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Markets look to US inflation after solid payrolls report

After several weeks of gains and having finished 2023 on a high note, it was inevitable that at some point markets would probably take a step back, having been given a lift into year-end by a belief that rate cuts were coming in early 2024. Last week saw a modest correction to that narrative, with a rebound in EU inflation in December.

There was also Friday's solid US non-farm payrolls report, which showed that the US economy added another 216,000 jobs, although there was also a 71,000 downward revision to previous months. A fall in the unemployment rate to 3.7% was welcome, although on a slightly more worrying note the participation rate fell sharply to 62.5% from 62.8%, while wage growth rose to 4.1%, indicating that the US labour market continues to look tight.

Leading into last week’s data, markets were pricing in the prospect of a March rate cut at about 73.8%, a simply mind-boggling probability when you look at how the US economy is performing relative to say the EU, where inflation levels are almost identical and where the economy is on its knees.

There was some disappointment at the softness of the US ISM services data for December, which showed that hiring slowed sharply to 43.3 from 50.7, however that could merely have been a case of US employers doing their seasonal hiring earlier and not leaving it so late this year. The headline number was also disappointing, slowing to 50.6 from 52.7, while prices paid came in at 57.4, suggesting that price pressures remained elevated.

This week attention shifts to the December CPI numbers, which does have the potential to put the speculation about a March cut firmly back in its box. The sharp rebound in yields last week does suggest that markets are paring back pricing of a March cut with the US dollar also rebounding, as stocks in the US declined for the first time in nine weeks.

European markets also slid back with the DAX posting its biggest weekly loss since October, while the FTSE 100 posted its biggest loss since November, as a rebound in inflation and better than expected economic numbers saw traders pare back rate cut bets. 

This week’s main excitement looks set to be generated towards the back end of the week with the US CPI report, followed by China inflation and trade numbers for December. Opinions about inflation are becoming increasingly split between concerns over a sharp rebound in inflationary pressures caused by higher pay settlements, and the deflationary impulse being generated by the slowdown in China where both headline CPI and PPI are both in negative territory.

This perhaps helps to explain why central banks don’t want to ease off the brakes when it comes to tighter monetary policy quite yet. The problem is the markets appear to have already made up its mind, with the sharp slide in yields seen since the October peaks. One thing seems certain, rate cuts are coming, with the key question being around the timing, and it is here that the market may be getting ahead of itself. This week ought to offer a better insight into when that might be, with the main risk being that markets are being premature in assuming it will be March.

US markets managed to finish last week mainly flat on the day after a choppy session, albeit close to the lows of the week, despite rising confidence in bond markets of an upcoming March rate cut. As we look ahead to today’s European open, markets here look set to open modestly lower ahead of the latest German trade data factory orders data for November both of which are expected to show an improvement on some dire October numbers. Both German exports and imports are forecast to rise by 0.5% and 0.4% respectively after both coming in negative in October. Factory orders are also expected to rebound by 1.1% after a -3.7% decline in October.

EUR/USD – slipped to a 2-week low last week at 1.0875 before rebounding. Still feels like it wants to move higher while above the 200-day SMA at 1.0830. A break above 1.1030 has the potential to target the December peaks at 1.1140.

GBP/USD – has found support above the 1.2600 area this past 3-weeks. Remains in the uptrend from the October lows. The bias remains for further gains while above the 200-day SMA as well as support at the 1.2590 area. On course for a move towards 1.3000 while above the 200-day SMA at 1.2520.

EUR/GBP – range bound with resistance at 0.8720 and support at the 0.8570/80 area. Bias towards downside while below 0.8670.

USD/JPY – ran out of steam at the 146.00 level last week. Vulnerable to a pullback towards the 200-day SMA at 143.20, with the 140.00 lows the next support.

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