Global equity markets have come under renewed pressure this week as crude oil surpassed the $100-per-barrel threshold, reviving worries about inflation and raising the market-implied probability of a Federal Reserve rate increase next week to about 70%.
Barclays strategists, led by Emmanuel Cau, described the upcoming U.S. consumer price index release on Friday as "pivotal." Barclays economists have penciled in a 0.23% month-over-month rise in core CPI for August. The strategists noted that a print consistent with that forecast "would not preclude a hike next week," and Barclays now expects two Fed hikes by the end of the year.
The team said that a softer-than-feared inflation reading would be consistent with the more dovish tone recently struck by Fed officials Waller and Williams, potentially allowing the Fed room to pause. At the same time, they cautioned that as long as energy prices remain elevated, "markets are likely to continue pricing the risk of further tightening down the line," a dynamic that would leave policy uncertainty unresolved and act as a headwind for equities and duration-sensitive assets.
Barclays also argued that a Fed move higher could, paradoxically, reduce uncertainty by clarifying the central bank's reaction function and the likely terminal rate. The strategists acknowledged that the immediate market reaction to a hike might be mixed, but they pointed out that "equities eventually tend to regain the uptrend soon" after the Fed resumes mid-cycle hiking, framing a potential rate increase next week as "a clearing event for markets."
In Europe, the bank flagged growing stagflation risk as the correlation between equities and oil has strengthened. Rising gas prices ahead of the winter season, combined with relatively tight storage levels, have heightened inflation concerns in the region.
That said, the strategists qualified their view by noting this is not a repeat of 2022 "yet." They emphasized that elevated energy costs are not unique to Europe, that EU corporates have made progress in diversifying their energy mix, and that German activity is recovering with support from fiscal stimulus - all factors that could moderate the downside for regional demand.
The European Central Bank's rate increase earlier this week, Barclays said, reflected mounting inflation pressures while also taking into account a strengthening growth backdrop. Barclays economists expect one more ECB hike in December, and they indicated additional tightening remains possible if energy prices stay elevated and growth continues to hold up.
Against this backdrop, Barclays continues to favor "old economy" capital expenditure beneficiaries and banks, and it remains Overweight the banking sector. The bank also highlighted Utilities and Telecoms as increasingly compelling bond-proxy alternatives. In Telecoms, Barclays said earnings momentum is improving and that much of the rates risk appears to already be priced into valuations.
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Barclays' analysis frames the current environment as one in which energy-driven inflationary pressures are the dominant near-term risk to risk assets, while central bank actions - particularly from the Fed and the ECB - will be decisive in shaping market direction. The firm’s sectoral preferences reflect an emphasis on beneficiaries of higher capex and financials, alongside defensive or bond-like equity plays where yields and valuations have begun to incorporate rate risk.