Keep Calm And Carry On

The Bank of England is likely reminding itself to "keep calm and carry on" after new data last week showed Britain’s inflation rate came in much higher than expected in April. European firms might also want to be reminding themselves of the same saying as they contend with a growing headache: a weaker dollar. That could spell trouble for a key European stock index, whose companies rely on North America for nearly a third of their sales. Elsewhere, the price of copper hit its lowest level since November last week, sounding an ominous alarm considering the red metal's status as an economic bellwether. Finally, something unusual is happening in the crypto world: ether is demonstrating less volatility than bitcoin, and that can have important implications for the world’s second-biggest cryptocurrency. Find out more in this week’s review.

Macro

The latest inflation report showed consumer prices in the UK increased by 8.7% last month from a year ago – a sharp drop from March’s 10.1% rate as last year’s sky-high energy prices fell out of the annual comparison. However, the decline was much lower than the 8.2% expected by economists as well as the 8.4% predicted by the Bank of England (BoE) itself. And this is where things got really worrying: core inflation, which strips out volatile food and energy components, accelerated from 6.2% in March to 6.8% last month – its highest level since 1992. The prices of services also registered their biggest year-on-year increase in more than three decades.

These two indicators of underlying price pressures (core and services inflation) are closely watched by the BoE, and the fact that both of them accelerated last month makes it more likely that the central bank will continue raising rates through the summer. In fact, interest rate futures are now pricing in almost a full percentage point of hikes through the end of the year. This implies that the BoE will reach a peak rate of around 5.5%, compared to the 5.1% seen the day before the release of April’s inflation data.

Stocks

The outperformance in European stocks this year was built on three key pillars: the avoidance of a full-blown energy crisis; the relative stability of the bloc’s banking sector; and hopes that the removal of lockdown measures in China would result in booming luxury sales, boosting profits at Europe’s prominent luxury goods firms. While the first two have held up, the third of these legs is looking a little shaky, with recent Chinese data showing scant evidence of the fast growth and big spending some had hoped for. And now, Europe's firms are contending with a new headache: a weaker dollar. 

Since September, the euro, Swiss franc, and British pound have all appreciated by more than 10% versus the dollar, with several analysts anticipating further gains driven by the currencies’ diverging monetary policies compared to the greenback. For businesses with overseas operations, a stronger currency at home is a double-edged sword. It helps lower imported inflation – crucial at a time when companies are suffering from high input costs. But it also makes their products pricier for overseas buyers, potentially lowering sales. What’s more, it diminishes the value of foreign earnings when converted into the firm’s home currency.

A weaker dollar could spell trouble for a key European stock index (the Stoxx 600), whose companies rely on North America for nearly a third of their sales. As a rule of thumb, a 10% rise in the euro shaves 2% to 3% off earnings-per-share growth for European companies, according to a senior equity strategist at Goldman Sachs. But some sectors are more at risk than others, with Europe’s telecommunications, health care, media, and consumer staples companies generating the greatest proportion of their revenue from North America.

Commodities

Copper’s many industrial uses – construction, transportation, infrastructure, and more – make it an extremely useful economic bellwether (i.e. a good gauge of how the global economy is doing). So somebody please call an ambulance: the price of the red metal sank below $8,000 a ton last week, hitting its lowest level since November on the back of tumbling demand and ample supply. Copper’s demand weakness is most apparent in the increased inventories held by the London Metal Exchange, which have nearly doubled since mid-April. Meanwhile, a key spread is also indicating an oversupply situation, with copper's spot price currently $66 per ton lower than three-month futures on the LME. This represents the widest contango, where futures trade at a premium to the spot price, on record based on data going back to 1994.

Industrial metals have come under renewed pressure lately after a slew of data in recent weeks indicated that the post-virus rebound in China is stuttering. Official figures out earlier this month, for example, showed industrial output, retail sales, and fixed investment in the world’s second-biggest economy grew at a much slower pace than expected in April. And unlike in previous economic slowdowns, policymakers in China are refraining from implementing significant spending packages on infrastructure or property, depriving metals of a safety net. That’s pushing investors to increasingly write off the prospects for a decisive economic recovery in China this year, which would further add to copper’s woes considering that the country consumes around half the world’s supply of the red metal.

Crypto

A unique shift has emerged in the cryptocurrency market recently: ether is demonstrating less volatility than bitcoin – both on an implied, forward-looking basis and on a realized, historical basis. The T3 Ether Volatility Index – a measure of implied 30-day price swings in the cryptocurrency derived from options prices – trails a comparable gauge for bitcoin by a margin not seen since at least 2021. That's unusual because ether and alternative cryptocurrencies generally tend to be more volatile than bitcoin.

At the same time, the difference between the 180-day realized volatility (or historical volatility) of ether and bitcoin is at its smallest since 2020. What’s driving this trend? Some investors point to ether’s staking yield, which has been increasing this year and is now in the high-single-digits. A higher yield could suppress volatility as it encourages more traders to stake their ether. (Staking is when users lock up their existing coins for a fixed period to help operate the blockchain network and earn rewards). Bitcoin’s blockchain, meanwhile, has recently been roiled by an explosion of NFTs and memecoins after an upgrade allowed the two to be deployed on the network for the first time.

Why should investors care? Well, according to some prominent crypto watchers, ether’s relatively tame behavior could spell good news for the world’s second-biggest cryptocurrency by attracting more long-term investors. That’s because lower volatility typically encourages big institutional investors to allocate more capital to the crypto since it becomes cheaper to buy protection on it via options contracts and easier to manage overall risk exposures. Time will tell whether these dynamics prove to be the catalyst that pushes ether to break out above $2,000.

This week

• Monday: Nothing major (29 May is a public holiday in many countries).
• Tuesday: Japan unemployment rate (April), US consumer confidence (May), eurozone business climate and economic sentiment indicators (May). Earnings: Hewlett Packard.
• Wednesday: India GDP (Q1), Japan retail sales (April), Canada GDP (Q1). Earnings: Salesforce, CrowdStrike.
• Thursday: Eurozone inflation (May) and unemployment rate (April), minutes of the ECB’s latest meeting, China manufacturing PMI (May). Earnings: Broadcom, Zscaler.
• Friday: US job market report (May).