Stocks drift lower, Italian political risks to the fore

Flattish start to trade in Europe this morning morphed into a more obvious decline shift after a down day on Wall Street following the CPI report. US inflation remains super-hot at 9.1% year-on-year in June, +1.3% month on month. Core also hot at +5.9% vs 5.7% expected. Markets price in about a 75% chance that the Fed will raise rates by 100bps at its July meeting, pricing in much more aggressive tightening than prior to the report. I think this is about right; the Fed has been very clear about where it stands on inflation and the strength of the labour market means there is no real reason not to go big. Atlanta Fed’s Bostic said “everything is in play” for the next FOMC meeting, while Cleveland Fed’s Mester declined to rule out a 100bps move. Moreover, the Fed had kind of painted itself into a corner where it needs to up the ante whenever inflation moves higher to remain credible.

Market reaction to the print was sharp. We got a fresh 20-year high for the USD…front end yields up sharply and inversion got worse with the 2s10s inversion north of 25bps, the widest in many years. The S&P 500 declined almost half a percent but held onto 3,800 at the close – futures are indicating a lower open today. Gold was sold in big volume as yields and the dollar jumped. My feeling is this could be an opportunity as inflation expectations are too low and the Fed won’t go as far as it needs to go. Bitcoin fell too but tried to recapture $20k this morning. Oil weakest since April but front month WTI holds its 200-day moving average. 

Italian bond yields marched higher as the Five Star Movement chose not to take part in a confidence vote today, which could knock out the Draghi government…this is a big headache for the ECB as it looks to deal with fragmentation risks from its gentle tightening. The yield on Italian 10yr BTPs jumped to almost 3.35% from a little above 3.1% earlier. The political uncertainty means Italy’s spread with German bunds has moved to a month high. This is exactly what the ECB is seeking to avoid and makes the job of raising interest rates harder. 

Attention now shifts from the inflation story to earnings with JPMorgan and Morgan Stanley due to unofficially kick off earnings season today. My sense is that this will be a quarter that triggers analysts to downgrade their forward earnings estimates. 

Twitter shares rallied almost 8% to $36.75 as the arbs bet on the company winning its case against lawsuit. Now whilst the Delaware courts may not enforce ‘specific performance’ and force Musk to buy the company at $54.20, they could easily award the kind of damages that would dwarf the accumulated profits made by Twitter over the last 15 years or so, which would be kind of useful.