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April weakness continues into May for European stocks, RBA hikes rates

Reserve Bank of Australia

Asia markets got off to a poor start to the month yesterday, as did markets in Europe after the latest China PMIs showed that economic activity in April fell back by more than expected.

Much was made of the slowdown in China manufacturing to 47.4 from 49.5, however non-manufacturing saw an even bigger fall, plunging from 48.4 to 41.9, and the lowest levels since February 2020, when the Chinese economy was locked down. It is clear that the disruptions caused by the Chinese government's lockdown measures in trying to combat the Omicron variant are having a drastic effect on economic activity. With little sign that the Chinese government is willing to admit its zero-Covid strategy is doomed to fail, as reports grow that Beijing could follow Shanghai into lockdown, the prospect of any significant improvement here looks slim.

With manufacturing activity across Europe also slowing to a 15-month low due to rising prices and economic uncertainty caused by the war in Ukraine, the outlook is unlikely to improve, although the inability of oil prices to push higher could offer some respite to hard-pressed consumers.

With central banks under pressure to tackle rising inflationary forces, investors don’t have the luxury of falling back on a benign interest rate environment, with the US Federal Reserve set to raise rates tomorrow by 50bps and the Bank of England set to follow suit with at least another 25bps on Thursday.

US markets initially didn’t fare much better, with the S&P 500 coming off its worst month since March 2020, and the worst start to the year since 1939. The index slid below its February lows, along with the Nasdaq 100, however a late recovery saw a big tech-inspired rebound, led by the Nasdaq 100, and a positive start to the month.

The US 10-year yield also pushed higher, up to the 3% level for the first since 2018. This is expected to translate into a mixed open for markets in Europe later this morning, with the FTSE 100 set to fall as it plays catch up on yesterday’s market declines for the DAX and CAC 40.

Earlier this morning, the Reserve Bank of Australia felt the need to set aside concerns about influencing this month’s Federal election by raising its own headline rate from 0.1% to 0.35%, in a move that is already long overdue. The move, the first time the RBA has raised rates in over 10 years, was a response to concerns over rising prices, while the Bank also raised its inflation forecasts and reduced its GDP forecasts.

Like the European Central Bank, the RBA had been at pains, at the end of last year, to insist a rate rise this year was unlikely, a position that was never remotely credible, and which it now belatedly has had to accept was a position it needs to reverse, and quickly. At a minimum, markets had been expecting a move to 0.25%, and is likely to be the first of many, with another hike expected in June, sending the Australian dollar sharply higher. The ECB is also slowly coming around to this realisation in the face of surging prices, with today’s March PPI numbers expected to show another big jump in prices. In February these rose to 31.4% on an annualised basis, and are expected to show a month-on-month rise of 5%, taking the annualised figure to a new record high of 36.3%.

Today’s UK manufacturing PMI for April is expected to show that economic activity slowed to 55.3 from 55.5 in March, with output expectations slowing quite markedly in the recent flash numbers, suggesting that businesses are starting to become concerned about their ability, as well as their customers’ ability to absorb further increases in costs, which are already at record levels. Continued supply chain disruptions in China aren’t going to make this problem any easier.

In the US we also have the latest JOLTs numbers for March which measures the number of vacancies in the US economy, and which have remained steady at over 11m the last 2 months. Despite rising prices, as well as interest rates, there’s been little sign of the jobs market slowing down which is a good thing given that the first thing to go when businesses start to struggle is headcount. The first sign that this is changing, would be a decline in job openings, as well as a rise in unemployment levels. For now this isn’t happening as we look ahead to Friday’s April payrolls report.

EUR/USD – fallen back to 1.0470 on the way to a potential retest of the 2017 lows at 1.0340. To alleviate the risk of a move towards parity we need to see a move back above the 1.0820 area.   

GBP/USD – fell to 1.2412 last week, and briefly below 1.2490 which is the 61.8% retracement of the move from the 2020 lows at 1.1410, to the peaks last year at 1.4240. We need to see a move back above 1.2630 to suggest a retest of the 1.2830 area or risk a move towards 1.2250.  

EUR/GBP – last week’s failure at the 0.8470/80 area has seen the euro slip back. Still in the wider 0.8200/0.8500 range with support at 0.8320.

USD/JPY – appears to have run out of a bit of steam at 131.25 but is now on course for a potential test of the 135.00 area, and 2002 highs, while above 129.20.

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