Rising rates and rising stock markets aren’t usually a combination that sits comfortably with a lot of investors, but that’s exactly what we saw last week, with European markets enjoying their best week in over two months, while US markets and the S&P 500 had their best week since March.
One of the reasons behind this rebound is a belief that Chinese demand may well pick up as the authorities there implement stimulus measures to support the struggling economy. There is also a belief that despite the US Federal Reserve delivering a hawkish pause to its rate-hiking cycle, and the ECB delivering another 25bps rate hike last week, that we are close to the peak level for interest rate rises, even though there is a growing acceptance that rates aren’t coming down any time soon.
We did have one notable outlier from last week and that was the Bank of Japan, who left their current policy settings unchanged in the monetary policy equivalent of what could be described as sticking one’s fingers in one’s ears and shouting loudly, and pretending core inflation isn’t already at 40-year highs.
This week, attention turns to the Swiss National Bank, as well as the Bank of England, who are both expected to follow in the ECB’s footsteps and hike rates by 25bps. The UK especially has a big inflation problem, with average wages up by 7.2% for the three months to April, as the Bank of England, not for the first time, has allowed inflation expectations to get out of control. This was despite many warnings over the last 18 months that they were acting too slowly, even though they were the first central bank to start hiking rates.
We heard over the weekend from former Bank of England governor Mark Carney that this state of affairs wasn’t surprising to him, and that Brexit was partly to blame for the UK’s high inflation rate and that he was proved correct when he warned of the long-term effects back in 2016. Aside from the fact that UK inflation is not that much higher than its European peers, Carney’s intervention is a helpful reminder of what a poor job he did as Bank of England governor. At the time, he warned of an economic apocalypse, arguing that growth would collapse and unemployment would soar, and yet here we are with a participation rate at near record levels, and an economy that isn’t in recession, unlike Germany and the EU, which are.
The reality is that two huge supply shocks have hit the global economy, firstly Covid-19, and then the Russian invasion of Ukraine, and the UK’s reliance on imported energy and lack of gas storage has served to magnify the shock on the UK economy. That would have happened with or without Brexit and to pretend otherwise is nonsense on stilts. If anything is to blame, it is decades of poor energy policy and economic planning by successive and existing UK governments.
UK inflation is also taking longer to come down due to the residual effects of the energy price cap, another misguided, and ultimately costly government policy. Carney is probably correct about one thing, and that is interest rates are unlikely to come down any time soon, and could stay at current levels for years.
This week is likely to be a big week for the pound, currently at 14-month highs against the US dollar, with markets pricing in the prospect of another 100bps of rate hikes. UK 2-year gilt yields are already above their October peaks, and at 15-year highs, although 5- and 10-year yields aren’t. This feels like an overreaction, and while many UK mortgage holders are looking at UK rates with trepidation, this comes across as overpriced. It seems highly likely we will get one rate rise this week and perhaps another in August, but beyond another 50bps seems a stretch and would be a surprise.
With US markets closed for the Juneteenth public holiday, today’s European session is likely to be a quiet one, with a modestly negative open after US markets finished the end of a positive week with their first daily decline in six days.
EUR/USD – pushed up to the 1.0970 area last week having broken above the 50-day SMA at 1.0880. We now look set for a move towards the April highs at the 1 1095 area. Support comes in at the 50-day SMA between the 1.0870/80 area.
GBP/USD – broken above previous highs this year at 1.2680 last week as well as moving above the 1.2760a area which is 61.8% retracement of the 1.4250/1.0344 down move. This puts us on course for a move towards the 1.3000 area. We now have support at 1.2630.
EUR/GBP – broken below the 0.8530/40 area negating the key reversal day last week and opening up the risk of further losses towards the 0.8350 area. Initial support at the 0.8470/80 area. Resistance at 0.8620.
USD/JPY – continues to push higher and on towards the next resistance at 142.50 which is 61.8% retracement of the 151.95/127.20 down move. Support now comes in at 140.20/30.