A combination of rising yields and mixed economic data conspired to send European and US markets to their second successive week of declines last week.
The rise in US yields came against a backdrop of slightly firmer PPI numbers for July, which helped push the Nasdaq 100 to one-month lows, and the first time this year it has fallen for 2 weeks in succession.
Asia markets have fallen sharply this morning as a sell-off on Chinese markets, amidst concern over defaults in its property sector, and broader economic weakness has prompted fears that this weakness could spread to other areas of the economy, after it was claimed that a Chinese trust company failed to make payments to some clients. These claims, along with concerns over broader economic weakness in the Chinese economy looks set to translate into a weaker start for markets here in Europe.
UK gilt yields also saw strong gains last week after Q2 GDP came in better than expected at 0.2%, helped by a strong performance in June where we saw an expansion of 0.5%. The strong showing in June was driven by services, as the hot weather prompted consumers to go out and spend money on travel, hotels and restaurants, as well as other leisure pursuits.
We also saw a strong performance in construction and manufacturing with strong motor vehicle sales. The weak spots were in health and education due to industrial action, and while the resilience of the UK economy is welcome given the tough cost of living backdrop, there is a concern that the Bank of England might derail this by further rate hikes in the coming months.
Friday’s data shifts the focus to this week’s wages, unemployment and inflation numbers, with the strength of these numbers likely to be a key factor as to whether we might be able to avoid further rate rises. The main question will be by how much will inflation fall as the effect of the lowering of the energy price cap gets factored into the July numbers.
Market expectations are for at least another 2 more rate rises, and then for rates to stay elevated for over a year, however a significant slowing could see that get repriced. The prospect of 2 more rate hikes isn’t a particularly welcome one given some of the underlying vulnerabilities of the UK economy, with the housing market especially vulnerable. Stung by justified criticism of its stewardship of the UK economy over the last 18 months there is a feeling that the Bank of England could overcompensate in the other direction.
If the monetary policy committee deigned to look at PPI, input prices are already negative, and by the central banks own admission, monetary policy is already restrictive, and with a base rate already at 5.25%, it couldn’t hurt to signal a pause in September. The Fed has already paused once this year, so we know it can be done.
Another unwelcome development last week was another week of gains for crude oil, the 7th successive weekly increase, with prices up by over 15% from their June lows, and close to their highest levels this year. The worry is that they are showing little sign of slowing down against a backdrop of tighter supply and rising demand.
These sorts of rapid gains can have the unintended consequence of stopping economic activity in its tracks. Last week’s China data pointed to a weak domestic as well as global outlook, and for all of OPEC+’s determination to put a floor under prices, there is a risk that their aggressive output cuts could well cause demand destruction.
EUR/USD – failed to sustain a move above the 1.1050 area last week, but equally is finding support just above the 1.0900 area. Below the 1.0900 area targets 1.0830
GBP/USD – continues to find support above the 1.2600 area. A break below 1.2600 targets 1.2400. Until then the bias is for a move back above the 1.2800 area through 1.2830 to target 1.3000.
EUR/GBP – the 100-day SMA appears to be acting as resistance at the 0.8670/80 area. Support comes in at the 0.8580 area with a break below targeting the 0.8530 area. Above the 100-day SMA targets the 0.8720 area.
USD/JPY – pushed through the previous highs at 145.10, pushing up to 145.22. A break above 145 30 could well target a move towards 147.50. Support now comes in at the 143.80 area.