Markets staged a rather bright start to the new year, especially in Europe. Though 2022 was a year most market participants would sooner forget – the first calendar year ever where total returns on the S&P 500 and US 10Y Treasuries were both lower than -10%, and global bonds and equities together lost over $30tn of value (almost 1.5 US economies!) – its dominant theme of inflation’s trajectory and central banks’ consequent monetary moves has not gone away. European markets led the way this week, aided by a series of encouraging downside inflation surprises. First Spain’s December print came in at 5.8% YoY, down from 6.8% in November, then came Germany’s at 9.6% (down from November’s 11.3% and the first single-digit reading since the summer), followed by France with 6.7% (versus 7.1% the previous month). All of these handily undershot consensus estimates and sparked successive daily rises for European stocks. Despite lightly paring the gains yesterday, by Thursday’s close the Euro Stoxx 50 (+4.4%), CAC 40 (+4.4%), DAX 40 (+3.7%), and Switzerland’s SMI (+3.1%) were all up appreciably YTD and today resumed their climbs as the full Eurozone’s inflation print was released. This, too, marked a sharper cooling than anticipated, at 9.2%, following two months of double-digit price surges. European yields declined (the German 10Y Bund closing as low as 2.27% on Wednesday), while the euro strengthened against the dollar. While cooling economies are part of the picture (German factory orders are down), continued easing of supply disruptions and above all tumbling energy prices are a major boon. European natural gas futures have dropped to a one-year low of €62.75 per megawatt-hour, down more than -80% since the summer and erasing the stinging premium resulting from Putin’s energy blackmail. Abnormally warm weather across the continent is helping as January temperature records melt from Spain (25°C, 11 degrees warmer than the 14°C average) to Poland (19°C on New Year’s Day in Warsaw, compared to an average January high of 1°C), cutting demand and enabling storage levels to remain unprecedentedly high for this time of year. Given what it says about the damage to our environment, multi standard deviation temperature shocks would ordinarily not be something to celebrate. But it is a grim irony of this era of so-called polycrisis that what is a source for optimism in one dimension of crisis is terrible news for another. Either way, markets are taking heart from signs European inflation has peaked and are betting the ECB will be less hawkish in 2023 than previously anticipated. Futures now price peak Eurozone rates of 3.37% in July, down from the 3.50% previously priced. However, while welcoming these first signs of cooling, we emphasise that European inflation is still historically high and the ECB remains adamant about its hawkish intent.
US stocks have been far more reticent participants in the week’s gains – indeed, they may yet close out the week in negative territory. They got off to a slow start, the S&P 500 (-0.4%) and Nasdaq (-0.8%) both falling on Tuesday’s first day of trading. Tesla was the day’s worst performer, falling -12.2% after announcing lacklustre new vehicle deliveries, while Apple was also a major drag as slipping demand, disrupted production, and a -3.7% share price decline saw its market capitalisation fall back below $2tn (it broke through the $3tn mark a year ago). Both indices climbed on Wednesday before returning to the red on Thursday, as release of hawkish Fed FOMC December minutes put the brakes on nascent momentum. However, as we went to press, today’s US jobs report showed a fifth consecutive monthly deceleration in jobs growth and below-expectations wage gains, sparking renewed stock market gains as investors interpreted it as a sign that the Fed’s existing hikes were taking effect, lessening the need for more constriction. Whether US stocks make it to the weekend in the green, an appreciable gap has opened up behind European shares; by yesterday’s close, the European blue chip index was 5 percentage points ahead of its American cousin. European stocks also remain more attractively valued, with a forward price/earnings ratio of 11.9x for the Euro Stoxx 50, compared to 16.8x for the S&P 500.
