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China unrest to prompt a weaker European open

Last week saw an eighth successive weekly gain for the DAX, and fresh five-month highs, with the German index closing in on peaks seen back in June. The FTSE 100 also finished strongly, closing just shy of the 7,500 level.

While equity markets continued to hold up well, we’ve seen bond yields continue to come under pressure, with US 10-year yields closing at seven-week lows. Even UK gilt yields, which only a few weeks ago were well above 4%, have slipped back to levels last seen in August, as concerns about sharply rising inflationary pressure continue to ease.

The past few weeks have seen a remarkable shift in tone from the lows in October, with a strong recovery also in US equity markets, with the S&P 500 trying to break above its 200-day simple moving average for the first time March this year.

Asia markets have also seen a decent recovery, however that is being tempered this morning by civil unrest in China over fresh anti-Covid restrictions, which has prompted further weakness in commodity markets this morning. This in turn looks set to translate into a lower European open, over concerns that the unrest could prompt a stricter crackdown by Chinese authorities in response.

The main reason for the sudden change in sentiment in the past few weeks has been the hope that while the US Federal Reserve has continued to talk tough when it comes to inflation, there appears to be a growing belief that we have seen a peak when it comes to rising prices. This has been reflected in the data, and while the likes of Fed governor Christopher Waller can talk about the fact that the FOMC is not going to react based on one CPI print from October, when the headline number came in below expectations at 7.7%, the inescapable fact remains that US CPI has been rising at a slower rate since June, when it peaked at 9.1%.

That certainly speaks to a trend, and although it can be argued that 7.7% is still way too high, we’ve also seen in the price of energy that a peak might be in, with Brent crude and US WTI prices hitting their lowest levels since January this morning, on concerns over weaker Chinese demand as Covid lockdowns there return against a backdrop of spreading unrest.

We’re also seeing big falls in container freight markets, with declines in shipping rates. The Drewry’s composite world container index has now fallen for the 39th week in a row, and is over 70% down on the same period last year, indicating an easing in global supply chain pressures, although it is still well above pre-pandemic levels. Whether this is due to overcapacity, or simply a symptom of slowing global trade, the net effect is the same; less inflationary pressure, which will in time be reflected in weaker producer and factory gate prices, although energy prices are likely to remain highly volatile over the winter period.

Nonetheless central banks are likely to be keeping a close eye on pricing trends over the course of the next three to four weeks in the lead-up to Christmas, starting this week with the latest PCE core deflator inflation numbers from the US for October, as well as the November non-farm payrolls report on Friday. It will also be worth paying attention to the latest prices paid components of the latest ISM manufacturing survey for November for further evidence of falling input prices, given that these have been rising at a consistently slower pace since their March peaks. We also have the EU flash CPI for November this week, which could well have hit its high-water mark of 10.7% in October.

EUR/USD – currently struggling to gain traction above the 1.0400 area and 200-day SMA area, however the lack of dip so far suggests the scope for a move towards the 1.0600 area. A close above 1.0430 is needed to push up towards the 1.0600 area. If we slip back below 1.0320, we could see a move back towards 1.0180.  

GBP/USD – running up towards the 200-day SMA at 1.2190, where we have resistance. Need to take out 1.2200 to target the 1.2500 area. Support now back at the 1.1870 area.  

EUR/GBP – looks set for a test of the 200-day SMA at 0.8530 now that we’ve slid below trend line support from the August lows. Continues to look heavy while below the 0.8780 area.

USD/JPY – last week’s failure at the 142.50 area has seen the US dollar slide back below the 140.30 area, with the next support back at the lows this month at 137.65/70. The bias appears to have shifted with resistance back at the 142.25 area. 

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