The biggest companies in the market could benefit the most.
Investors on Wall Street came in Thursday morning in a downbeat mood, and the stock market seemed to reflect the high levels of uncertainty about the macroeconomic picture. Futures had been up much of the morning, but they gave up gains after the release of economic data showing a rise in unemployment claims over the past week. As of 9 a.m. ET, futures on the Dow Jones Industrial Average (^DJI -0.49%) were down 28 points to 32,861. S&P 500 (^GSPC -0.49%) futures had fallen 5 points to 4,109, and Nasdaq Composite (^IXIC -0.40%) futures had lost 28 points to 12,588.
U.S. investors are painfully aware of just how hawkish the Federal Reserve has become on the interest rate front, as the central bank tries to respond to inflationary pressures. However, there hasn’t been as much discussion about the Fed’s counterparts in Europe following suit. On Thursday morning, investors finally got some clarity from the European Central Bank, which now intends to move forward in a similar direction to what the Fed has already done. Although that confirms that high inflation is a global phenomenon, it’s also good news for some U.S. companies that have been at a growing competitive disadvantage for a while.
How Europe is responding to inflation
Inflation has become just as big a problem among European countries as it is for Americans. Consumer prices across the 19 countries that use the euro as a common currency rose 8.1% year over year as of May.
Yet the European Central Bank (ECB) has been hesitant to make moves that are as aggressive as the Fed’s recent decisions. The economic sanctions against Russia as a result of its invasion of Ukraine have hit the economies of European countries a lot harder than they’ve hit the U.S., and policymakers fear that big moves to fight inflation could worsen what’s already likely to be a substantial economic slowdown across the Eurozone.
Nevertheless, the ECB said it would boost its key interest rates by a quarter percentage point at its July meeting. It further expects an additional hike in September, with the potential for a larger increase if inflation continues to remain problematic.
In addition, European policymakers had already decided to complete the bond purchase program that had implemented its own version of quantitative easing. It’s unclear whether the ECB will follow that up with outright quantitative tightening in the near future, but even the removal of additional liquidity could have an impact on the markets there.
Why the U.S. stock market could benefit
One big challenge for U.S. stocks lately has been the rise of the U.S. dollar against foreign currencies. As the Fed took aggressive action to increase interest rates, it made the dollar more attractive to investors across the globe. For instance, faced with the alternative of accepting negative interest rates by keeping money in euros, many European investors exchanged euros for dollars to take advantage of the opportunity to earn positive rates of interest. That sent exchange rates higher.
As a result, U.S. companies that do business abroad found their foreign currency worth less in dollar terms than before. That has exacerbated pressure on sales and profits, particularly in the first quarter of 2022.
Higher interest rates in Europe, however, could help to reverse those foreign currency flows over time. If that happens, then foreign currency headwinds could turn into tailwinds, boosting prospects for multinational corporations.
Prepare to be patient
It’s good that the ECB is joining the fight against inflation. However, its pace appears likely to be more measured than what the Fed is doing, and so investors might have to wait for the positive impacts of unified action to become apparent. In the meantime, plenty of other factors could play a key role in what happens with consumer prices — and how they affect the broader stock market.
Photo by Christian Lue on Unsplash