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Europe set for lower open, after US markets close off their highs

European markets underwent another positive session yesterday, with the FTSE100 hitting a one month high as optimism over US/China trade talks and a dovish Fed continued to feed into a markedly different tone to the selling seen towards the end of last year.

US markets managed to close higher for the fourth day in succession, with the S&P500 posting its best run since September last year, though they closed off their highs on reports that talks between President Trump and his Democrat counterpart Nancy Pelosi, broke down in acrimony, as they looked for an agreement to reopen the government.

This modest pullback is likely to see markets in Europe open slightly lower this morning, with the declining inflationary outlook reinforced this morning by sharp declines in both China CPI and PPI for December which came in at 1.9% and 0.9% respectively. What was most noticeable was the plunge in factory gate prices or PPI, from 2.7% to 0.9%. This would suggest the risk that China might once again start to export a deflationary impulse across the rest of the global economy, given that trends in PPI tend to manifest themselves in the headline CPI numbers a few months later.

Crude oil prices also continued their rebound from 15-month lows with their seventh positive day in a row, as the more conciliatory tone between the US and China, Saudi production cuts and a weaker US dollar, helped put a floor under prices, and prompt some short covering.

Last nights Fed minutes showed that some members were a little reluctant to pull the trigger on a rate rise last month given the lack of inflationary pressure. This reluctance certainly wasn’t evident in the post meeting press conference when Chair Powell was much more hawkish than expected, particularly about balance sheet reduction, however the softer tone since the end of last week was had a notable difference on sentiment, which fellow FOMC policymakers have gone on to reinforce in comments made over the past few days.

This has had the effect of putting the US dollar under pressure this week, as these speakers built on last week’s caution from Jay Powell by also talking down the prospect of further aggressive tightening. In a marked change of tone from last month both Raphael Bostic and James Bullard both suggested that they would be open to a rate cut if downside risks came to bear in the coming months. While this may seem a statement of the obvious it is something that has never been stated so explicitly and coming as it does on the back of last month’s bumper payrolls report is a signal that this year’s FOMC is likely to be much more dovish in its outlook than it was last year.

Chicago Fed chief Charles Evans also weighed on by saying that inflationary pressures aren’t currently evident. While Bostic isn’t a voting member this year, both Bullard and Evans are and that would suggest that unless their rhetoric alters in the coming weeks the bar to future tightening is likely to be quite high. Bullard and Evans are expected to make further comments later today along with Fed Chair Jerome Powell, albeit at different economic events.

The pound came under pressure yesterday after an alliance of MPs came together to force two amendments that would tie the government’s hands in preparing contingencies for a “no deal” Brexit,  and require Prime Minister May to produce a plan B for Brexit within three days in the event she loses next week’s scheduled parliamentary vote on her Brexit deal, which seems quite likely.

The amendments have been lauded as the latest attempt by MPs to force the government away from pursuing a no deal option, however in reality they do no such thing.

What they do is stop the government from taking measures to mitigate against a “no deal” outcome and do nothing to solve the underlying conundrum as to what other scenario MPs would vote for.

In the event of any other option the UK will leave the European Union on the 29th March, unless or until MPs to either support the deal on the table, reverse the act of Parliament which takes the UK out of the EU, or coalesce around one of the following.

A single market or customs union solution or a variant thereof, or a second referendum.

There are some MPs who appear keen to try and push for an extension to article 50, however it is not immediately clear what that would achieve given any extension is unlikely to be pushed beyond May’s European Parliamentary elections, even if one can be agreed.

For now, there is no majority in Parliament for any of the options outlined above which means, as things stand, the UK will leave the EU without a deal in 78 days’ time. None of what happened yesterday changes that fact, and from the outside looking in the impression is that MPs appear to have no idea of what they are trying to achieve.

If this were a football match, most of the electorate would probably be chanting “you don’t know what you’re doing” from the sidelines”.

EURUSD – pushed above the 1.1500 area yesterday and looks ready to head towards the 1.1600 level, and potentially the 200-day MA at 1.1640, if we can hold above the 1.1420 area or Tuesday’s low.

GBPUSD – for now the pound is struggling just shy of the 1.2820 area, which it needs to overcome to signal the potential for further gains. We have interim support at 1.2680. A move below 1.2400 retargets the 2016 lows near the 1.2000 area.

EURGBP – the 0.9100 level remains a key resistance area despite a brief spike to 0.9120 last week.  Bias remains for a move back below 0.8920 towards the 0.8820 level as the broad range of 0.8700/0.9100 that has held sway for the last four months remains intact.

USDJPY – while below the 109.20 area the US dollar is susceptible to a move back towards the 107.50 area, and back down towards the 106.00 area, towards the lows at 104.60. We need to recover back through the 109.20 area to argue for a return to the 110.30 area.

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