European markets underwent another negative session yesterday, clobbered by concerns over weaker than expected economic activity, which in turn is raising concern for earnings growth heading into the second half of the year. Throw in a US credit rating downgrade from Fitch and the catalyst for further profit taking after recent record highs for the DAX completed the circle of negativity.
US markets also underwent a negative session, with the Nasdaq 100 undergoing its worst session since February, while the US dollar acted as a haven and the yield curve steepened.
As a result of the continued sell-off in the US, and weakness in Asia markets, European markets look set to open lower later today, and while the Fitch downgrade doesn’t tell us anything about the US political governance that we don’t already know investors appear to be looking to test the extent of the downside in the market.
Earlier this week we saw some poor manufacturing PMI numbers which showed that the European economy was very much in recession, with disinflation very much front and centre. This has raised questions as to whether the services sector will eventually succumb to similar weakness. There has been some evidence of that in recent readings but by and large services activity has been reasonably robust.
In Spain services activity is expected to remain steady at 53.4, along with Italy at 52.2. The recent flash numbers from France saw further weakness to 47.4, while in Germany we can expect to see a resilient 52, down from 54.1.
EU PPI for June is expected to slip further into deflation to -3.2% year on year.
In the UK services activity is expected to slow to 51.5 from 53.7.
With inflation unexpectedly slowing more than expected in June to 7.9% it could be argued that the pressure on the Bank of England to hike by another 50bps has eased somewhat, especially since the Fed and the ECB both hiked by 25bps last week.
Having seen core CPI slow by more than expected to 6.9% forward rate expectations have eased quite markedly in the past few weeks. Forward market expectations of where the terminal rate is likely to be, have slipped from 6.5%, to below 6%.
It’s also likely that inflation for July will slow even more markedly as the effects of the energy price cap get adjusted lower which might suggest there is an argument that we might be close to the end of the current rate hiking cycle.
The fly in the ointment for the Bank of England is the rather thorny issue of wage growth which has moved above core CPI, and could prompt the MPC to err towards the hawkish side of monetary policy and raise rates by 50bps, with a view to suggesting that this could signal a pause over the coming weeks as the central bank gets set to consider how quickly inflation falls back over the course of Q3.
Such an aggressive move would be a mistake given that a lot of the pass-through effects of previous rate increases haven’t fully filtered down with some suggesting that the Bank of England should pause. In the current environment this seems unlikely given a 25bps is priced in already.
In a nutshell we can expect to see a hawkish 25bps as a bare minimum, and we could also see a split with some pushing for 50bps.
We could also get an insight into how new MPC member Megan Greene views the current situation when it comes to casting her vote. One thing seems certain, she is unlikely to be dovish as Tenreyro whom she replaced on the MPC.
We’ll also get a further insight into the US labour market after another bumper ADP payrolls report yesterday which saw another 324k jobs added in July. Weekly jobless claims are expected to come in at 225k, while we’ll also get an insight into the services sector with the ISM services index for July which is expected to come in at 53.
The employment component will be of particular interest, coming in at 53.1 in June, having jumped from 49.2 in May.
EUR/USD – managed to hold above the 50-day SMA for the time being, with a break below targeting further losses towards 1.0830. Resistance currently at last week’s high at 1.1150.
GBP/USD – also flirting with the 50-day SMA with a clean break targeting a move towards the 1.2600 area. Resistance at the 1.2830 area as well as 1.3000.
EUR/GBP – continues to edge higher drifting up to the 0.8630 level before slipping back, although it is now finding some support at the 0.8580 area. We need to see a concerted move above 0.8620 to target the July highs at 0.8700/10.
USD/JPY – continues to look well supported above the 142.00 area, with the next target at the previous peaks at 145.00. Support comes in at this week’s lows at 140.70.