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Lagarde Gives The Dollar What It Needed — A Peak

The ECB chief’s blog post laying out a more hawkish policy for euro will come as a relief to multinationals and emerging markets.

<div class="paragraphs"><p>European Central Bank President Christine Lagarde.</p></div>
European Central Bank President Christine Lagarde.

The $1.07 Blog Post

The US dollar might just have peaked, and if it has then a blog post by Christine Lagarde has a lot to do with it. The president of the European Central Bank chose Monday morning to post an essay to the ECB website, effectively setting out a new and more hawkish policy. Both the policy itself and the fact that she had felt the matter so urgent that she needed to launch it online between meetings helped strengthen the euro significantly against the dollar. The leap almost to $1.07 is clear from a currency chart:

Lagarde Gives The Dollar What It Needed — A Peak

Effectively, she outlined a rationale for the ECB to turn away from a decade of aggressively dovish monetary policy and committed the bank to two interest rate hikes by September, which would bring its overnight interest rate back up to zero. That is still a lenient monetary policy by any definition, but after years of negative rates it’s a big deal. Here is the key passage from her blog post:

It would be hard to make that much clearer, even if she could have stated it a little more directly. The ECB has form for effectively promising monetary policy moves months in advance. Jean-Claude Trichet, one of Lagarde’s predecessors, developed a code with reporters; if he said in a press conference after a board meeting that the ECB had an attitude of “extreme vigilance,” that meant there would be a rate hike at the next meeting. In 2022, “extreme vigilance” means getting rates back up to zero within four months.

The reasons for concern about the eurozone economy are legion, even before a neighbor was invaded in a land war and access to energy was thrown into doubt. But even if fear for the future has a sound foundation, confidence in the business sector remains strong. The latest IFO survey showed optimism rising, and higher than it was during the eurozone’s sovereign debt crisis a decade ago:

Lagarde Gives The Dollar What It Needed — A Peak

Strong macroeconomic news combined with a more hawkish Lagarde to push up estimates for target rates by the end of this year. The first three months saw a wide gap open between the Federal Reserve and the ECB, with the estimated spread of US over eurozone overnight rates as of the central banks’ meetings in December this year rising by more than a percentage point. The following chart illustrates this using the Bloomberg WIRP (World Interest Rate Probabilities) function, and also shows that increasing US rate expectations strengthened the dollar:

Lagarde Gives The Dollar What It Needed — A Peak

The difference between the two central banks now seems to have been priced in, and the belief is that they may even converge a little. That weakens the dollar, which is a relief to more or less everyone. A lower dollar should buoy US corporate profits by flattering multinationals’ overseas earnings. It also eases pressure on emerging markets at a time when they could use some relief:

Lagarde Gives The Dollar What It Needed — A Peak

Later in the day, comments from Raphael Bostic, head of the Atlanta Fed, that a pause in rate hikes as early as September might make sense represented the first hint in a dovish direction from the Fed in some months, and helped ensure that the euro maintained its gains. It’s still too soon to say with any confidence that the dollar is now into a weakening trend, but its decline is another indication that the “stagflation and ever-higher rates” narrative is being rethought.

Profits of Doom

Corporate earnings are beginning to matter a lot. For an indicator, look no further than after-market trading, when Snap Inc., owners of Snapchat, announced that earnings would be below the lower end of expectations, and were rewarded with a 35% slash to their share price (while Meta Platforms Inc., owner of Facebook, dropped 9% at one point). You can read the Snap CEO’s letter to staff here.

The market reaction to that news was emphatic, as it has been when other big companies announced disappointing earnings or guidance. But this conceals a more complicated picture. Expectations for S&P 500 margins for the whole of this year have begun to move downward, but remain very high. There is room for a lot more disappointment:

Lagarde Gives The Dollar What It Needed — A Peak

Meanwhile, the direction of earnings revisions has turned negative, as graphed here by Bloomberg Opinion contributor Jim Bianco of Bianco Research LLC. There’s nothing particularly surprising about this; it’s the natural way of things for earnings estimates to be talked down as companies look to give themselves a lower bar to clear. But this follows an unusually protracted period when earnings were forever being revised upward:

