It was a disappointing end to the week for stock markets in Europe on Friday, with the after effects from Wednesday’s Fed decision continuing to reverberate across global markets, while comments from St Louis Fed president James Bullard, who said he was leaning towards a US rate rise in 2022, helped to pull the rug out from stocks even further, a trend that has continued in Asia this morning with the Nikkei 225 getting hit particularly hard.
It was a move that undermined the entire narrative that the US central bank had been pushing for most of this year, that it wasn’t looking to embark on an imminent tightening of monetary policy. The only surprise was that the market was surprised at the sudden change of tone. With an improving economy it was starting to become increasingly self-evident that the overarching narrative of no rate hikes before 2024 was likely to shift.
It is true that the jobs market probably hasn’t improved as much as perhaps was expected back in March, however even allowing for that it is apparent that price pressures are rising, and that the number of job vacancies that are currently available is likely to lead to some level of wage inflation even if it’s not apparent now. This also probably helps explain the Feds apparent shift in position, which when you look at it objectively isn’t that unreasonable.
The end result however has been a sharp shift in short term interest rate expectations as US 2-year yields broke above 0.2%, breaking above the level that has capped it for the last 12 months or so, hitting a post pandemic peak of 0.28%, while longer term yields fell back after an initial spike higher, with the US 10 year yield falling even further this morning, and now below 1.37%.
These moves appear to a concern on the part of some that the Fed might be acting prematurely, sending short term rates higher and long term rates lower, however it doesn’t change the fact that the US central bank is still buying $120bn of bonds on a monthly basis, and is likely to continue to do so until September at the very least. Another thing that the Fed appeared to achieve last week was to let some more of the air out of the commodity price boom.
Given Bullard’s Friday comments, tomorrow’s testimony to Congress from Fed chair Jay Powell, coming so soon after last week's press conference, will be much more closely analysed for how he sees the US economy, as he briefs US lawmakers on how he and the Federal Reserve see the US economy, along with the timing of a tapering of bond purchases.
The US dollar had one of its best weeks since April 2020, rising to a two-month high against a basket of currencies as a consequence of last week’s Fed shift of position, with this week’s PCE numbers for May likely to reinforce the narrative around last week’s change of tack.
Particularly vulnerable will be the likes of the euro which many had predicted could see a move towards the 1.2500 level later this year. This looks highly unlikely now, while the pound will also be in focus this week as the Bank of England gets set to meet against a similarly spikey inflation backdrop. Last week’s decline in sterling was caused by a number of factors, the decision to delay this week’s reopening of the economy, a poor retail sales number, and a fear that the UK’s recovery might well be starting to run out of steam.
This seems unlikely at this stage, with all eyes on the Bank of England later in the week against a backdrop of a CPI rate now above the banks 2% target level, and an economy that still looks fairly resilient, with this week’s flash PMIs for June only expected to see a modest slowdown from May’s strong numbers.
Later today we can expect to hear from ECB president Christine Lagarde when she speaks to the European Parliament where she could add to the recent pressure in the euro, in the wake of last week’s dovish intervention by the ECB’s chief economist Philip Lane when he said it was premature to talk about ending emergency bond purchases.
As a consequence of today’s weakness in Asia today’s European open looks set to be a negative one with the FTSE 100 looking to open below the 7,000 level.
US private equity look to play UK supermarket sweep?
The UK supermarket sector is set to be in focus this morning after Morrisons turned down a £5.5bn weekend bid from US buyout firm Clayton Dubilier and Rice, saying it significantly undervalued the business. The surprise bid could well give the entire sector a boost when the market opens later this morning, given the surprising underperformance seen so far this year, despite the resilience shown by all, in their stepping up to the challenges of the pandemic.
All three, Morrisons, Sainsbury's and Tesco have seen costs rise as a result of Covid, and while in the case of Morrisons, profits halved last year, like-for-like sales growth remained resilient in its first quarter, rising 2.7%, despite the tough comparatives of last year, when sales surged for all three as people stockpiled all manner of staples. It has been battling with a falling market share, now down at 10%, from 10.6% five years ago, a trend that has been reflected in this year’s share price performance, unchanged year to date, although it is better than Tesco’s share price which is down over 20%, and Sainsbury's, which is up over 15%.
Tesco’s underperformance is down to the £5bn special dividend that was paid out in February, while last week’s decent Q1 results surprisingly saw the share price post its biggest fall since the decline in February. When compared to the likes of the food retail sector in the US, the share price performance of the entire sector has been woeful despite being profitable and having dividend yields of around 4%. Maybe that is about to change?
EUR/USD – has fallen back to the 1.1850 area and could well go lower towards the lows in March at 1.1704. Any pullbacks are likely to find resistance all the way back at the 200-day MA at 1.2000.
GBP/USD – slid below the 1.4000 area last week and made its way all the way back to the 1.3790/1.3800 area. This break raises the prospect of a move towards 1.3750 and potentially even as far as the March and April lows at 1.3670. The 1.4000 area now becomes resistance.
EUR/GBP – found support again at the 0.8540/50 area which continues to act as a line in the sand against further losses. We still have resistance at the 0.8640 area, with a break above this level retargeting the recent range highs at 0.8720. A break below 0.8540/50 opens up the recent lows at 0.8480.
USD/JPY – stuck between resistance just below the 111.00 area, and support while above the 109.80 area. A move below trend line support now at 109.70 opens a move back towards the 108.60 area on a break below 109.20.