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Europe set for weak start, as focus turns to US CPI

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Equity markets were caught between two competing narratives last week, and could face similar cross-currents this week, as we look to a weaker open on the back of Friday’s modest gains. There were also further US dollar gains, and uncertainty about the economy in China, as worries about renewed covid lockdowns weighed on sentiment.

On the one hand we've seen energy and metals prices slide back sharply on rising concerns over recession risk and demand destruction. We’ve also seen big falls in the price of wheat and corn, with our own Agricultural index falling over 10% from its May peaks. The top three weightings of this index are soybean, wheat and corn, which make up 59% of the overall weighting.

On the other hand, these concerns were offset by a decent US non-farm payrolls report, which saw the US economy add 372,000 jobs in June. The resilience of the US labour market, with the unemployment rate at 3.6%, as well as jobs markets elsewhere, helps to offer a compelling narrative to those who think recession concerns are overblown.

Better than expected wages growth also offered a pep to US bond yields sending the 2-, 5- and 10-year yield all back above 3%, with the 10-year yield still below both the 2- and 5-year yield in a sign that usually means economic stagnation and or recession may well be on the way.

The resilience of US markets last week was a welcome respite after the declines of the week before. Despite the buoyant tone of the last few days, they are about to face another big test later this week, with the June CPI report, as well as the start of US earnings season on Thursday, as JPMorgan Chase kicks off US banks' earnings with the release of its Q2 numbers.

Nonetheless Friday’s payrolls report has helped raise the stakes when it comes to the next policy steps from the US Federal Reserve. Despite compelling evidence that inflation may well have peaked, or is starting to, expectations are rising that the US central bank will not only raise rates by 75bps at its next meeting at the end of this month, but it will follow that up with another 75bps in September. This would double the Fed funds rate in the space of two months from its current 1.5%, and in all likelihood force central banks elsewhere to react in a similar fashion to mitigate the inflationary impulse that the Fed’s actions would send out into the wider global economy.

As such much is riding on this week’s US CPI numbers, which are forecast to rise to a new 40-year high of 8.8%. This would be in contrast to what the core PCE and PPI inflation numbers have been telling us in recent months. These have been in decline since hitting respective peak readings in March, raising the question as to whether the CPI is a bit of an outlier, and the Fed is overcompensating.

Later this week, we’ll also be getting an insight into how much damage the various lockdowns and other covid restrictions have had on the economy in China with the Q2 GDP numbers, as well as a snapshot of the UK economy, with the latest rolling monthly GDP numbers for May.

The Bank of Canada is also expected to raise rates by 75bps on Wednesday as it looks to keep pace with the Federal Reserve’s own hiking cycle.  

EUR/USD – the break below 1.0340 and the fall below 1.0100 to a new 19 year low keeps the move towards parity on track, as well as the longer-term target at 0.9660. A move back above 1.0340/50 delays this move.

GBP/USD – has yet to overcome the 1.2040/50 area which it needs to target the 50-day SMA and 1.2120 area. The risk of further losses towards 1.1500 remains on a break below 1.1875 and last week’s lows.

EUR/GBP – saw its biggest weekly fall this year, finding support at the 100- and 200-day SMA at 0.8440/50 area. Given the sharp nature of the fall we could see further weakness towards 0.8380. Resistance comes in at the 0.8520/30 area.  

USD/JPY – has got some decent support at the 134.80 area, which while above could see further gains on a move through the 137.00 area, towards the 140.00 level. 

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