MARKET WRAPS

Watch For:

Eurozone Long Term Interest Rates, ECB Economic Bulletin; Italy Industrial Production; U.K. Bank of England Credit Conditions, Liabilities Surveys; updates from Geberit, BMW, Vonovia, Vinci, Persimmon, Marks & Spencer, Wood Group, Tesco, Ferguson

Opening Call:

Europe is poised for a cautious start with Fed policy in focus following the U.S. CPI reading. In Asia, stocks were mostly lower, along with the dollar, oil and gold, while Treasury yields edged higher.

Equities:

European shares could struggle for direction early Thursday as investors continue to assess the hot pace of U.S. inflation and consider whether the Federal Reserve will need to move more aggressively on rate rises this year to stem the surge.

Wall Street took the inflation news in stride Wednesday, with major stock indexes closing modestly higher. While shares finished off the session's best levels, Kent Engelke, chief economic strategist at Capitol Securities Management, said the market was showing signs of relief that inflation pressures didn't overshoot expectations.

"Now the next test is will inflation pressure actually moderate," Engelke said. "I do believe it will, but I don't think it will back off the 2% target range the market is expecting."

"We still will have above-trend growth and above-trend inflation," he predicted, adding that such a mix could reignite the recent sharp rotation by investors into value stocks, but away from growth.

In an interview with the Wall Street Journal Wednesday, St. Louis Fed President James Bullard said that four interest rate increases now appear likely to be needed to tackle high inflation.

"We want to bring inflation under control in a way that does not disrupt the real economy, but we are also firm in our desire to get inflation to return to 2% over the medium term."

Whereas he recently believed the Fed would need to raise rates three times this year, "I actually now think we should maybe go to four hikes in 2022."

Stocks to Watch:

Rio Tinto's recent share-price gains--more than 10% already this year--can mostly be attributed to the strength of iron-ore prices, Jefferies said. The miner's stock underperformed in the second half of 2021 and is also likely benefiting from flows out of BHP in London as its rival prepares to leave the FTSE, Jefferies said.

"We prefer pure-play copper and aluminum producers over iron-ore miners, but we do believe iron ore and Rio can continue to outperform in the near term."

Forsyth Barr said Rio Tinto's New Zealand aluminum smelter, which uses about 12% of the country's electricity, is likely to again loom large, predicting Rio will negotiate to keep it operating beyond its planned end-2024 closure.

Aluminum prices have rocketed while key ingredient alumina has eased in price, making the smelter more profitable. Also, some European smelters have curtailed production and China could slow its production, the broker said.

It makes sense for Rio to start talks with its electricity suppliers Meridian and Contact sooner than later, Forsyth Barr reckons. Otherwise it risks them finding sufficient alternative demand, which would mean the smelter closure is no longer a big deal for them.

Economic Insight:

The Omicron variant could knock around 1% off GDP in advanced economies at its height, Capital Economics said, adding the caveat that the estimate "is very uncertain."

The shock stems from workers too sick to work, even from home, but it would be smaller than in previous waves of Covid-19. "And the damage should fade quickly as staff return to work and some lost output is made up," Capital Economics said.

"But the implications for inflation could be more worrying, meaning that most central banks will press on with policy tightening regardless."

Forex:

The USD Index remained below the 95.00 level with the dollar struggling to deliver fresh gains as U.S. interest rate rise expectations are largely priced in, said Credit Suisse.

As well as positioning and "already-aggressive" 2022 rate rise bets, other problems for the dollar in the near-term include rising government bond yields outside the U.S. and expectations for strong global economic growth in 2022 that would reduce demand for safe havens.

"Still, relatively high and still-rising U.S. bond yields keep the dollar a buy on dips against low yielders." Credit Suisse expects EUR/USD to fall to 1.1150 at the end of the first quarter.

CBA said the dollar is likely on a weakening trend this year despite the prospect of Fed rate increases.

The currency's outlook is not a simple equation of FOMC rate hikes equals strong dollar, CBA said. "The USD is a counter-cyclical currency which decreases as the world economy recovers. The burgeoning U.S. current account deficit...will also be a weight on the USD this year in our view."

For a commodity currency such as AUD there should be a return to strength, CBA said, expecting AUD/USD to end 2022 at 0.8000.

Sterling should rise in the near term on expectations that the Bank of England will raise interest rates further, but the currency could start to weaken from the second quarter on U.K. economic headwinds, Credit Suisse said.

The market expects four 25-basis-point rate hikes over the next 12 months, Credit Suisse analysts said. "While this can be seen as aggressive for 2022 at least, GBP has not been a popular currency so can outperform in Q1 while structural positions adapt to a hawkish BOE stance."

EUR/GBP could fall to 0.8275 in the near term from 0.8344 currently, but from the second quarter, it will likely face a hit from U.K. growth risks stemming from higher taxes and energy bills, the analysts said.

