US markets continued their weak start to the year with more heavy falls on Friday with the Nasdaq 100 posting its lowest weekly close since June last year, and its worst weekly loss since February 2020, as well as closing below its 200-day MA for the first time since June 2020.
Friday’s losses also saw the S&P500 follow a similar path also falling below its 200-day MA, as well as below its December lows in the process.
Investors appear to be spooked by several things, with weak company guidance only part of the story.
For a start, the shift in tone from central banks would appear to suggest that they have belatedly started to become more concerned about how recent price surges might become more embedded than was thought to be the case only a few weeks ago. It’s not hard to see why when you look at inflation levels that are now at levels last seen in the 1980’s and 1990’s
We also have the added complication of a much more perilous geopolitical backdrop caused by escalating tensions on the Russia, Ukraine border. On Friday markets accelerated their falls on reports that the US was considering evacuating the families of its diplomats from the region over the risk of war, a story that was confirmed over the weekend, and which is unlikely to improve matters when markets in Europe open later. There is also the concern that China’s determination to pursue a zero-covid policy when it comes to tackling its own Covid outbreaks could create the potential for much higher prices in the medium and longer term, and potentially well into next year.
For several years, the markets have become accustomed to buying the dips no matter the fundamental backdrop, however recent events appear to be seeing a significant loss of confidence in this mindset, and while European markets haven’t seen the levels of selling pressure, the ability to move higher has been tempered by the weakness being seen in the US, with today’s European session set to see a lower open.
As we look ahead to this week's Federal Reserve rate meeting there has been plenty of speculation that the FOMC may well have to go faster and harder when it comes to the number of rate hikes this year, as well as how quickly the central bank will act in starting to reduce the size of its balance sheet.
It is this shift in expectations that has seen bond markets slide sharply this year, helping to push yields sharply higher, and the US 10 year briefly above 1.9% last week, and a two year high, before falling back to close the week lower, and below its 200-week MA.
This inability to hang onto any of last week’s gains could be significant when it comes to the sharp move higher, we’ve seen in the US 10 year. What suddenly caused US yields to stop rising and reverse last week?
Is it that markets have changed their minds about what might come from the Fed this year, or is there something else at play, and are markets becoming concerned about events in Eastern Europe?
Whatever it is, the failure of the 10-year yield to break higher could be a signal that we’ve seen the high in yields in the short term, and that concern over multiple rate rises this year is overplayed.
Ahead of this week's Fed meeting, we’ll be getting the latest flash PMIs from Germany, France and the UK for January and they aren’t expected to be particularly positive.
Last month German services activity slipped into contraction territory, and its lowest level since February last year, as the German economy struggled with the twin challenges of a disjointed regional government response when it comes to restrictions, and sharply rising Delta outbreaks. These were then compounded by the spread of the Omicron variant, and rapidly rising energy prices, which could see further weakness to 48, from 48.7.
While the services sector has struggled manufacturing activity has proved to be more resilient, ending last year at 57.4, however these numbers don’t chime with the industrial production and factory orders numbers which have been poor.
Earlier this month the Federal Statistics office estimated that the German economy had shrunk by between 0.5% and 1% in the final quarter of 2021, well behind its peers like France and Italy, due to supply chain disruptions and higher energy costs, as well as high Covid infection rates.
Economic activity has proved to be a little better in France with both services and manufacturing activity remaining steady over the past few months. This trend looks set to continue, although virus levels have been high in the past few weeks, which might constrain the services sector, with expectations for both services and manufacturing to decline to 55.3.
December saw a sharp fall in UK services sector activity, to 53.6 from 58.5 in November, a trend that could well continue in January due to the Plan B restrictions brought in by the UK government half way through the month due to concerns about the Omicron variant.
The restrictions on the hospitality sector clearly hit pubs and restaurants, as well as some retail outlets, it would be surprising if we didn’t see a post-Christmas and New Year rebound, now that families have had their annual get-togethers and there is less fear about having to self-isolate, now that Christmas is in the rear-view mirror, however weak consumer confidence amidst surging inflation could temper any New Year recovery, with services expected to remain steady at 53.6.
On an anecdotal basis, while it was easy to get a restaurant booking in the lead-up to Christmas due to the sudden wave of cancellations, between Christmas and New Year was almost impossible. Manufacturing activity in the meantime remained steady throughout the quarter, with selling price inflation hitting a record high in December, while new orders and employment also rose.
EUR/USD – still holding above the trend line support from the recent lows, with support still around the 1.1280 level. We need to see a sustained move through the 1.1380 level to open up a move back towards 1.1500. A move below 1.1280 reopens the November lows at 1.1195.
GBP/USD – starting to look a little soft slipping below the 1.3570 area, and could slip back towards the 1.3480 area and even 1.3420. We need to see a move back above the 1.3670 area to retest the 200-day MA and 1.3750 area.
EUR/GBP – last week’s failure to move below 0.8300 saw a big short squeeze on Friday. For this to be sustained we need to see a move through 0.8380 towards 0.8420, and to kick on towards 0.8480. Above 0.8400 suggests the low is in, on a short-term basis.
USD/JPY – could well see further weakness towards the 112.80 area on a break below 113.40, which is where we lower cloud support. We need to move back above 115.30 to retarget the recent highs above 116.00.