Daily Market Comment – Euro edges up on Nord Stream relief, awaits ECB outcome  

  • Euro buoyed as gas flows resume ahead of ECB decision, but turmoil in Italy
  • Earnings lift S&P 500 to 6-week high but stocks mixed today
  • Gold slumps to one-year low as it loses out to rising rates, bullish dollar

All eyes on size of ECB rate hike and new bond tool

The euro is clawing higher ahead of the European Central Bank’s widely anticipated interest rate rise – the first in 11 years – later today. There is some uncertainty as to how heavily the ECB will lean on the hawkish side after it was disclosed that policymakers are considering a 50-basis-point increase despite having signalled a 25-bps hike at the June meeting.

But it’s not just about today’s decision as investors are nervous as to how steep a rate path the ECB will lay out for this year and next. In addition, President Christine Lagarde will unveil a new tool aimed at preventing fragmentation in Eurozone bond markets. Spreads between periphery and core bond yields have widened since late last year as expectations about higher rates kicked in and growth worries emerged.

If the ECB is effective in instilling confidence about its ability to tackle unwarranted spikes in periphery yields, it could be quite powerful in shoring up the euro if it coincides with a hawkish message.

Such a tool also couldn’t have come at a better time amid a fresh political crisis in Italy where Prime Minister Mario Draghi has just handed in his resignation and early elections appear to be the only way out of this mess. The big risk with an election is that Italy could end up with a coalition of far-right parties.

Euro gets gas boost ahead of ECB decision

Nevertheless, the euro has gotten off to a positive start, retesting the $1.02 level, as Europe breathed a sigh of relief after Russia restarted gas flows to Germany, although the initial boost faded rather quickly.

The Nord Stream 1 pipeline is back up and running following a 10-day closure for annual maintenance. However, the early indications suggest capacity remains at the same levels as before the maintenance at about 40% or less, which means countries heavily reliant on Russian natural gas imports such as Germany will struggle to fill up their storage to required levels before the winter months.

Hence, the resumption of gas flows hasn’t changed much as far as Europe’s energy crunch is concerned and the situation could still get a lot worse. There is a danger that if the ECB isn’t as worried about the growth outlook as markets are and presses ahead with an aggressive tightening pace, the euro won’t gain much.

Pound skids again, yen finds some love despite BoJ stance

In other currencies, the pound came back under pressure after an earlier bounce as the US dollar firmed from overnight lows. Although the odds of the Bank of England hiking rates by 50 bps at its meeting next month have risen and this week’s UK employment and CPI data back the case for a larger increment, there is some anxiety about who will be Britain’s next prime minister.

Yesterday’s vote for selecting the final two candidates in the Tory leadership contest put ex-Chancellor Rishi Sunak head-to-head with Liz Truss – the Foreign Secretary. Sunak is seen as a safer pair of hands than Truss, whose more radical policy ideas have investors on edge. So the late surge in support for her could be a drag on sterling until the final results are announced on September 5.

The aussie and kiwi also slipped as risk sentiment deteriorated somewhat during the course of European trading, but the yen was mixed, drawing some safe haven bids even as the Bank of Japan kept its policy settings unchanged. The dollar inched up to around 138.50 yen after the Bank of Japan not only stuck to its ultra-accommodative stance but also maintained its easing bias.

Gold plunges to new depths

The slight risk averse mood was unable to prop up gold, however, as the precious metal sank to a new one-year low on Thursday and is fast approaching $1,680/oz. With interest rate hikes around the world gathering pace now that the ECB is expected to join the tightening club, gold’s appeal as an inflation hedge is fading.

But perhaps more importantly, there’s been no let-up in the US dollar’s strength. Even now, when many market participants are foreshadowing a recession in America later this year, the greenback remains the favourite safe haven for investors that can weather the current economic and geopolitical storms.

Wall Street rebound on stronger footing

In equities, European markets were mostly lower after a mixed session in Asia. US stock futures also dipped as the rebound on Wall Street lost some of its fizz. The S&P 500 closed at its highest in six weeks yesterday after a see-saw session.

With fears of the Fed hiking rates by 100 bps next week dissipating and the earnings so far being better than expected, the latest rebound in stocks is looking more promising than the previous attempts we’ve had this year. Not that any of the earnings have been stellar and quarterly profits across the board are basically down, but margins and guidance have generally been better than feared.

Tesla fell into this boat when it yesterday reported lower vehicle deliveries in Q2 compared to the previous quarter, but its gross profit margins impressed as the electric car maker was able to raise prices.

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