European equities moved modestly higher at the start of the week as declining government bond yields and a weaker U.S. dollar improved risk appetite, with investors increasingly expecting the Federal Reserve to keep interest rates unchanged at its September meeting.
The pan-European Stoxx Europe 600 Index gained 0.2%, recovering some ground after ending a four-week winning streak on Friday. Among the major regional markets, Germany’s DAX advanced 0.2%, France’s CAC 40 was broadly unchanged and London’s FTSE 100 climbed 0.4%.
European sovereign bond yields retreated from the multi-week highs reached recently, providing some relief to equity markets. The move was particularly supportive for growth-oriented sectors, which tend to be more sensitive to changes in borrowing costs and discount rates.
At the same time, the U.S. dollar weakened against major currencies as investors reduced expectations for further near-term Federal Reserve tightening.
Weak U.S. data pushes Fed pause probability towards 70%
Money markets are now pricing in approximately a 70% chance that the Federal Reserve will leave its benchmark interest rate unchanged at its September policy meeting.
Expectations have shifted following a series of softer U.S. economic releases that have weakened the argument for additional monetary tightening in the near term.
Investors have recently digested several important data points, including a weaker-than-expected July employment report showing a contraction in payrolls, Consumer Price Index figures that met expectations, a flat Producer Price Index reading and an unexpected 0.6% month-on-month decline in July retail sales.
Taken together, the figures have reduced concerns that inflationary pressures will require an immediate policy response. That has encouraged expectations that the Federal Reserve can maintain its current policy stance for longer while assessing the direction of the U.S. economy.
For equity markets, the possibility of an extended pause has provided support by reducing fears of another increase in borrowing costs.
Sparse European calendar keeps global risks in focus
Europe’s economic calendar is unusually quiet this week, leaving regional equity markets more dependent on developments in the global economy, bond markets, currencies and commodities for direction.
Several risks that influenced trading throughout August nevertheless remain unresolved.
One of the most significant is the continuing disruption to shipping through the Strait of Hormuz. Diplomatic negotiations between Washington and Tehran over commercial transit remain deadlocked, keeping crude oil prices elevated and maintaining pressure on input costs for energy-intensive European companies.
European equities have already enjoyed a strong summer rally that brought several benchmarks close to record highs. As a result, strategists remain divided over whether equity risk premiums have become too compressed relative to persistently high real borrowing costs.
The second-quarter earnings season is also largely complete. The succession of better-than-expected corporate results that supported European stocks through late July has therefore faded, leaving macroeconomic developments as a more important driver of market direction.
Markets turn to U.S. PMIs and Jackson Hole
Attention is now shifting towards upcoming U.S. economic indicators that could provide the next significant catalyst for global markets.
S&P Global’s preliminary August Purchasing Managers’ Index readings for U.S. manufacturing and services are due later this week. They will be followed by the Federal Reserve’s annual Jackson Hole Symposium the following week.
Investors will examine the data for evidence that economic activity is cooling at a controlled pace. A gradual slowdown would strengthen expectations for a soft landing while supporting the case for the Federal Reserve to keep rates unchanged.
Markets will also be watching closely for any signs that inflationary pressures are rebuilding, which could challenge the increasingly widespread expectation of an extended policy pause.
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