Having managed to reverse a sequence of seven successive weekly losses only a week before, US markets ended a holiday-shortened week very much on the back foot. The weakness on Friday came in the aftermath of another solid jobs report, with the rebound off the recent lows starting to show signs of faltering, both in the US and Europe as well, although markets in Europe do appear to be showing slightly more resilience.
At the beginning of last week, US yields had just come off the back of three successive weekly declines, on optimism that inflationary pressures in the US economy may well have peaked. This in turn prompted speculation that we start to see signs of a possible pause by the Federal Reserve after the expected 50bps hikes that are expected to be delivered in June and July.
Comments from Atlanta Fed president Raphael Bostic that he might be minded to consider a pause got this hare running even faster, however this didn’t last very long, with yields finishing the week strongly higher. This rebound in yields was down to a variety of factors, firstly a stronger than expected ISM manufacturing report, which came alongside hawkish comments from Fed governor Christopher Waller, who indicated he wanted to go down the route of several 50bps rate hikes to be certain that inflation is brought under control.
Friday’s non-farm payrolls report for May was also a factor, with the US economy adding 390,000 jobs, more than was expected, while the April number was revised up to 436,000. The unemployment rate remained steady at 3.6%, prompting a modest rebound in the US dollar. That said, wages data was still relatively weak, slipping back to 5.2% from 5.5% in April. With so many vacancies still outstanding, the mediocrity in wages growth remains one of the bigger puzzles in the inflation narrative.
As we look ahead to this week’s US CPI numbers for May, the main worry for investors is that in their increasing urgency to contain upside risk in inflation, central banks tighten monetary policy too quickly and tip the global economy into recession. Putting to one side the fact that surging inflation is probably already doing that in terms of a cost-of-living squeeze on consumption patterns, markets appear to be navigating a tightrope of concern over which is the better option.
It is becoming increasingly obvious from the tone of a number of Fed policymakers that a pause in the US rate-hiking cycle appears unlikely at the moment. Last week we heard from Fed vice chair Lael Brainard, who is generally considered one of the more dovish voices on the FOMC, arguing that the case for a September pause was a hard one to make. This suggests little in the way of a consensus for a delay at this point.
The European Central Bank is also due to meet this week, and while no change in policy is expected given that its asset purchase program is still running, the calculus here has already shifted towards a rate hike in July, and possibly September as well. This policy pivot has become all the more urgent given that inflation across the EU has been accelerating at the same as CPI in the US appears to be slowing down, and possibly plateauing. The biggest challenge for the ECB this week will be trying to justify why they are waiting until July to act, given the urgency of the situation. If anything, they are making the same mistake as the Federal Reserve did earlier this year, in persisting with a too easy monetary policy, and then having to tighten even more aggressively. The move in US treasury yields over the past few weeks shows that bond markets are having similar thoughts about the direction of travel for US inflation.
As we look ahead to what is set to be big week for both US and European markets, the outlook for the Chinese economy is expected to show a slightly more positive picture, when May trade numbers are released on Thursday, however given how poor the March and April numbers were due to lockdowns and covid restrictions, that’s a pretty low bar. Despite these concerns, Asia markets have edged their way higher as Chinese authorities continued to ease covid restrictions across the country. The latest Caixin services survey showed a modest improvement on April’s 36.2 reading coming in at a weaker than expected 41.4. This rise in Asia markets looks set to translate into a positive European open in a few hours' time.
EUR/USD – currently struggling below the 1.0790 area, trend line resistance from the highs this year. There is support just above the 1.0640 area, which while it holds keeps the potential for a move towards 1.0850. A move below 1.0640, opens up the 1.0530 area.
GBP/USD – currently finding support just above 1.2450 and the lows last week. A break below 1.2450 argues for a move towards 1.2320. While above support from last week lows, we can see a move back above 1.2550 towards 1.2630.
EUR/GBP – edging back towards resistance at the range highs near 0.8600. We have trend line support from the April lows currently at 0.8480. A move below 0.8470 retargets the 0.8420 area.
USD/JPY – next resistance remains at recent highs at 131.35. A break above 131.50 opens up the 2002 peaks at 135.00. Only a move below the 50-day MA, undermines upward momentum and argues for a move lower towards the 123.00 area.