Bonds:

U.S. government bond yields recovered slightly in Asia after they fell Wednesday following the U.S. inflation data.

Some analysts said Wednesday's move might have stemmed from investors repositioning after the CPI reading didn't shift expectations for the pace of Federal Reserve interest-rate increases in coming months.

"There is a strong argument to be made that investors were positioned for a more dramatic response," and began covering bets against Treasurys after the data, wrote Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, in a note to clients.

Bank of America noted that the 20-year Treasury "currently offers the highest yield on the Treasury curve," something the bank said could be due to low liquidity.

"The 20s30s Treasury curve is near the flattest level since the 20 year was reintroduced in May 2020," BofA said. "The flatter Treasury curve has driven 20s30s [investment-grade] yield curve also to the flattest levels since 2019," except for the liquidity crisis early in the pandemic. "That makes the 20 year maturity point attractive from the yield perspective," BofA said.

Both the 20-year and the 30-year yield have been dancing around 2% this year.

The Fed is likely to transition relatively fast to higher caps in its quantitative tightening, Deutsche Bank said.

If quantitative tightening is announced in July, Deutsche Bank expects the central bank to initially set a cap of $20 billion for Treasurys and $15 billion for mortgage-backed securities, reaching a maximum of $60 billion and $45 billion, respectively, by the end of the year.

At that pace, the Fed's balance sheet would be reduced by about $560 billion this year and $1 trillion more in 2023. "More hawkish scenarios in which QT is announced in May or the caps are scaled up more quickly could see up to $750[billion] of runoff this year," Deutsche Bank said.

Energy:

Oil prices eased lower in Asia after they settled at a 2-month high Wednesday, with U.S. crude supplies down for a seventh week in a row.

ANZ said supply disruptions which could keep stockpiles tight: The EIA reported that crude oil stockpiles fell to a two-year low, while the IEA has also said that demand for oil may remain more robust than market observers had previously expected, due to the effect of Omicron being milder.

"Crude prices continue to set new highs for 2022, with prompt benchmarks now near their highest point since November last year," said Robbie Fraser, global research and analytics manager at Schneider Electric. "The current bullishness is a mixture of crude fundamentals and more macro factors tied to the broader economic outlook."

Inventory data will "continue to be key through the early weeks of 2022 as the market eyes any signal that balances are improving, and that the market could see a run of more oversupplied conditions," he said in a note.

The global gas market could face more upheaval this year, said research firm Wood Mackenzie, predicting European inventories to be at a record low of less than 15 billion cubic meters by end-March.

Weather and the start date of the Nord Stream 2 pipeline from Russia to Europe will be key factors in prices. A severe European winter could add up to 10 bcm of additional gas demand, depleting inventories before end-March, and Nord Stream 2 could face set backs if Russia-Ukraine tensions continue escalating.

"A cold winter and continued uncertainty about commissioning of Nord Stream 2 could see prices doubling, again," Wood Mackenzie said.

Metals:

Gold futures ticked lower in Asian trade after they climbed Wednesday for a fourth straight session, settling at their highest level of the year so far. Bullion's rise was helped by the declining dollar and Treasury yields in the wake of U.S. consumer inflation data.

"The most important takeaway for gold here is that gold is a rocket ship and inflation is its fuel," said Peter Spina, president and chief executive officer at GoldSeek.com. "Now with inflation showing itself to be baked into the system and growing recognition of inflation, gold is going to benefit in a big way."

Aluminum was lower in a likely technical selloff, with support faltering as prices edged near a resistance level of $3,000 a ton, brokerage Marex said.

However, declines are likely to be capped, as high energy prices keep costs of production elevated, Marex said. This could lead to tighter supplies of the metal and put upward pressure on prices.

Jefferies said few were surprised by iron ore's slump to less than $90/ton in November as the Chinese housing market stumbled. However, the steel ingredient, known for bucking market expectations, has since surprised onlookers with a surge back above $130/ton.

Jefferies reckons worse-than-usual seasonal supply disruptions in Brazil and expectations of a recovery in Chinese demand have been driving the unexpected gains. "We forecast a small surplus in the iron ore market this year, with an average benchmark price of $90/ton...but risk to this price assumption is to the upside if Chinese credit growth continues to accelerate from the 2H21 trough."

TODAY'S TOP HEADLINES

Fed's Bullard: Four Interest Rate Rises in 2022 Now Appear Likely

Federal Reserve Bank of St. Louis President James Bullard said the U.S. central bank will need to move more aggressively on rate rises this year as it seeks to stem an inflation surge, amid a job market that could see the unemployment rate fall below 3% by the end of the year.

"We want to bring inflation under control in a way that does not disrupt the real economy, but we are also firm in our desire to get inflation to return to 2% over the medium term," Mr. Bullard said in a Wall Street Journal interview Wednesday.

