Yesterday’s surge in the US dollar to new 20-year peaks against the euro, appears to suggest that investors are becoming increasingly concerned that the Federal Reserve may well not pivot on monetary policy next year.
It’s almost as if markets have got so conditioned to the Fed riding to the rescue that its hard to envisage them not doing so this time, however yesterday’s slide in US markets could be the gradual realisation that this time is different, as they posted their worst day since June, and yields rose sharply.
Now markets appear to be starting to price in the prospect that inflation may well be higher for longer, although the continued surge in natural gas prices yesterday has also helped. It is becoming ever clearer that prices are likely to remain higher for longer, and if indeed that turns out to be the case, that means rates are likely to be higher for longer.
These concerns also saw European markets close sharply lower yesterday, with surging natural gas prices adding to the angst, after Gazprom announced it will once again be closing Nord Stream One for “maintenance” for 3 days at the end of the month. This closure is once again raising concern that this could happen on a more regular basis as the weather gets colder.
It matters little whether Russia decides to cut off flows completely given the market is behaving as if they will, prompting consistent revisions higher of where inflation is likely to be this time next year.
Today we’ll get further insight into the damage that has not only been done by high energy prices, but also the extreme weather we saw in Europe with the low river water levels, as well as the various forest fires.
PMIs across Europe and the UK have remained in positive territory for nearly all this year despite the combined challenges of rising prices and weakening economic activity. Up until a couple of months ago manufacturing had managed to remain remarkably resilient despite a challenging macro backdrop.
As Q3 has got under way the resilience of Q2 has given way to an increasing drop-off in economic activity, as shown by the sharp fall in the latest ZEW expectations survey, which dropped to its lowest levels since 2008.
Surging energy prices, along with sharply declining water levels on the Rhine have cut the rug out from the manufacturing sector in Germany with today’s August flash PMI expected to see a further decline from 49.3 to 48, while services activity is also expected to slip further from 49.7 to 49.
In France the picture isn’t any better, although the services sector is benefitting from a bit of a tourism boost, however the forest fires could well pull economic activity here down quite a lot more. In manufacturing economic activity is likely to slip to 49, from 49.5, while services could slip from 53.2 by a lot more than the 53 that is currently being forecast.
In the UK, the picture is slightly better, with hiring patterns remaining robust, and while costs have been rising businesses have been able to pass on the increase in costs. Whether that will be enough to prevent an August contraction is debatable, given that in July enthusiasm about the economic outlook was already starting to wane. With August being a slow period due to holidays, we could well start to see economic activity on the PMI level start to slide into contraction territory, from 52.1 for manufacturing in July and from 52.6 for services in July.
In the US we got a bit of a curveball on the services PMI in July, as it unexpectedly fell into contraction territory of 47.3 in stark contrast to the ISM services which jumped to 56.7. Was this a one-off for US services, or was the ISM an outlier? Judging by the payrolls numbers it would appear the ISM is more representative. It’s still worth keeping an eye on cost prices paid for further evidence of a slowdown in the pace of rising costs.
EUR/USD – has made a fresh 20 year low, breaking below the 0.9950 previous lows as it looks to move towards the next key support at 0.9620. The 1.0220 area is still minor resistance on any pullback, followed by major trend line resistance from the January highs at 1.0340.
GBP/USD – slipped below the previous lows at 1.1760 increasing the risk of further losses towards the lockdown lows of March 2020 at 1.1500. Resistance comes in at 1.1980 area.
EUR/GBP – fallen back from the 0.8510 area, and the 50 day MA, with support coming in around the 0.8410 area. Below the 0.8400 area targets 0.8370.
USD/JPY – continues to push higher and away from the cloud and 50-day SMA, with the move through 136.30, now opening up the previous highs at 139.40. Now have support at 136.30.
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