Markets in Europe rebounded yesterday, helped to some extent by the reduced prospect of an immediate escalation in tension between China and the US, as well as a slightly softer tone from President Trump regarding prospective next steps with China.

While the US Treasury outlined the $300bn list of Chinese goods that would be subject to 25% tariffs, the calculation would appear to be that these will only be implemented if talks break down completely. For now, that appears unlikely, as it is neither sides interest to peer over that particular cliff edge.

It also helped that there are still a couple of weeks to go until China’s retaliation kicks in on 1 June, and similarly any new US tariffs on Chinese goods won’t take effect until Chinese goods hit US shores in about 10 days’ time.

This in turn helped US markets recover at least half of Monday’s decline as investors calculated that any increased tariffs may only be in place for a short period of time, with a deal being concluded soon after. Time will tell as to whether that belief turns out to be anywhere near close to the truth, or just wishful thinking. Asia markets have picked up this positive vibe and run with it despite some disappointing Chinese economic data and this looks set to translate into a mildly positive European open this morning.

While no one disputes that an all-out trade war would be damaging to both the US and China, let alone the global economy, opinions differ as to who has most to lose in terms of damage to their economy.

China’s economy has been under significant scrutiny in recent months over concerns that internal demand is slowing sharply, while the manufacturing sector has been in recession. Last week’s trade numbers for April appeared to underscore concerns about weak domestic demand. With the US keeping up the pressure on the trade front, today’s April retail sales and industrial production numbers need to be able to maintain the rebound we saw in March.

Industrial production in particular saw a strong rebound, from 5.3% in February to 8.5% in March, a four and a half year high, though this might have been a result of some catch up after the lunar new year holiday prompting some restocking.

This appears to have been confirmed with April industrial production activity which slipped back sharply to 5.4%, and back to the levels pre Lunar New Year, while retail sales also slowed sharply coming in at 7.2% well down from the six-month highs of 8.7% we saw in March, and the lowest levels in 16 years. There is no sugar coating these numbers, they are dreadful and show that the March rebound was probably a flash in the pan, or a symptom of a distortion caused by Chinese New Year.

This sharp slowdown increases the likelihood that we will probably see further attempts by China to help stimulate its economy as well as raising concerns that any hopes of a Chinese economic rebound helping to prompt a global pickup in economic activity look a little bit forlorn at this point in time.

The German economy has also suffered from the effects of the ongoing trade uncertainty as well as the ongoing saga that is the Brexit talks, contracting in Q4 and concerns that a slumping manufacturing sector could well hit the Q1 GDP numbers. Recent manufacturing PMI’s appear to suggest that German manufacturing is in recession.

This makes this morning’s preliminary iteration of Q1 GDP all the more important amidst expectations of a rebound to 0.4%, This would probably be largely driven by the services sector, which has managed to hold up well. EU Q1 GDP is expected to be come in at 0.4%

The US economy has also been a little bit of a mixed picture recently, with a stronger than expected Q1, against a backdrop of a resilient labour market, and rising wages. This hasn’t really been reflected in consumer spending which has been a little patchy, popping one month and then slowing the next. Q1 activity was by and large positive largely due to a strong performance in March of 1.2%.

Whether this spills over into April remains an open question, however the labour market continues to look robust while wages are still growing at a healthy clip above inflation suggesting limited scope for disappointments in Q2. Expectations are for a rise of 0.7%.

EUR/USD – continues to look soggy while below the 1.1270 area which appears to be containing the upside for now, with wider resistance at the 1.1325/40 area and the April peaks. The bias remains to the downside, and the lows at 1.1110, while below this key resistance level.

GBP/USD – the pound has continued to struggle slipping down through the 1.2960/70 area, and heading for the 1.2860 area, and possibly lower towards the 1.2800 area. We need a move above 1.3070 to stabilise.

EUR/GBP – continues to edge higher with the recent range highs at 0.8720 a key level. While below 0.8720 the risk is for a drift back down towards the 0.8570 area on a break below 0.8620.

USD/JPY – appears to have found a short term base at the 109.00 area for now but the risk still geared for further declines towards the 108.00 area. It would need a recovery back above the 110.30 area to stabilise and signal a move back towards 111.00.

 

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