Fed's Mester Says Economy on Track for a March Rate Rise

Federal Reserve Bank of Cleveland President Loretta Mester said Wednesday the U.S. central bank is on track to raise its short-term interest-rate target at its March policy meeting.

With inflation high right now, "the case is very compelling" for the Fed to move toward raising its short-term target rate, Ms. Mester said in a virtual appearance Wednesday at The Wall Street Journal's CFO Network Summit.

Economists React: Inflation Expected to Cool This Year

The U.S. inflation report for December showed prices accelerating at the fastest pace in almost 40 years. But history isn't much of a guide in this case, economists say, because today's inflation is caused primarily by factors related to the Covid-19 pandemic and should fade in the coming months.

The past few months of price increases come from both a surge in consumer demand following the Biden administration's economic stimulus programs and supply shortages caused by a logjam at factories and U.S. ports.

Fed Beige Book: Economy Grew at Modest Pace to Close 2021

The U.S. economy grew at a modest pace in the closing weeks of 2021 as ongoing supply-chain issues and a shortage of available workers held back production, the Federal Reserve said Wednesday.

But demand remained strong and consumer spending grew, ahead of a rise in Covid-19 cases caused by the Omicron variant, the Fed said in its periodic collection of business anecdotes from around the country known as the Beige Book.

Federal Budget Deficit Narrowed in December

The federal government ran a $21 billion deficit during December, the smallest monthly gap in two years, as the government took in more tax revenue while spending edged higher.

Government receipts for the month rose by 41% from a year earlier to $487 billion, not adjusting for calendar differences, the Treasury Department said Wednesday. The Treasury said federal outlays in December rose by 4% to $508 billion.

PC Shipments Faced Tough Fourth Quarter, but Pandemic Supplies a Brace

Shortages and bottlenecks weighed on personal-computer shipments in the fourth quarter, but the pandemic-induced revival of the PC market is expected to continue, according to industry data.

International Data Corp. and Canalys said PC shipments in the fourth quarter rose about 1%, while Gartner Inc. said world-wide PC shipments declined 5% in the December quarter, which it said was the first year-over-year decline after six straight quarters of growth.

Omicron Puts China's Zero-Covid Strategy to Its Toughest Test

Over the past two years, China has used some of the strictest measures anywhere to keep Covid-19 out and long succeeded in holding numbers down. But as Omicron poses the biggest challenge since the start of the pandemic, the country is looking more boxed in by its own formula.

Beijing has repeatedly pointed to Western countries where the virus has run rampant as cautionary examples. But as the Omicron variant spreads inside China ahead of February's 2022 Beijing Winter Olympics, an uncomfortable reality is setting in: The country's ability to keep the virus at bay has meant low levels of natural immunity. Vaccination rates are high, but how effective Chinese vaccines are against Omicron remains in question.

HgCapital Targets $14.75 Billion for Buyout Funds

HgCapital in London is targeting roughly $14.75 billion for two new buyout funds less than two years after it secured almost $10 billion for the strategies.

The firm aims to collect at least $8.5 billion for Hg Saturn 3 LP, its large-company buyout fund and EUR5.5 billion, equivalent to $6.25 billion, for Hg Genesis 10 LP, which focuses on midsize businesses, according to public documents prepared for the Connecticut Retirement Plans and Trust Funds. Both strategies target investments in software and services businesses mainly in Northern Europe.

Russia, NATO Fail to Resolve Differences in Ukraine Talks

BRUSSELS-NATO's chief said significant differences remained with Russia but expressed hope that Moscow would agree to further talks, after the first joint council meeting between the two since 2019.

NATO Secretary-General Jens Stoltenberg said after discussions Wednesday that differences would be hard to bridge, with Russia increasing pressure on the West to accept its demands for sweeping security guarantees, and the alliance largely refusing to budge.

Write to paul.larkins@dowjones.com

Expected Major Events for Thursday

00:01/UK: CBI and PwC Financial Services Survey

01:01/UK: Dec KPMG and REC UK Report on Jobs

07:00/TUR: Nov Industrial Production Index

07:00/ROM: Nov Industrial production

08:00/CZE: Nov Retail trade

09:00/ITA: Nov Industrial Production

09:00/BUL: Oct Trade with EU Member States - preliminary data

09:00/BUL: Nov Trade with third countries - preliminary data

09:00/CZE: Nov Monthly Balance of Payments

09:00/EU: Dec Long term interest rates statistics

09:30/UK: 4Q Bank of England Credit Conditions Survey

09:30/UK: 4Q Bank of England's Bank Liabilities Survey

10:00/CRO: Dec PPI

10:00/GRE: Dec CPI

13:00/POL: Nov Balance of payments

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This article is a text version of a Wall Street Journal newsletter published earlier today.

(END) Dow Jones Newswires

January 13, 2022 00:48 ET (05:48 GMT)