Markets Surge After Optimistic Economic Data
European stocks climbed to their highest levels since February 2022 on Friday, with major indexes like the FTSE 100, DAX and Euro Stoxx 600 all seeing gains over 1%. The rally came after upbeat U.S. jobs data provided hope that inflation pressures may be easing faster than expected.
Investors are increasingly betting that major central banks like the Fed, ECB and Bank of England will start cutting interest rates in 2024 if inflation continues trending down. This optimism of potential rate cuts ahead has fueled the recent rise across European equities.
“European indexes are hitting near pre-pandemic levels on building confidence that the worst of inflation and aggressive rate hikes may be behind us,” said Mark Wilson, chief market analyst at IG. “The U.S. labor market remains exceptionally resilient, with hiring still strong while wage growth is beginning to ease back from painful highs.”
Miners, Tech and Luxury Shares Outperform
Mining and technology shares led the gains on European bourses last week, while luxury names like LVMH and Richemont also saw substantial increases.
The critical mining sector rebounded from previous losses, with iron ore producer Rio Tinto adding over 11% and diversified major Glencore climbing nearly 4%. Chipmakers like ASML Holdings and Infineon Technologies rose over 4% each.
Luxury goods providers have been standout winners in 2022, driven higher by robust demand from U.S. and Middle Eastern shoppers benefiting from a strong dollar and high oil prices. LVMH gained over 6% last week while Richemont was up over 3%, helping lift European indexes.
Analysts think these sectors could see continued momentum if markets grow more confident inflation and rates are peaking. Lower rates would benefit high-growth tech names, while easing price pressures may boost economic activity and raw material demand.
Key Index Performances Last Week
| Index | Gain |
|---|---|
| Euro Stoxx 600 | 1.3% |
| DAX (Germany) | 1.1% |
| FTSE 100 (UK) | 1.5% |
| CAC 40 (France) | 0.6% |
Focus Turns to Critical U.S. Inflation Data
Markets across Europe edged up slightly early this week ahead of critical U.S. CPI inflation data due on Tuesday. The figures will provide key insight into whether price pressures are easing at the pace necessary for the Fed to slow its monetary tightening cycle.
Most economists expect the headline inflation rate to fall from 7.7% to 7.3% in November, with the core rate dropping from 6.3% to 6.1%. Such declines would be signals that unprecedented Fed rate hikes this year are having the desired cooling effect on the economy and prices.
If inflation comes in lower than the forecasted figures, it could spark a relief rally in European indexes on optimism of a “soft landing” scenario playing out. However, upside may be limited ahead of several central bank decisions later in the week.
The Fed, ECB and Bank of England all have monetary policy verdicts on Wednesday and Thursday, where they are universally expected to raise rates by 50 basis points each – their smallest hikes in several meetings.
Investors Anticipate Rate Cuts in 2024
Remarkably, despite major central banks still raising rates this week, investors are increasingly pricing in interest rate cuts commencing in 2024. This largely reflects growing hopes that the battle against inflation will tilt favorably enough over the next 12 months to warrant policy easing.
“Market expectations for European Central Bank rate cuts next year is emblematic of broader hopes globally that inflation will come down quick enough for central banks to reverse course,” explained Mark Hackett, Nationwide’s chief of investment research.
For example, fed fund futures suggest about a 65% chance that the Fed implements rate cuts by December 2023. And swaps trading implies roughly 50 basis points in ECB rate reductions next year. If energy prices continue descending, wage growth moderates and demand softens to more sustainable levels, these bets on 2024 rate cuts may well prove prescient.
Major Risks: Recession and New Covid Wave in China
However, European stocks advancing over 15% in less than two months indicates investor optimism may be getting ahead of reality. Significant risks that could derail the recent euphoria still lurk.
Most concerning is the chance of recessions in major economies like the U.S., Europe and U.K.next year as borrowing costs restrict growth. Though a modest downturn is already largely priced in, a deeper slowdown than anticipated could spark a sharp reversal in equities.
Another worrying development is the explosion of Covid cases in China as it abandons strict zero-Covid policies. While this may ultimately prove cathartic, the huge infection wave risks hampering near-term economic activity and global supply chains. This is bearish for European exporters and manufacturers.
Finally, if inflation declines fail to materialize as quickly as markets now expect, central banks would be forced into more aggressive rate hikes – jeopardizing recent optimism.
Outlook for 2023
Despite these ongoing risks, the overall outlook for European stocks appears markedly brighter than just a month ago when indexes hovered around 2-year lows.
UBS analysts note that euro-zone equities remain inexpensive from a historical basis, trading at just 12 times forward earnings with a 4% dividend yield. This suggests room for additional upside as macro conditions incrementally improve.
Most experts predict modest single-digit returns for key benchmarks like the STOXX 600 next year – though gains could exceed 10% if inflation falls sharply and central banks successfully engineer soft landings. Still, markets likely face high volatility amid myriad crosscurrents in early 2023 before confirming more sustainable uptrends.
So while the latest surge reflects optimism that the worst economic and market turmoil is fading, European indexes have plausible upside but also remain prone to pullbacks as the region navigates persistent uncertainty.
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