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Cautious start for Europe’s markets in key CPI week

Despite posting three successive days of record highs the FTSE100 closed the week lower, as did the rest of Europe’s markets, as investors try to balance the risks from a slowing down in the pace of inflation, and central banks that, on the face it, want to continue to send a hawkish message on rate hikes.

That message didn’t appear to be cutting through until the January US non-farm payrolls report, as well as the services ISM, which painted a significantly better than expected look for the US economy.

Bond markets are starting to reflect this changing perception, with yields rallying strongly with the US 2 year closing at its highest level since November last year, above 4.5%.

US stock markets appear much harder to convince despite the sharp falls in the S&P500 and Nasdaq 100 last week, although the penny is showing early signs of dropping, with the Nasdaq 100 posting its first negative week this year.

Some of last week’s weakness may well also be down to caution ahead of tomorrow’s US CPI report which may well be more resilient than expected. One of the main reasons we’ve seen a sharp fall in the US dollar since those 22-year peaks back in October has been an almost universal belief that US inflation has peaked. While that may well be true it certainly doesn’t mean that inflation is likely to fall back equally as quickly as it has risen.

That realisation along with last week’s drip, drip narrative of hawkish Fed speakers which now finally appears to be cutting through, the most notable of which appears to be the comments from Fed vice-chair John Williams who said that rates might have to stay high for several years.

These comments were particularly noteworthy given that they explicitly pushed back against the narrative of rate cuts by year end, which markets had started to assume would be coming fairly soon.

It is true that in recent weeks, economic data has been much better than expected, not only in the US, but also in Europe as well, while on Friday the latest Canadian jobs report also painted a stronger than expected picture of the jobs market.

With energy prices also close to multi-month lows the hope is that the worst may be over, although with the Chinese economy likely to be much stronger this year, that will inevitably mean that inflation is likely to be stickier.

There is also little sign of a slowdown in services inflation and with all central banks having an inflation target of 2%, it is highly unlikely that central banks would contemplate cutting rates at a time when prices are well north of that figure.

As we look ahead to another week, the main focus is going to be on tomorrow’s US January CPI report, along with retail sales later in the week. Better than expected numbers are unlikely to be positive in the context of being near a peak for US rates.

It’s also a big week for UK economic data after last week’s Q4 GDP numbers which showed the economy stalled. While there were some pockets of strength there is little doubt that the UK economy remains fragile and will continue to remain so as we look towards Wednesday’s CPI and tomorrow’s wages data.

Headline inflation is still well above 10% and expected to remain so even after this week’s CPI reading, which means consumers are likely to remain cash-strapped for some time to come, a trend that is likely to be reinforced by January retail sales numbers on Friday.

EUR/USD – a move below the 50-day SMA opens the potential for a return to the lows this year at 1.0480. Resistance currently at 1.0780/90, with a move above 1.0800 stabilising and opening up 1.0920.  

GBP/USD – sandwiched between resistance at the 50-day SMA, at 1.2190 and support at the 200-day SMA at 1.1970 Below 1.1960 retargets the 1.1835 area, while a move above 1.2200 argues for a move towards 1.2300.

EUR/GBP – found support at the 0.8820 level last week. A move up through the 0.8880 retargets the 0.8930 area. Below 0.8820 targets a move towards 0.8780.

USD/JPY – dipped to 129.80 last week before rebounding. The 50-day SMA now at 132.20 continues to cap the US dollar’s advance. While below the 50-day SMA the bias is for a move back to the recent lows near 128.00.

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