European stocks tank as recovery concerns mount

European stocks are sinking lower, reversing gains from the previous session following a weak handover from Asia.

While stocks have been on a tear, hitting all-time highs last month, the mood in the markets is starting to sour. Concerns over the health of the economic recovery are denting risk sentiment and hitting demand for stocks even as the Federal Reserve moves towards tapering asset purchases.

Inflation concerns and fears that the Federal Reserve could move to start tightening monetary policy have been lingering over the past few weeks, particularly since its hawkish shift at the June meeting. The minutes from the Fed’s June policy meeting confirmed that the central bank is moving towards tapering its asset purchases, potentially as soon as this year. However, the minutes also revealed that more evidence of a robust economic recovery would be needed to set a more defined timeline for tapering.

Interestingly the minutes come as the bond market continues to show traders are increasingly less concerned with the risk of rising inflation and interest rate rises. This is pretty much the polar opposite of what some Fed policymakers appear to be worried about when they adopted the view of two interest rate rises in 2023. This certainly isn’t the first time the bond market and the Fed have been out of sync this year. Today, bond yields continue to slump lower. The yield on the 10-year treasury has tumbled to 1.26%, a fresh four-month low.

The overriding concern being reflected in the bond market is that peak growth has been reached, and the benefits from fiscal policy are starting to fade. Recent data has been disappointing. The Citigroup Economic Surprise Index is at its lowest level since February.

Banks in Europe are taking the biggest hit on the back of falling government bond yields. Other cyclical stocks such as automotive and miners are also firmly out of favour on global growth concerns.

Looking ahead, attention falls firmly on the US jobless claims data due later today. Expectations are for initial jobless claims to fall to 350k, down from 364k the previous week. This would be a new post-pandemic low and support the view that the US labour market is continuing along a steady but not too strong path to recovery.

FX – Euro capitalises on weak USD, ECB strategy report in focus

Despite the Fed’s hawkish bias appearing in the FOMC minutes, the US dollar is following bond yields lower. The greenback continues to edge away from the three-month high reached overnight.

The euro is outperforming its major peers, benefitting from the weaker USD even as investors expect the ECB to push the goalposts back for raising interest rates.

Following an 18-month policy review, the ECB is expected to set its inflation target at 2%, ditching the previous “below but close to 2%” stance. The central bank could also say that an overshoot beyond 2% is ok. Typically, this would have a negative impact on the value of the euro. However, today USD weakness is in the driving seat.

For a look at all of today’s economic events, please check out our economic calendar at www.marketpulse.com/economic-events/

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