending over the Lunar New Year, China’s most important holiday. More than 61 million rail trips were made in the first six days of the national holiday, a 61% increase over last year’s holiday, according to official media reported by Bloomberg. Travel by road and airplane also improved, while hotel sales on Chinese e-commerce platforms increased more than 60%, according to state media.

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The week ahead

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The big question on most traders’ radars is whether the relentless rally in risk assets can extend for another week. Despite the ostensible risks of inflation reaccelerating in the US, major indices all made record highs from Germany to the US to Japan, global bond yields rallied across the curve, Bitcoin – a quintessential measure of risk appetite – surged to 2-year highs, and even oil prices were able to rally up to approach their highest levels since November.

Looking ahead, the biggest hurdle for bulls to watch will be Nvidia’s earnings. The semiconductor giant saw its market cap eclipse fellow “Magnificent Seven” rivals Alphabet/Google and Amazon last week, signalling elevated optimism heading into the release.

The epicentre of the AI revolution, Nvidia trades at a massive multiple, but as long as it continues to deliver strong growth, traders will keep bidding it up. In addition to the usual EPS (expected at $4.18) and revenue ($20.4B expected) results, traders will also be hyper-focused on the company’s guidance and outlook for the rest of the year.

Following on strong results from rivals like AMD,SMCI, and TSMC, investors’ sky-high expectations will be put to the test with potential for outsized volatility; looking at the implied volatility on NVDA options, we can see that investors are projecting a +/- 11% move in response to earnings, a truly massive figure for a nearly $2T company.

Outside of Nvidia’s earnings, the most important release will likely be the Thursday’s PMI surveys from the US, UK, and Eurozone. Seen as one of the most timely measures of on-the-ground economic activity, these surveys will give traders insight into whether the strong momentum from January has carried over into this month. With traders aggressive pricing out interest rate cuts from all major central banks since the start of the year, it will take another round of strong PMI surveys to prevent near-term bearish reversals.

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