While US markets raced ahead last week, with the Nasdaq 100 posting its fourth week of gains, European markets have undergone a bit of pause in the last fortnight, with the FTSE100 slipping back from its recent highs, while the DAX managed to eke out a weekly gain, closing at its highest levels in 11 months.
The strong start to 2023 appears to have given way to a little bit of caution for markets in Europe as we look to this week’s trifecta of central bank meetings, and what sort of outlook is painted by the Federal Reserve, ECB and Bank of England, and more importantly how many more rate hikes can we expect to see after next week. This caution looks set to translate into a lower open for markets in Europe this morning ahead of Q4 German GDP numbers which are expected to show the economy in Germany ground to a halt.
US markets on the other hand, after a slow start to the year, appear to have got the bit between their teeth, with the Nasdaq 100 up over 11% year to date, with over 4% of that gain last week alone, as the tech heavy index, as well as the S&P500, broke through their 200-day SMA’s in a sign that could be the start of a new bull market.
Last week’s sudden surge of exuberance from US markets appears to be being driven by a belief that not only will the US economy avoid a hard landing, but that the Federal Reserve will not only signal another step down in its rate hiking cycle to 25bps but will also signal a pause.
This belief that we could see a pause in the Fed’s rate hiking cycle was given legs last week, when the Bank of Canada signalled that it was doing exactly that to further assess the impact of recent rate hikes on the wider economy.
While that may be an eminently sensible approach for the Bank of Canada, it certainly doesn’t mean the Fed will follow suit. In light of the resilience of last week’s US economic data, and especially the weekly jobless claims data, it would probably go down as a significant policy mistake if the Fed were to do that, as it could allow inflation to rebound sharply. That is something they can ill afford which suggests there is every sign that markets are getting well ahead of themselves.
As we head towards month end and what has been a strong month for not only US equity markets, but European markets, this week's central bank meetings could well determine whether the gains seen so far this month can be sustained, or whether we are in a bear market rally.
Even with the recent declines in headline inflation, which have been primarily driven by falls in energy prices, and natural gas prices especially, crude oil prices have been moving in the opposite direction on the back of the China reopening story
The speed of the recent falls in the inflation rate appears to be prompting complacency in some parts that we’ll see inflation back at 2% by year end and the prospect of rate cuts as soon as Q4 this year.
This comes across as highly optimistic, especially since a lot of companies have yet to pass on further increases in prices over the next few months, which means the easy wins of the recent falls in headline inflation could well slow and find a floor close to current levels.
Having made one mistake by underestimating the sharp rise in inflation seen in the last 12 months central banks can ill afford to make another and ease up too early in driving inflation out of the global economy.
For now stock markets look strong, however this week could well be the pin that pops this months rally and injects a dose of realism into market expectations. Whether it’s the Federal Reserve, or the European Central Bank, the market could well get delivered a few home truths by central bankers later this week.
As for the Bank of England there is a case for a 25bps and a 50bps rate hike this week, the big question is which one the MPC delivers.
EUR/USD – two failed attempts last week to move above the 1.0930 area has seen the euro slip back. The main resistance remains at the 1.0950 area which is 50% retracement of the move from the 2021 highs to last year’s lows at 0.9536. A move through 1.0950 opens up a move towards 1.1110. Support remains back at the 1.0780 area.
GBP/USD – tried and failed to move through the 1.2450 resistance area last week, before slipping back. We need to see a move through the 1.2450 area to target further gains towards 1.2600. A move below 1.2250 could see a move towards 1.2170.
EUR/GBP – the failure to make progress through the 0.8850 area last week has seen the euro slip back. Key support remains at the 50- and 100-day SMA which were earlier this month at the 0.8720/30 area. Below 0.8720 targets 0.8680.
USD/JPY – needs to break through the 131.00 area to target a move back towards 132.60. While below 131.00 the risk is for further declines towards the lows at 127.20. We have interim support at the 128.20 area initially.