Lagarde Gives The Dollar What It Needed — A Peak

However, Bianco also offers this chart using Bloomberg data. For a brief period earlier this year, company guidance turned negative. In other words, companies announcing lower forecasts (like Snap on Monday) outnumbered those revising their guidance higher. But that’s over. After a while to digest the impact of the Ukraine conflict and rising costs, companies are once again guiding estimates upward:

Lagarde Gives The Dollar What It Needed — A Peak

Much noise remains from the pandemic. As Savita Subramanian of Bank of America Corp. shows, there is a fall in the projections for  sellers of the “big ticket” consumer durable items that dominated the pandemic, while income from the services sector is now expected to rise. The turn in the forecasts happened swiftly with the start of the earnings season. Meanwhile, the dominance of Nasdaq 100 companies’ earnings as a proportion of S&P 500 earnings has begun to decline:

Lagarde Gives The Dollar What It Needed — A Peak

As for lessons for the macro environment, the message is still indistinct, but concerning. As Subramanian shows from an analysis of earnings call transcripts, complaints about weak demand jumped in this quarter to more or less the same extent in both the US and the eurozone. That might give ballast to the notion that inflation is leading to demand destruction:

Lagarde Gives The Dollar What It Needed — A Peak

But if concern about weak demand is growing, it’s still a long way from universal. This is from the summary of earnings calls published by Deutsche Bank AG’s investment strategist Bankim Chadha:

These are all polite ways of admitting to investors that inflation might soon make it harder for them to make sales. But on balance, it’s surprising how many companies remain confident that they have enough pricing power to keep selling. That’s good news for margins and share prices, except it implies more of an inflationary problem and therefore a greater risk of higher rates. This is Chadha's summary on the topic:

The macro conclusions to be drawn from this earnings season, then, were very much in the eye of the beholder. The fall for share prices so far this year, and the latest shocked reaction to the news from Snapchat, suggests that the average beholder tends still to be alarmed by the prospect of higher rates, and looking for excuses to sell rather than to buy.

Nut Jobs, Climate Change, and Responsible Investing

I have a viewing recommendation: Watch this video, of Stuart Kirk, head of responsible investing for HSBC Asset Management, speaking at a conference held by the Financial Times’ Moral Money newsletter last week. It’s entitled, “Why investors need not worry about climate risk.” HSBC’s corporate position is that investors should indeed worry about the climate, and as a result Stuart has been suspended. You can read about the ins and outs of the case here, here, and here. Stuart is a good speaker who was once the president of the Cambridge Union debating society, and he may have made his case a little too well (a sample: “After 25 years in the finance industry, there was always some nut job telling me about the end of the world,”) so I do recommend watching his presentation if you have 15 minutes to spare. 

Although I have a lot of thoughts about this, it would be inappropriate to share them because (Full Disclosure) Stuart used to be my deputy when I was head of the Lex Column at the Financial Times, and he succeeded me in the job when I moved on. We know each other. My sympathies are with him on this, although I can also understand the HSBC side. I would, however, be fascinated to hear from anyone out there with opinions both on the content of Stuart’s talk, and on the ethics surrounding HSBC’s reaction. 

Survival Tips

There’s one more Angell in heaven. This weekend brought the news that Roger Angell, best known as a baseball writer and columnist for the New Yorker, had passed away at the age of 101. What a life. You can read celebrations of it by the New Yorker, the New York Times, the Washington Post and Sports Illustrated. His writing about baseball earned him a slot in the Hall of Fame. This is an excerpt from his essay on the great 1975 World Series between the Boston Red Sox and the Cincinnati Reds, about the response to Carlton Fisk’s walk-off home run; and this is his exquisite essay on the Pittsburgh Pirates pitcher Steve Blass, and how he suddenly lost the ability to pitch. It’s a painful story told beautifully. Angell was the CLR James of baseball; we were lucky to have him for 101 years. More From Other Writers at Bloomberg Opinion:

  • HSBC's Discordant Climate Songbook: Chris Hughes
  • Biden's Taiwan 'Gaffe' Is a Smart Strategy on China: Hal Brands
  • The Great Rotation Meets The Great Inflation: Andrea Felsted

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

John Authers is a senior editor for markets and Bloomberg Opinion columnist. A former chief markets commentator and editor of the Lex column at the Financial Times, he is author of “The Fearful Rise of Markets.”

More stories like this are available on bloomberg.com/opinion

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