European stock markets took quite a 'shellacking' yesterday, with the Stoxx 600 posting its biggest one-day fall this year, as broad-based weakness saw investors take profits in the wake of last week's record highs.
Asia markets have continued that theme this morning with more big declines, and this weakness looks set to translate into the prospect of another negative start here in Europe later this morning. The FTSE 100 was the biggest faller yesterday and could well open below last week's lows if the current trend is sustained.
A number of reasons have been given for yesterday’s broad-based weakness, the main one being concern that the recent sustained rise in commodity prices could prompt a sharper permanent state of rising inflation, in the weeks and months ahead. These concerns were magnified by yesterday’s Chinese factory gate prices for March, which saw a rise of 6.8%, a rise of over 7% since the end of last year, and the highest level since November 2017.
US markets also carried over the weak theme from Europe, finishing the day sharply lower, with the Dow Jones posting its biggest one-day fall since February, although the Nasdaq, which initially led markets lower, managed to recover almost all of its losses, finishing the day only marginally lower. Opinion between US policymakers appears divided on the risks of rising prices, with the likes of Robert Kaplan of the Dallas Federal Reserve in the more hawkish camp, while permanent Fed governor Lael Brainard is among the doves, with attention expected to be focused on this afternoon’s US consumer price index (CPI) data for April.
Before that we have the initial iteration of UK Q1 GDP, which will be the first indication of the damage done to the UK economy as a result of the lockdown imposed at the beginning of January. At the time there was a real worry that the economic contraction would probably be of the magnitude of about -4%, given that it was made very clear that the lockdown was likely to endure for all of the first quarter. The Bank of England indicated it expected to see a significant contraction in its inflation report in February, until the monthly GDP data for January showed a contraction of -2.9%, before being subsequently adjusted up to -2.2%. As the weeks went by it soon became apparent that Q1 GDP was unlikely to be anywhere near as bad as feared, and that expectations could well be revised higher, and with the improvement in economic activity in the monthly purchasing manager index (PMI), optimism rose that the economic damage was likely to be containable.
In February, the monthly GDP numbers expanded by 0.4%, raising the prospect of another positive month in March, as businesses built up inventory in preparation for the economic reopening in Q2. In Q4, the economy expanded by 1.3%, with this week’s preliminary number expected to see a more modest contraction of -1.6%. While this morning’s headline numbers are likely to be better than was originally feared back in January, they won’t be able to disguise the damage in other areas, namely trade, where both imports and exports saw significant disruption as a consequence of the various trade and supply chain issues at the borders, with expectations of sharp declines in both imports and exports, of around -7%. The monthly GDP number for March is expected to see a 1.5% expansion.
One of the bright spots of the UK economy over the past few months has been the manufacturing sector, which has performed quite well after the big drop as a result or the first lockdown, just over a year ago. The sector, by and large, has managed to stay open despite all of the lockdown restrictions, the pity being it makes up such a small part of the UK economy. Since the ending of the first lockdown, the sector has grown consistently every month since a 4.6% decline in March 2020, and a 24.4% decline in April. This trend of unbroken positive readings faltered in January, with tighter restrictions, trade disruptions at ports due to Brexit and other backlogs, as well as a slowdown in economic activity acting as a bit of a brake on output, with a fall of 2.3%, while industrial production output slowed as well, by -1.5%. Since then, we’ve seen a pickup in economic activity with a rebound of 1.3% in February, as companies look to restock in anticipation of an economic reopening at the end of the quarter. This trend looks set to continue in today’s March numbers, with an expectation of 1% in both manufacturing production and industrial production.
Away from the UK, all eyes are expected to be on this afternoon’s US CPI numbers for March, given yesterday’s sharp rise in China factory gate prices, and the sharp rises in US forward inflation expectations in the last couple of days, which has prompted somewhat of a rout in equity markets these past two days. While it's important to understand the reasons why markets are concerned about sharp rises in inflation expectations, it's hard to see how today’s US CPI data will do anything to crystallise these concerns into anything meaningful. We are expecting to see a big jump in headline CPI for April from 2.6% to 3.6%, while excluding food and energy, it's expected to jump from 1.6% to 2.3%. A jump of this magnitude shouldn’t surprise anybody with a rudimentary knowledge of base effects, and looking at where commodity prices were this time last year.
The Federal Reserve would have us believe that today’s move higher is likely to be transitory, and it's certainly true that some of it probably will be. Unfortunately, we won’t know if they are right for another two or three months, which means we can probably expect to see further gyrations in global equity markets until the picture becomes clearer
EUR/USD – continues to find itself capped at the 1.2180 level, which could prompt slide back to the 1.2080 level. While above the 1.2080 area the risk remains for a revisit of the high this year at 1.2305. Only a fall below 1.2070 negates and opens up a move back towards 1.2020.
GBP/USD – the break above the 1.4020 area, opens up the prospect towards the 2018 highs at 1.4375. The 1.4020 area now becomes a key support for this move higher. A fall back below 1.4000 undermines and argues for a move back to 1.3920.
EUR/GBP – last week’s failure at 0.8730 has seen the euro fall back through the 50-day MA and 0.8620 area and open up a move back towards the 0.8580 area. A break through 0.8570 opens up a move back to the April lows at 0.8478.
USD/JPY – still under pressure, but while above the trend line support from the January lows now at the 108.15 area, the trend remains up. A move below 108.00 opens up the prospect of a move back towards 106.80.