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Lower start expected ahead of German PPI

Last week saw another positive session for European markets with the DAX closing higher for the 7th week in a row and its highest levels since the beginning of June, and a 5-month high.

The FTSE100 also managed to finish the week higher, posting a 2-month high in the process, although it has continued to struggle to get much beyond the 7,400 level.

Since the October lows, markets in Europe have been rallying on an expectation that eventual interest rate hikes might not be as high as was thought to be the baseline case a few weeks ago, although we can expect to see a lower open today, as rising Covid infections in China prompt tighter controls, and weakness in Asia markets.

While that may be true in the US where headline CPI has been slowly rising at a slower pace since June, that certainly isn’t the case in Europe and the UK, where it has continued to remain on an upward trajectory.

US markets have had an altogether patchier performance since their October lows, as investors absorbed comments from St. Louis Fed President James Bullard, who said that the Federal Reserve needed to go much further in raising rates, saying that to really get a handle on inflation the terminal rate had to rise to between 5% and 7%. This is much higher than the current target level for markets of just over 4%, and while markets in the US did finish down on the week, they still finished higher on the day.

The comments from Bullard were all the more surprising given that there has been a clear trend since June that US inflation has been easing, helped by the aggressive nature of the Federal Reserve’s reaction response since March, as well as a stronger US dollar, something that appears to have escaped the attention of Fed governor Christopher Waller who last week said that it would take more than one CPI report for the Fed to ease back on its hiking policy. Someone should point out to him that the October reading was the lowest CPI print since January.  

In contrast to the Federal Reserve, who seem determined to drive up US rates, the European Central Bank, as well as the Bank of England seem more reluctant to do so despite weaker currencies acting as a drag on their own economies, and as a tailwind for their own domestic inflation pressures.

Nonetheless both the euro and the pound have managed to hold onto their recent gains from the low points seen back at the end of September, with the pound proving remarkably resilient, despite a bleak economic outlook for the UK economy over the next two to three years.

Last week UK CPI hit another record high at 10.7% for October, while EU CPI was confirmed at 10.6%.

Nonetheless, the ongoing uncertainty over what the Federal Reserve is likely to do over the next two to three months appears to be the main factor driving the more resilient tone in equity markets even as US markets finished last week lower.  

Weaker energy prices are also helping the narrative that inflation may have peaked in the short term, thus helping to temper rate rise expectations despite Bullard’s unexpectedly hawkish tone at the end of last week.

Oil prices in the US fell 10% last week, as rising covid cases in China fuelled concern over demand during the winter months, while Brent crude prices fell 9%.

The recent weakness in energy prices is one of the few silver linings the markets have been able to latch onto in recent weeks, with natural gas prices also falling back quite sharply in recent weeks.

UK natural gas prices for instance have fallen sharply since their peaks in August, falling over 70%, and it’s been a similar story for European gas prices.

Despite this weakness in energy prices there has been precious little evidence that inflation is slowing in Europe. Back in August German PPI hit a record high of 45.8%, and stayed at that level in September. If we are to start seeing evidence that inflation is slowing this is where we need to see it, with today’s October PPI numbers expected to slip back to 42.1% on an annualised basis.

On a month-on-month basis German PPI rose 7.9% in August, and then 2.3% in September. For October we’re expecting to see another rise, albeit a more modest 0 6%.

EUR/USD – currently capped at the 1.0400 and the 200-day SMA area. A close above 1.0430 is needed to push up towards the 1.0600 area. Support all the way back at the 1.0180 area. 

GBP/USD – still have resistance up near the 1.1960 level. The 1.2030 area remains the broader resistance. This is likely to be a huge barrier for any further gains. Support remains all the way back at the 1.1640/50 area.

EUR/GBP – remains under pressure with a break below the 0.8670/80 level opening up the potential for further losses towards the 100-day SMA.

USD/JPY – currently struggling to move beyond the 141.00 area. Need to move through this level to minimise the risk of a move back to the recent lows at 137.65.

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