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Europe set for lower open after another US rout

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Having seen some decent gains in the early part of the week, yesterday saw European markets slide back after Fed chair Jay Powell reiterated the determination of the Federal Reserve to regain the initiative when it comes to reining in inflation.

The weakness in Europe rippled into the US market session, after a big profits miss from US retailer Target, which following on from Walmart the day before, saw losses accelerate, with the S&P 500 and Nasdaq 100 both closing over 4% lower. Asia markets haven’t been able to shake off this negative mindset, with a similarly weak session primarily led by Chinese tech stocks after Tencent also missed on profits.

Powell’s comments that the Federal Reserve wouldn’t hesitate to tighten the rates ratchet beyond neutral until there is clear evidence that inflation is under control, has sparked concerns of a much more aggressive pace of rate rises, beyond what was outlined at the last Fed meeting.

While markets seemed comfortable with the idea of this month’s 50bps move, followed by another 50bps in June, there now appears to be talk of 50bps in July as well, after comments from Philadelphia Fed President Patrick Harker to that effect last night, with the possibility of more moves at a measured pace thereafter.  

With US inflation already at 40-year highs and starting to look increasingly sticky, the tone from some Fed officials appears to shifting to an even more hawkish pivot with the intent to soften the market up for faster moves in the Fed funds rate. Sentiment has been further damaged by inflation in the UK surging to a record high on the CPI measure of 9%, and Canadian CPI jumping to a 32 year high, it is becoming more apparent that prices will stay elevated for a lot longer than originally thought. That will be bad news for consumers, margins and therefore growth, and ergo could well signal further weakness for stock markets.

Powell’s remarks appear to be part of that strategy as do Harker’s, and with the US labour market still looking tight it would appear that the Fed is prepared to run the risk of pushing the US economy into a recession, given the buffer of an unemployment rate which is at multi year lows, and vacancy rates at record highs.

These concerns were further compounded by yesterday’s earnings miss from Target, following on from Walmart the day before, which appears to offer further evidence that high levels of inflation are already starting to impact the consumer decision making process.

The extent of the selloff in US markets last night sparked a move into US treasuries, as yields fell back from the 3% level to close at 2.87%, 11bps lower, while the US dollar saw a sharp rebound.

This nervousness around tech valuations won’t have been helped by the latest guidance from Cisco Systems, after the US close, who slashed their Q4 revenue outlook to -1% to -5.5%, against an expectation of +5.7%, as well as cutting its full year forecasts.

This weakness in US and Asia markets is set to translate into a sharply lower open for European markets, as we look ahead to the latest US weekly jobless claims numbers which in recent weeks have started to edge higher again, above 200k. The latest Philadelphia Fed business survey for May will also be closely monitored after the recent huge miss on the Empire manufacturing survey from earlier this week.

EUR/USD – the rally off the 1.0340 level ran out of steam above the 1.0560 level, and we’ve subsequently slipped back. The bias remains for a move lower towards parity, while below 1.0650.

GBP/USD – the failure to hold above 1.2400 is concerning but also not unexpected, after failing to move above the 1.2500 area. While below the 1.2630 level the risk remains for a move bac towards 1.2000, on a break below 1.2150.

EUR/GBP – slid briefly below the 0.8420 area before rebounding, and we’ve now moved back towards the 0.8500 area. We also have resistance at 0.8520/30 area.  

USD/JPY – the big resistance lies at the 131.35 area; however, we still appear to be vulnerable to a move towards 126.80. If that holds then the 135.00 area target remains intact. A move below 126.80 targets the 123.00 area.

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