S&P 500 Wearily Eyes Key CPI Data, Ukraine War, World Bank Report

S&P 500 ANALYSIS, UKRAINE WAR, ECONOMIC OUTLOOK, CPI DATA – TALKING POINTS

  • European Union phasing out Russian oil likely to hurt regional growth
  • OECD and World Bank reports will shed light on the economic outlook
  • S&P 500 bounce from late-mid May could be giving investors false hope

UKRAINE WAR UPDATE

The Defense Secretary of the UK recently announced that his country will be sending long-range missiles to Ukraine and training local forces on how to use them. This comes despite threats from Moscow that doing so would escalate the conflict. Specifically, President Vladimir Putin warned that Russian forces will strike at facilities that are storing these missile systems.

The military hardware (multiple-launch rocket systems, or “MLRS”) is not unlike the weapon system the US recently shipped to Ukraine as part of a US$700 million military package. However, US President Joe Biden made it very clear that long-range missiles will not be sent to the embattled country.

READ MORE: How to Trade the Impact of Politics on Global Financial Markets

The West and its allies are ramping up economic pressure too. European Union leaders recently agreed to ban the majority of Russian oil imports, specifically by seaborne vessels. The distinction is crucial: negotiations were held up by Hungary, who (along with other landlocked countries) argued that a complete ban by pipelines would drastically increase energy prices. A compromise was reached.

90% of Russian oil imports will be banned by the end of the year, apart from Hungary and its geographically similar peers. However, Europe runs the risk of shooting itself in the foot if what is politically profitable in the short term and turns out to be economically (and maybe geopolitically) costly in the long term. See my thoughts on the matter here.

Furthermore, European leaders agreed to cut Sberbank – the largest Russian bank – from the Society for Worldwide Interbank Financial Telecommunication (SWIFT). This is a crucial correspondence system enabling banks to process payments internationally. These punitive measures come as Russia continues to press its attack in the Donbas region (consisting of the breakaway territories of Luhansk and Donetsk). How will all this impact financial markets?

For more updates on geopolitical risks, follow me on Twitter @ZabelinDimitri.

Increased military escalation by Russia against Ukraine could prompt the West to impose additional punitive measures to increase the economic cost of the invasion. However, as seen in Europe, this could undermine regional economic dynamics if the supply shock from sanctions reverberates back to the issuer and increases inflationary trends.

Central banks as a result may be more inclined to ratchet up their rhetoric and policy on raising rates to combat aggressive price growth. However, if economic fundamentals erode and credit conditions tighten, investors may have little to look forward to. As a result, growth-oriented assets (such as stocks and commodity-linked currencies) would likely suffer.

S&P 500 – Weekly Chart

S&P 500 chart created using TradingView

Looking at the S&P 500 index over a weekly time horizon shows its spectacular decline from an all-time high of 4818.62, to now just barely above 4100. While there has been a bounce since mid-late May, this in no way suggests with certainty that a full-blown recovery is in the cards. If anything, given the macro-fundamental circumstances, this may be a short-term retracement in an otherwise steep, longer-term decline.

GLOOMY PRESENTIMENTS AHEAD?

Markets may also get dampened by two key publications coming out this week. On Tuesday, the World Bank will be releasing its Global Economic Prospects report, which is likely to contain gloomy overtones. The following day, the Organization for Economic Co-operation and Development (OECD) will be releasing its biannual Economic Outlook.

Both reports will likely flag major macro-fundamental risks such as the Ukraine war, and how disruptions there are amplifying supply chain bottlenecks linked to COVID-19. Rising commodity prices from persistent demand and lagging supply fanning the flames of inflation and prompting central banks to raise rates will also almost certainly be a headline risk.

Tightening credit conditions will perhaps be one of the biggest threats to financial stability. Investors have enjoyed a long ultra-easy credit regime, which has fueled the proliferation of complex derivatives that were issued with increasingly-fewer protections. Rising interest rates will test their integrity, and the instability that could follow will likely spill over into equities and drag the S&P 500 down.

See my breakdown of the collateralized loan obligation (CLO) and leverage loan market

KEY INFLATION DATA

On Friday, China will be publishing its year-on-year CPI and PPI data for May, with economists expecting 2.2% and 6.5% figures, respectively. The US will be publishing similar statistics, with estimates of an 8.2% increase on a year-on-year basis for CPI, and 0.7% on a month-on-month basis. Will it impact markets?

With inflation at the forefront of policymakers’ minds, higher figures will likely buttress hawks at the Fed and the People’s Bank of China (PBOC). Interest rate futures suggest traders are already expecting another 50 basis point rate hike from the Fed, so the inflation report this week will almost certainly not affect that decision. However, if CPI data surprises to the upside, investors may panic at the prospect of accelerated stimulus withdrawal in the coming months. Equities would pay a price in this scenario.

{{RESERCH|DNAFX}}