While we were able to see a positive end to the week for stock markets on Friday, this was largely down to a rebound in bond yields, which saw the US yield curve move out of inversion on the 2/10, and the 30-year yield moving back above 2%.

Last week’s plunge in yields was an acceleration of a move that has been happening since the beginning of the month, with the US 30-year yield down over 50 basis points at one stage last week before closing the week at 2.044%, still well down from where it started this month at 2.52%.

German yields also continued to decline with the yield on the bund down for the fifth successive week in a row, though here we also saw a rebound in yields on speculation that the German government was considering a possible fiscal stimulus in the event of an economic crisis.

German finance minister Olaf Scholz appeared to put a possible number on that at the weekend when he suggested that €50bn could be mustered if the need arose, though he gave no indication that such action was imminent. Nonetheless this appears to have prompted a minor rally in yields and a firmer tone in Asia markets this morning, which is likely to offer a slightly firmer tone to the start of the week here in Europe.

That in itself is significant given Germany’s tendency to err towards fiscal prudence. It is true that the economic data last week was disappointing, however it is far from being anywhere near bad enough to prompt the German government to deviate away from its zero deficit or “black zero” policy.

A small contraction in Q2 is hardly apocalyptic stuff and even if the German economy contracts in Q3, which seems increasingly likely, it’s not the type of event that could shift that sort of dogma.

Quite simply the bar is too low, and besides €50bn isn’t likely to be anywhere near enough.

Today’s latest EU CPI numbers are expected to show that inflationary pressures remain subdued as expectations around further easing from the ECB gather pace. Headline inflation is expected to come in at 1.1%, and core CPI at 0.9%, with the German 2 year yield already pricing in a deposit rate cut of 40bps to -0.8%.  

This week all eyes are expected to be back on the US Federal Reserve, and the Jackson Hole annual symposium, especially since the latest US economic data show little signs of a sharp slowdown, despite markets pricing in the prospect of a 50-basis point rate cut next month. This divergence in expectations is likely to be tested significantly in the coming days.

Investors are still trying to juggle the same cocktail of risks of US, China trade, the prospect of an escalation of tensions in Hong Kong, a slowing global economy, Brexit, political uncertainty in Italy, and tensions between the US and Iran, which has helped push money out of stocks and into havens like gold, the Swiss franc and government bonds, and in the process introduced a significant increase in market volatility over the last two weeks.

That this is coming at a time when risks to the global economy are rising isn’t a coincidence, however there is a risk that markets are overestimating the ability of central banks to combat the next economic downturn.

With little prospect of an imminent US, China trade solution, markets will continue to be driven by every little twist and turn in the narrative coming from both sides, and with neither side in any particular hurry to conclude a resolution markets are likely to remain choppy with a bias towards the downside.

One thing does appear certain in amongst all of this, government bonds with a positive yield are likely to remain in demand, which means US treasuries and UK gilts are likely to continue to go higher.

EURUSD – the failure last week to overcome the 50-day MA and the 1.1250 area, has seen the euro slip back with the potential to retest the lows at 1.1020, and on towards the 1.0800 area. We need to overcome the 1.1280 level to retarget the June peaks.

GBPUSD – having rebounded from another two-year low at 1.2015 last week, the pound looks vulnerable to a move higher. We still have major support sitting at the 1.1980 area. Needs to move back above the 1.2260 area to prompt further gains back to 1.2380.

EURGBP – saw a weekly reversal last week after making a new multi-year high of 0.9325, raising the prospect that the top might be in. The break back below 0.9230, which is now resistance, could well see further losses towards 0.9000.

USDJPY – the flash crash lows this year at 104.70 are the next key support level, with last week’s rebound running into trouble at the 107.00 area. We need to see a recovery back above the 107.20 area to stabilise and argue for a move back to the 108.20 area.

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