Despite coming off the back of eight consecutive weeks of gains, May turned out to be a somewhat mixed affair for European investors with only the DAX and FTSE 100 managing to finish in positive territory.

While rising uncertainty over the progress of trade talks has been one of the factors limiting the upside in stock markets, helping prompt some light profit-taking initially, the political uncertainty unfolding in both Italy and Spain hasn’t particularly helped either.

The imposition of $50bn of tariffs on Chinese goods in the last few days, which was followed up yesterday by the confirmation that President Trump would finally impose his long-expected steel and aluminium tariffs on the EU, Canada and Mexico, saw stock markets further extend their recent declines on both sides of the Atlantic. 

In the short-term the immediate economic impact may well be limited as we’ve known these have been coming for some time, which may have given companies time to build up some inventory, however the decision to retaliate by the EU, Canada and Mexico on a range of other US goods, could well lead to a further escalation in the days ahead.

It remains to be seen how Italian markets will react to the news that there appears to be an agreement on a new populist government between the League and Five Star ,having agreed that the contentious Paolo Savona should move to a European affairs brief while the finance ministry brief will be held by Giovanni Tria, a Roman faculty professor, who has warned of an implosion of the euro if it isn’t reformed.

While this may be acceptable to President Mattarella under the leadership of Giuseppe Conte in its current guise, future relations with Brussels are likely to be much more prickly than previous administrations, even with Savona away from the finance brief, as the new government looks to implement their tax cuts and citizens income programme.

In Spain it is becoming increasingly likely that Prime Minister Mariano Rajoy’s position could become untenable with the prospect of new elections in the coming weeks, after the opposition parties secured enough votes to pass a motion of no confidence, meaning further political gridlock there.

Today’s US non-farm payrolls aren’t expected to alter the calculus that US rates will rise again later this month, despite a weaker than expected headline number in April of 164,000. This surprisingly low number, which also coincided with a similarly soft ADP number earlier this week, could merely be the result of a tighter labour market given that unemployment is now at 3.9%.

Expectations for May are for a 190,000 number, however even if that number comes in on the low side markets aren’t expected to be concerned about a miss in this direction. What is surprising is that since the beginning of the year wage growth has slowed from 2.9% to 2.6% and remained at this level.

Rising cost price inflation doesn’t, as yet appear to be translating into higher wage growth, and the latest May numbers are only expected to see a modest increase to 2.7%. This is still way below where it needs to be, however a strong number here could well spark further speculation that the Fed might look at the possibility of four rate rises this year, despite the recent minutes suggesting that they might be prepared to tolerate a higher level of inflation before becoming concerned about prices running away from them.

We are now finally seeing the impact of higher fuel prices in the latest May inflation numbers in Europe. Yesterday EU CPI for May showed a sharp rise to 1.9%, from 1.2% in April. This is a significant jump in inflationary pressure as inflation jumps from its lowest level in over a year to a one year high in the space of a month. This could well be problematic for the ECB at a time when political risk in Italy could exert downward pressure in growth expectations across the bloc, as it looks to exit its stimulus program.

If this jump in EU inflation is in any way indicative of a wider trend then inflation expectations could well be being underestimated by central bankers as well as the wider market. It also makes it all the more puzzling that the Bank of England downgraded its inflation forecast for this year.

After a strong year of economic activity in 2017 the manufacturing sector got off to a slightly softer start at the beginning of this year, across the board. In some of the recent April data there is evidence that this softness has evened out a little and started to stabilise. In Europe activity was able to rebound a little in part, while in the US we also saw increasing evidence of rising prices with prices paid at 7-year highs. If this trend continues in today’s numbers then that should be supportive of a rebound in Q2. Expectations for Spain, Italy, France and Germany manufacturing are for 54, 53, 55.1 and 56.8.

In the UK we also saw a decent rebound after a soft March number, which may well have been weather related. Activity in May is expected to have steadied at around 53.5, a slight decline from the modest rebound seen in the April numbers with particular attention likely to be on cost price inflation which still looks fairly robust. This will present problems in terms of company ability to pass these prices on down the supply chain.

EUR/USD – the rebound from the 1.1500 level which is also trend line support from the December 2016 lows at 1.0340, was also a bullish daily reversal. This suggests we could well see a move beyond the 1.1730 level and a retest of the 1.1830 area. A move below 1.1500 opens up 1.1360.

GBP/USD – has found support at the 1.3200 area with broader support just below that at 1.3110 trend line support from the January 2017 lows. Resistance now comes in at the 1.3360 area, with a break retargeting the 1.3460 area.

EUR/GBP – the rebound from the 0.8690 area has prompted a move bac through the 100-day MA and could see a test of the 0.8830 level, and behind that the 200-day MA at 0.8850.

USD/JPY – holding above the 50-day MA at 108.35 but needs to push back through 109.30 to suggest a retest of the 110.30 level. 


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