In our last letter we flagged many of the questions looming over markets in 2023. One we did not namecheck but which will grow increasingly important as the year progresses is what direction US politics will take – most concretely in the form of who will represent the two major parties in the 2024 Presidential Elections. Developments on Capitol Hill this week – or perhaps rather the lack thereof – point to just how fraught this question is likely to become. Following November’s mid-term elections, a new session of Congress began this week, its first item of business the selection of a new Speaker of the lower House of Representatives. Having gained a majority in the House in November, the Republicans seize this powerful role from the Democrats’ Nancy Pelosi. However, what had been forecast as a mid-term Republican ‘red wave’ or even ‘red tsunami’ – not least by the Grand Old Party themselves – turned out to be a mere red ripple lapping anticlimactically at the lower reaches of Capitol Hill. The Republican majority in the House is slender. And cementing the best mid-term showing for an incumbent presidential party in over two decades, Joe Biden’s Democrats not only fended off major GOP gains in the House but also extended their own control of the Senate. Though not mandated by the Constitution, historical precedent dictates that the majority party’s Leader in the House – in this case, Kevin McCarthy, Republican Leader for the last four years – should be a shoo-in for the Speaker job, requiring a simple majority in a House vote. However, amidst recriminations at November’s mediocre showing and the ongoing fallout from Trump’s presidency – and attempt to overturn his electoral defeat – the Republicans are divided and uncertain of the way forward. The Republicans’ narrow majority giving him a 4-vote margin of error, McCarthy on Tuesday because the first Majority Leader in over a century to fail to win the Speakership at the first vote. He has gone on to collect lost votes like Sam Bankman-Fried collects Bahamian real estate – racking up 11 defeats and counting as we went to press – as a group of 20 radical-right rebels entrenched, vowing ‘Never Kevin’, despite a series of McCarthy concessions. The tussle will resume later today, with it guaranteed to be the first race to require 12 votes since 1821 – and perhaps more. McCarthy and his supporters have clearly opted for a war of attrition but it remains possible he will be forced to concede in favour of some other candidate – but no signs of a credible alternative have yet emerged.
The tug-of-war for the Speakership is important in its own right. The Speaker’s gavel, when wielded to the full, is one of the most powerful forces in US politics. Formal powers include setting the legislative agenda, controlling committee assignments, and determining the House’s work calendar, including votes. The informal powers of a skilled Speaker go well beyond that, marshalling the party’s legislative forces behind the scenes. The Speaker is also second in the presidential succession, a couple of heartbeats from the presidency, as it were. McCarthy – or whoever ultimately wins the Speakership – will need considerable political skill to make full use of the Republicans’ small majority but would be in a position to stymy Biden’s agenda for his remaining two years and to determine how the US responds to a plethora of issues, not least its ongoing support to Ukraine. That things have got off to such a bumpy start suggests this will be a highly volatile Congressional session. However, McCarthy’s struggling bid is also a telling bellwether for the state of play in presidential politics, ahead of the 2024 election. Former President Trump is to date the only Republican to have officially declared a 2024 run but his political capital is decidedly on the wane. Many mid-term candidates personally endorsed by Trump were soundly beaten, the Mar-a-Lago Emperor’s imprimatur seen by many as having sealed their fate. His role in the failed 6 January putsch is in danger of catching up with him; the House Select Committee investigating the insurrection in December recommended the Department of Justice pursue criminal charges against him. Other legal troubles are also mounting, including relating to his financial dealings and seeming theft of secret government documents. Polling is beginning to whisper that Trump no longer has the grip on the Republican grassroots that once he had. Tellingly, his characteristically solemn intervention in the Speakership battle this week (‘VOTE FOR KEVIN, CLOSE THE DEAL, TAKE THE VICTORY’) fell on deaf ears, despite the holdouts being amongst the Representatives most closely made in Trump’s political image. Without wanting to jump the gun with premature predictions this far out (primaries only get underway in earnest in January 2024), it is looking increasingly unlikely Trump will secure his party’s nomination. Nonetheless, if his legal troubles do not disbar him, a potentially vicious – and unpredictable – primary race looms.
Diverting though this drama amongst the politicos has been, it has not this week been enough to move markets. However, a whole host of possibilities that flow from it have that power in abundance – not least the implications for Congress’ spending decisions. It is early days yet, though, and we will be keeping a close eye on the US political landscape as it shapes up this year, especially as Republican challengers finally dare to throw their hat into the ring against the Donald. And that is before we even come to the question of whether Joe Biden will declare a 2024 run or rather quit whilst he is ahead and bring a long political career to an end (he will be 82 in 2024 and has spent half a century in Washington). In the meantime, this week’s data releases show a possible macroeconomic turning point on both sides of the Atlantic – but the picture remains unclear and the real question on inflation (and thus rates) will remain less about the peak, more about the persistence.
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