European stocks dipped on Friday as investors continued to absorb a hawkish turn by the Federal Reserve. Banks and energy companies led the decliners.
On the data front, U.K. retail sales fell 1.4% in May, driven by decreases at food stores and on the heels of a sharp rise in the previous month, the Office for National Statistics said Friday. Economists polled by The Wall Street Journal expected retail sales to increase 1.6%.
Shares of Tesco fell more than 2%, after the British grocer reported a 1% rise in retail sales 1% on the year on a comparable basis and said that its profit outlook for the full year remains unchanged.
"Tesco's first quarter numbers look sluggish, but that's because they're lapping the unprecedented demand triggered by the pandemic this time last year," said Sophie Lund-Yates, equity analyst at Hargreaves Lansdown, in a note to clients.
As reflation trades unwound, bank stocks came under pressure, with HSBC down 0.4% and BNP Paribas slumping 2.3%. Energy stocks fell as TotalEnergies and BP each lost close to 1%, while Royal Dutch Shell was 1.3% down.
Shares of Kerry Group surged 3% after the Ireland based food company said late Thursday that it will sell its consumer foods' meats and meals business in the U.K. and Ireland to Pilgrim's Pride for 819 million euros ($975.1 million).
Stock futures wobbled, leaving the Dow on track for its worst weekly performance since the end of January.
Futures tied to the Dow Jones Industrial Average wavered between gains and losses. The index of blue-chip stocks had dropped 1.9% this week through Thursday, leaving it poised for its worst showing since it fell almost 3.3% in the last week of January.
Investors have gained some confidence that the Federal Reserve will act to curb rising inflation after policy makers signaled Wednesday that they expect to raise interest rates by late 2023.
That has started to take the steam out of a recent rally in stocks linked to a broad economic recovery, leading to a retreat in banking and energy shares this week. It is also reviving appetite for technology stocks and other assets that could benefit from lower inflation and higher rates.
"If the Fed tapers bond purchases and it raises rates, then all of a sudden the inflation dragon gets tamed," said Gregory Perdon, co-chief investment officer at private bank Arbuthnot Latham. "If inflation gets tamed, you want to buy the long-duration assets," or investments that are sensitive to interest rates, he added.
In the near term, Mr. Perdon expects inflation to creep higher, due to supply-chain bottlenecks, chip shortages, strong demand for goods and services and easing pandemic restrictions. Stocks are still likely to advance, he said.
"The Fed hasn't done anything yet. All they've done is signal, and they're a long way off from doing anything," Mr. Perdon said. "Markets are supported by the trifecta of monetary and fiscal policy and the vaccine rollout. Markets may face a reckoning, but that won't happen in 2021."
Some investors are also booking profits after a strong monthslong rally that has left the S&P 500 off just 0.78% from its record close on June 14.
"Given that a lot of investors are sitting on huge gains, the temptation is to reduce risk," said Luca Paolini, chief strategist at Pictet Asset Management. "When you have the combination of expensive valuations and changes in Fed policies, it's better to lock in gains."
The dollar extended its rise, hitting a two-month high against a basket of currencies, after the Fed this week unexpectedly forecast a first interest-rate rise in 2023, with two increases during that year.
Positioning data indicate that the market had been running substantial short dollar positions, which are now being unwound, MUFG said. However, given that longer-term U.S. bond yields have dropped back, perhaps reflecting the Fed's much tamer message on prospects of tapering asset purchases, a "sustained move stronger for the dollar might not materialize," MUFG's Derek Halpenny said.
The Swiss franc and the Japanese yen's correlation with risk appetite has fallen since the pandemic took hold and the dollar is now the favored safe haven but this isn't sustainable, RBC Capital Markets said.
"The U.S. has some of the properties one would expect to see in a haven (a large, relatively closed economy and light exposure to commodities) but lacks others (it is a net debtor)," RBC's Adam Cole said.
Markets have probably taken yield as a proxy for riskiness recently, lifting the dollar, he said. But as yields normalize, the dollar will turn more risk-neutral and the yen and the franc will re-assume their roles as key havens, he said.
The pound fell, hitting a six-week low of 1.3855 against the dollar after U.K. data showed retail sales fell, raising concerns about a slowing economic recovery.
The currency is also vulnerable to trade tensions between the U.K. and the EU, with the former threatening to unilaterally extend a grace period for processed meat exports to Northern Ireland, ING said.
The next few weeks "could be a vulnerable period" for GBP/USD, which risks falling to 1.3800, ING said.
The European Central Bank's monetary policy divergence with the Fed will likely limit any euro gains against the dollar, ING said.
ECB Chief Economist Philip Lane on Thursday said it is premature to discuss ending pandemic bond purchases, while the Fed on Wednesday brought forward its interest-rate-rise expectations into 2023. By inserting this wedge with the Fed, the ECB will try to encourage a weaker euro, ING analysts said.
"We doubt now EUR/USD can make it much above the 1.1950/80 area on any intra-day correction and momentum may well carry EUR/USD towards the 1.1835 area and potentially 1.1700 should any data/Fed commentary add to tightening fears this summer."
In bond markets, the yield on the 10-year Treasury note ticked down to 1.489%, from 1.509% Thursday.
Treasuries continue to look attractive to foreign investors on a currency adjusted basis, despite the recent decline in yields, as extraordinary policy actions by global central banks have kept global bond yields low, said U.S. rates strategists Subadra Rajappa and Shakeeb Hulikatti of Societe Generale.
They say foreigners' demand was evident in recnet three- and 10-year UST auctions despite the recent rally which brought the 10-year UST yield below 1.50%.
"Strong demand from Japanese and European investors is also likely to persist in a low interest rate regime," they said.
Oil was lower in Europe, with the firmer dollar continuing to weigh on prices. DNB Markets' Helge Andre Martinsen points to the dollar's move as being responsible for oil's slip in the past day or so.
Separately, Iran's presidential election takes place today. While that vote might see a hard-liner oust moderate Hassan Rouhani, the backing of Iran's supreme leader means "a change in president is not expected to derail [nuclear] talks," Martinsen added.
Gold futures rose, recovering some of their losses from Thursday, when they suffered their largest drop in over 10 months. The price of the precious metal tends to decline when investors anticipate rates rising and yield-bearing investments becoming more attractive.
Copper prices also rebounded somewhat but the gains did little to erase the sharp losses the red-metal has seen this week. Three-month copper on the LME was up 0.6% at $9,246.50 a metric ton, but is set to close the week 7.5% lower.
That would be its worst weekly loss since the pandemic first roiled markets in March 2020. The red-metal has been hit by a combination of Chinese plans to offload stockpiles and a hawkish turn by the Fed.
"Less liquidity from the U.S. and a firmer dollar, plus prospects of a slowdown in China as the top consumer tries to rein in overheated markets weighed on sentiment," said Anna Stablum at brokerage Marex.
Tesco 1Q Retail Sales Growth Slowed, Backs FY 2022 Profit Outlook
Tesco PLC said Friday that first-quarter retail sales grew on year on a comparable basis, but at a slower pace as the boost from the coronavirus pandemic began to fade, and said its profit outlook for the full year remains unchanged.
UK Retail Sales Fell in May as Spending Broadened
Retail sales in the U.K. fell in May after increasing sharply the previous month as the further easing of restrictions across the country gave consumers more opportunities to spend aside from goods.
Sales fell 1.4% on the month, the Office for National Statistics said Friday, driven by decreases at food stores. Economists polled by The Wall Street Journal expected retail sales to increase 1.6%.
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