The jitters surrounding a strong dollar but were bought into at the end of the week, keeping the US stock market in a tight range with low volatility. There are some high expectations for the big US tech company earnings this week from Apple, Amazon and Alphabet. If US tech firms did well in Q3, it could add some conviction to the idea that the earnings slowdown, that has been in place over a year, is drawing to a close.
Progress was hard-coming in the UK stock market last week as the British pound found some footing above 1.20 to the dollar. The impact of the Bank of England’s latest decision to cut rates on the Q3 earnings of UK banks Lloyds, RBS and Barclays will be a key driver of sentiment this week.
In the currency market, the divergence trade is back on. The US dollar index broke above 98 last week and is now within striking distance of 100. The continuously hawkish stance of the Federal Reserve stands in stark contrast with the other central banks. The 180 degree change in position since Brexit, of the Bank of England, leaves the Fed out on its own looking for policy tightening.
Core CPI inflation in the US cooled in September but remains above the Fed’s 2% target. Should inflation start to pick up, the market will begin to price in a steeper pace of rate hikes. Whilst US economic data remains supportive and Hillary Clinton takes the White House the Fed should remain on course for its first rate hike this year. Should the performance of the US economy, including inflation, start to slip, investors could switch attention from divergence back to carry trades in low yield environment. There are a number of US economic data points this week; notably durable goods, Markit reports on economic activity and culminating in third quarter GDP on Friday.
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The euro was in such a tight trading range that it only took a relatively small move to take it to the lowest in seven months. The drop in the euro was largely because of speculation that the European Central Bank will soon announce more money printing. There appears to be an element of markets hearing what they want to hear because there wasn’t anything too explicit from Mario Draghi. At its meeting last week, the ECB governing council didn’t discuss extending or tapering QE – so was pretty neutral. Whether the euro can sustain the move lower could rest on another speech from Mario Draghi this week. If no more evidence of an extension of QE is imminent, the euro could stabilise with EUR/USD returning to 1.10.
There is still no significant evidence that momentum in the UK economy is fading. UK inflation hit the highest in two years, even without any explicit evidence of any impact from the lower pound. September saw another firm employment report that saw wage growth moderate slightly and retail sales was flat on the month but had an overall very good quarter. The pound is under pressure because political, not economic uncertainty after Brexit. As such, UK Q3 GDP later this week is probably a non-event for Sterling. The flash crash has also rendered some question marks over liquidity of trading the pound.
Last week saw some short-covering in the cable rate when it was indicated the UK parliament would have it’s say on Brexit. It’s unlikely that parliament will be given the right to vote for or against Brexit – but could vote on the terms of Brexit – a Sterling positive result given that the majority of MPs supported remaining in the European Union. MPs being given a vote on the terms of leaving the EU would make a “soft Brexit” more likely. Of course, whether a soft Brexit is even possible, even if UK politicians wanted it is unknown, given the hard stance of EU bureaucrats. The pound unwound a lot of the week’s gains when Donald Tusk said the other 27 members of the EU will start to work separately from the UK even before Article 50 is triggered.
EURUSD – The euro has dropped out of the price range of June 24 that kept it in check for multiple months. The break lower is bearish but there is a cluster of support surrounding 1.08 that could limit the downside
GBPUSD – Cable has formed a triangle pattern since the flash crash, which could be either be a bottom or continuation. The trend is to the downside with 1.2130 the next major support. A break of 1.2330 is needed for a bullish trend.
EURGBP – euro-Sterling has been stalling at 0.89. The move down has been slow and would be expecting the uptrend to resume near 0.88/40 support.
USDJPY – dollar-yen is stuck in a tight range underneath 104. A break higher could extend towards the 200m DMA near 107.
Equity market calls
FTSE100: to open 22 points higher at 7,042
DAX: to open 20 points higher at 10,730
CAC40: to open 5 points higher at 4,541
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