After two weeks of strong gains, European markets gave back some of this year’s early momentum with a modest pullback last week, with some suggesting that we may well have seen the peaks in the short term, in a manner similar to last year. US markets had an altogether more mixed week, with the Dow Jones having its worst week since early December, while the Nasdaq 100 finished the week higher.
While there may be some logic in the argument that we may have seen the peaks in US markets, given how they have performed in the last few months, there is less of an argument when you look at markets in Europe, which look set to open higher later this morning. Valuations in Europe are lower to begin with, and on an income/dividend basis, much more compelling, compared to the US, with the FTSE 100 and DAX both trading on forward dividend yields of 3.77% and 3.36% respectively.
Nonetheless, financial markets appear to have a rising conviction that central banks are on the cusp of a significant pivot on monetary policy sometime later this year, a view that appears to be getting additional traction now that a number of US Federal Reserve policymakers appear comfortable with the idea of another step down in the central bank's rate-hiking cycle to 25 basis-points (bps) next week.
This view continues to be reflected in the US bond market, where yields continued to make fresh multi-week lows with the US 2-year yield closing lower for the third week in a row, as has the 10-year yield. The performance of the US dollar was no less nuanced, posting a fresh eight-month low, as various European Central Bank officials continued to make more hawkish noises. The pound also held up well last week, closing higher for the fourth week in succession against the US dollar.
As we look ahead to a new week, most of the attention is set to remain on the latest set of earnings reports, as investors look to decide whether the current strong run of gains can continue, and how much further central banks are prepared to go to get a handle on inflation.
Last week markets appeared to take some comfort from the fact that companies were focusing much more on maintaining their margins, and cutting costs, as well as jobs, amid uncertainty over the global economic outlook. This comfort appears to be predicated on an assumption that any economic slowdown will prompt a pause first and foremost in the central banks' rate-hike plans, followed by some rapid rate cuts. Of course this assumes that these aforementioned central banks will be happy to start cutting rates when inflation is still well above target. This seems highly unlikely, and while markets appear to have become conditioned to this sort of mindset since the financial crisis took rates sharply lower, it is by no means the given that markets appear to think that it is.
Unemployment is still low, not only in US but in the UK and Europe as well, and having heard last week from the likes of Fed governor Lael Brainard, who is normally considered dovish, that inflation in her view still remains way too high, it is difficult to envisage a scenario where rate cuts this year are likely at this point. ECB president Christine Lagarde was also at it, saying that inflation is still way too high and markets are underestimating the ECB’s resolve to drive prices back towards their 2% inflation target. While the ECB did step down to a 50bps hike in December, there were a number on the governing council who wanted another 75bps hike.
When the ECB met last month, Lagarde more or less pre-committed the ECB to at least another three 50bps rate hikes at the next three meetings, in a move that saw the euro push higher, but thus far has failed to see it follow through. This would suggest that markets are unconvinced the ECB will be able to follow through on such guidance given the risks it might pose to the borrowing costs of the more highly indebted members of the euro area.
As we look ahead to a new week, the main focus will once again be on the US economy and this week’s Q4 GDP data, as well as the December core PCE deflator inflation numbers, which are due on Thursday and Friday.
EUR/USD – is still finding the air quite thin anywhere near to the 1.0900 area and support around the 1.0770/80 area. Could see a deeper fall towards 1.0720. The key resistance sits at 1.0950, which is a 50% retracement of the move from the 2021 highs to last year’s lows at 0.9536. A move through 1.0950 opens up a move towards 1.1110.
GBP/USD – ran out of steam just shy of the December peaks at 1.2440, last week, but closed near the highs of the week. Has managed to hold above the 1.2300 area for the last two days. Above 1.2450 could see a move towards 1.2600. We need to hold above the 1.2000 area for further gains to unfold or risk a return to 1.1830.
EUR/GBP – held above the 50- and 100-day SMA last week at the 0.8720 area, before squeezing back to the 0.8775/85 area. We need to see a move through 0.8800 to retarget the three-month highs of earlier this month. The next support below 0.8720 targets 0.8680.
USD/JPY – last week’s rebound from the 127.00 area has thus far struggled to maintain traction above the 130.20 area, although we did overshoot briefly to 131.60 after the Bank of Japan decision. We need to see a move through the highs last week to open up 132.50. We currently have support at 128.30.