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STOXX 50 tests 50-day SMA resistance ahead of ECB hike

The coast isn’t yet clear for European stocks, despite Russia resuming its gas shipments to Germany via the Nord Stream 1 pipeline today.

While the risk of an imminent energy crisis has been staved for now, markets are still on tenterhooks ahead of a contentious European Central Bank (ECB) policy decision due at 2:15PM Frankfurt time, with ECB President Christine Lagarde set to address the media half an hour later.

And then there’s the Italian government in disarray, adding to woes surrounding European assets.

Such caution-filled headlines are keeping the STOXX 50 index below its 50-day simple moving average for now.

This index, which tracks 50 blue-chip companies in the Eurozone (including industry-leading names such as LVMH, TotalEnergies, and Siemens), has already shed over 16% so far this year and remains firmly in its year-to-date downtrend.

STOXX 50 tests 50-day SMA resistance ahead of ECB hike

 

Two key things to look out for from today’s ECB meeting
 

  1. The size of the ECB rate hike

    Markets have fully come to expect that the ECB is set to hike its benchmark rate today for the first time since 2011.

    The question now is how big the hike will be, and the quantum of that hike is set to have an immediate bearing on equities.

    A 25-basis point hike had been long-telegraphed by ECB officials. However, there’s also about an even chance for a 50-basis point hike as well.

    Such a “two-in-one” move would allow the ECB to end its negative rates regime in one go (the ECB’s benchmark Deposit Facility Rate has been at minus 0.5% since 2019).

    Rate hikes also come with negative risks, as they could hasten a recession if the economy is not resilient enough to withstand higher rates.

    Still, the case for an ECB rate hike is clear: its consumer price index (CPI) posted a fresh record high of 8.6% in June. That’s also more than four times above the ECB’s inflation target of 2%. Noting that rate hikes are a central bank’s main weapon against red-hot inflation, the ECB is long overdue in finally raising its own rates, joining the other 80 or so other central banks around the world that have already made such moves this year.

     
  2. Details about the ECB’s new anti-fragmentation tool

    The ECB’s intended rate hikes are also feared that they could raise “fragmentation risks” between members.
    The word “fragmentation” in this sense means that the borrowing costs of its weaker members to the south (e.g. Italy) may rise far higher than its more economically-sound members (think Germany). The extra money needed to service such high levels of debt could not be spent on supporting these more-vulnerable economies.

    Furthermore, it’s imperative that the ECB can convince markets that this new tool will work; that it can indeed prevent yields of the more vulnerable economies in the Eurozone from spiralling out of control.

    If investors and traders don’t believe that the ECB can sufficiently contain such fragmentation risks, that could see the unwinding of recent gains for not just European stocks, but for the bloc’s currency as well.

 

How could ECB’s announcement impact European stocks?

  • A larger-than-usual 50bps hike could trigger the unwinding of recent gains for the STOXX 50, given that risk assets generally tend to shudder in the face of higher interest rates.
     
  • On the other hand, a more incremental 25bps hike could lift this blue-chip index above its immediate resistance line (50-day SMA).
     
  • Again, the immediate performance of European stocks depends on whether markets sufficiently believe in the effectiveness of the ECB’s new tool to contain fragmentation risks.
    Should markets scoff at this new tool (or the lack of details around it), risk assets could fall.
    Shore up confidence that fragmentation risks will be contained, and risk assets could be more daring in carving out gains.

 

European stocks’ upside appears capped

Still, even if the ECB were to sound relatively dovish today (only raising rates gradually at an incremental 25-bps), any resurgence in the STOXX 50 index is expected to be curtailed by the remaining woes that hang over the Eurozone.

With the Russia-Ukraine conflict still raging off to the Eurozone’s east, coupled with the chaos that’s engulfing the Italian government (with Prime Minister Mario Draghi expected to resign today), there appears to be enough looming downside risks to keep a lid on its equity markets.

Looking at the chart, any relief for the Eurozone may only translate into yet another short-lived foray for the STOXX 50 above its 50-day SMA.

A ramping up of the EU’s economic woes could see this index testing its May low of 3490 for support. Stronger support is then set to arrive at 3400, noting that dips below that psychologically-important mark so far this year have proved fleeting.

 

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