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Weekly Focus – Recession Fears Dominate

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After a constructive start to the week, risk sentiment soured again as recession fears crept back into markets, with equities trading heavy and global yields moving lower. However, the discussion regarding the ECB anti-fragmentation tool has brought some stability to the closely-watched 10Y Italian-German government bond spread, which has fallen back below 200bp. After surprising resilience during the spring, rising global growth concerns took their toll on oil prices this week and Brent Crude has fallen back to 111 USD/bbl. The broad USD strengthened and cyclically sensitive currencies like NOK and SEK traded on the back-foot, despite Norges Bank surprising with a hawkish 50bp hike at the June meeting (read more in Reading the Markets Norway, 23 June). The JPY slide has also resumed this week, after Prime Minister Kishida confirmed his backing of Bank of Japan’s continued yield curve control.

Markets’ recession fears were further stoked by gloomy PMIs reports for June. The euro area economy registered a noticeable slowdown in the growth pace at the end of Q2, as the tailwind to services from pent-up demand is already fading amid the cost of living squeeze to consumers and manufacturing production fell for the first time in two years amid ongoing supply chain disruptions and weakening demand prospects. But the slowdown was not contained to Europe, as also US PMIs fell well short of expectations, with a noticeable drop in demand for goods and services compared to prior months and deteriorating forward-looking indicators. A positive side-effect of weaker demand are easing pressure on prices, with input and output cost measures increasingly pointing to an approaching peak in inflation on both sides of the Atlantic and supplier delivery times also continuing to normalize.

French President Macron’s party and allies lost their absolute majority in parliament, while hard left and far right parties gained. Weeks of negotiations will now follow, as Macron has to seek allies from rival parties, but he will face difficulties in implementing his ambitious reform agenda. The election result points towards an increasingly divided France and political uncertainty is just returning at a time when the economy has lost steam and fiscal vulnerabilities have resurfaced with rising public borrowing costs. While he retains significant powers over foreign and defence policy, a challenging second term awaits Macron on the domestic front.

Next week, markets will keep a close watch on the ECB’s Sintra forum. Focus is on any discussions of the new anti-fragmentation tool and we particularly look forward to Lagarde’s speech on Tuesday at 9:00 CET, and on Wednesday at 14:30 CET, Bank of England’s Bailey, BIS’ Carstens and Fed’s Powell will join Lagarde for a policy panel. We also keep an eye on headlines from the G7 meeting ending on Tuesday, where leaders will discuss solutions to the global food crisis and a possible “price cap” on Russian oil. Euro area HICP inflation (Friday) will likely show a further increase in headline and core inflation (Danske forecast: 8.6% and 4.0%, respectively), keeping the pressure high on ECB to hike policy rates. In China focus will be on the PMI’s for June (Thursday), which we expect to show a further rebound after the Shanghai lockdown ended, which could help calming global recession fears somewhat.

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