European markets rounded off a solid start to the new year last week as optimism grew that the US economy would be able to avoid a hard landing, with the FTSE 100 closing at a three-year high after the US non-farm payrolls report for December came in better than expected.
US markets also managed to close strongly higher, with the S&P 500 closing at three-week highs, as yields fell sharply. If Friday’s price action tells us anything, it’s that investors really want to believe the peak inflation narrative that has helped support the rebound in equity markets that we’ve seen so far this year.
The December payrolls report was at best a goldilocks report with something for everyone, bull and bear alike, with the wider question being as to what it is actually telling us about the wider US economy. Markets latched on to the surprise decline in average hourly earnings which rose by 4.6% in December, well below expectations, while the November numbers were revised down from 5.1% to 4.8%, playing down concerns about upward pressure on wages.
The slide in the US dollar, along with a sharp decline in US 2-year yields, saw US equity markets surge into the weekend, having spent most of the week on the back foot over concerns that inflation could be much stickier than thought. The focus on Friday’s average earnings numbers is all the more curious given that it isn’t a particularly accurate reflection of wage growth, and that most of the data seen last week suggests that the US labour market remains tight, and that US wage growth remains strong. Last Thursday’s ADP report was testament to that reality, when it showed that wage growth came in at 7.3%, led by a 10.1% increase in hospitality and leisure roles.
Furthermore, weekly jobless claims have remained stubbornly low, and while it is true that headline inflation has been falling sharply since the summer, the fall in core prices is proving to be a little sticker. There is also the fact that even at 6%, core prices still remain three times higher than the Federal Reserve would like.
It therefore comes across as a little premature to think that we’ll see another downshift by the Federal Reserve to a 25bps rate hike on 1 February, when they next meet to raise rates. However, that appears to be what the market is pricing given the reaction to last Friday’s payrolls numbers. It is certainly becoming clearer that there are divisions opening up between Fed policymakers about how many more rate hikes are likely to be needed in the coming months, particularly in light of St. Louis Fed president James Bullard’s comments last week, when he said that rates are closer to being sufficiently high enough to becoming restrictive.
While a modestly softer tone than some of his recent comments, the remarks certainly don’t suggest that another slowdown in the pace of rate hikes is imminent, especially when you have notable doves like Neel Kashkari of the Minneapolis Fed pushing the idea of a terminal rate of 5.4%, 90bps above the upper bound of the current Fed funds rate. This suggests that a 50bps rate move remains the more likely outcome in a few weeks’ time, and that anything else appears to be wishful thinking at present.
With other Fed officials, like governor Lisa D Cook and Atlanta Fed president Raphael Bostic, saying that there remains some way to go before any thoughts of a change in outlook, the market is likely to try and continue second guessing Fed officials in the coming weeks and months.
This week’s US CPI numbers for December on Wednesday are set to be the next waypoint for speculation as to where the terminal rate is likely to be, with a further slowdown in the pace of price rises expected, with the main focus set to be on what core prices are doing, and less on the headline numbers which are expected to continue to fall sharply. Nonetheless, in the wake of Friday’s US jobs report and the strong reaction to it, today's European open looks set to be a positive one, with Asia markets also getting a boost as China took further steps to reopen its economy, as it relaxed its zero-Covid policy, further resuming travel with Hong Kong.
EUR/USD – a big reversal off three-week lows at 1.0480/85 last week has seen the euro recover back above the 1.0600 area with the main resistance still at last month’s peaks at 1.0730. This area remains a key barrier to a return to the 1.0800 area.
GBP/USD – slipped back to six-week lows at 1.1830/35 on Friday, before rebounding strongly to close the week higher. We need to hold above the 1.2000 area to retest the recent highs at 1.2450 and the 50-day SMA.
EUR/GBP – has continued to struggle at the 0.8870/80 resistance area, with a break targeting a potential move to the 0.9000 area. Support currently at the 0.8770/80 area with a break below opening up the risk of a move towards the 50-day SMA at 0.8690.
USD/JPY – failed to sustain a move above the 134.50 area, slipping back after hitting a six-month low at 129.50 at the start of last week. The failure to sustain last week’s rebound keeps the risk of a return to the recent lows, as well as the 126.50 area.
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