The initial optimism that we might see evidence that US inflation might be slowing, and that had helped push US markets higher at the start of this week, sharply evaporated in the aftermath of yesterday’s CPI numbers. The Nasdaq 100 was the biggest faller, reversing abruptly away from its 200-day MA, to open and close sharply lower, although it is still marginally higher on the week.
The bigger than expected jump in US CPI to a 40 year high of 7.5% in January, with core prices tipping the scales at 6%, sent yields sharply higher with the US 10-year surging through 2%, while the 2-year yield blasted through 1.5%, rising 26bps on the day, to finish above 1.6%. This week alone the US 2-year yield has risen by 30bps. These accelerated moves higher are indicative of a bond market pricing in a much higher probability that the Federal Reserve could raise rates by 50bps when they next meet in March, and go a lot faster over the rest of the year.
The move higher was given added fuel by FOMC member James Bullard who said he favoured a 50bps hike in March, with another 50bps by July, while also suggesting that the central bank hold an emergency meeting and hike early. This seems unlikely given that they are still doing QE and it's due to end in March anyway, so a few more weeks isn’t likely to change too much, but it’s clear that he is spooked by yesterday’s inflation number, and he may not be alone.
Away from used car and petrol prices, which are up 40% year to date, double digit price rises are being seen in domestic gas, as well as meat, dairy, fish, and fruit. It rather begs the question as to why the Fed is still adding to its balance sheet even now, a point seemingly not lost on St. Louis Fed President Bullard, judging by his comments yesterday.
The move higher in US yields also had a spill over effect on UK borrowing costs with the UK 2-year gilt yield rising to 1.36% and a ten year high, as the effects on global inflation threaten to ripple out further across the world with German CPI for January due this morning, and UK CPI for January due next week.
Today’s focus, while likely to be on whether US markets follow through on yesterday’s falls, is also set to be focussed on the UK economy as we get the first iteration of Q4 GDP, December GDP and the industrial and manufacturing production for December.
Q4 had been shaping up to be a reasonably decent quarter until the Omicron wave broke over the UK economy in December, with the distinct possibility that December could see a contraction in economic activity, although it probably won’t be enough to see a contraction.
Looking at the monthly GDP numbers we saw the UK economy expand by 0.2% in October, and then a strong performance in November of 0.9%, driven by rebounds in consumer spending as well as industrial production and construction output. December is expected to see a -0.5% contraction, largely driven by a sharp drop of -0.7% in the index of services.
The big question is how much of this November rebound in manufacturing and construction carried over into December, and whether it was enough to offset the collapse in retail sales which fell by -3.6%, more than wiping out the collective 2.7% gain seen in October and November.
Expectations for the UK economy come in slightly below the 1.1% gain seen in Q3, with a rebound in exports and imports also likely to be seen, as consumers here in the UK and across Europe shop early for Christmas. Industrial and manufacturing production is expected to slow from the strong performance seen in November, with forecasts of about 0.1%.
In light of yesterday’s sharp falls in the US, it's likely that we’ll see markets here in Europe open sharply lower, largely as a result of yesterday’s comments from Bullard about an accelerated path for monetary policy tightening.
EUR/USD – we saw both sides of the range yesterday, rebounding from the 1.1375/80 area, before squeezing above 1.1485, although we weren’t able to break above 1.1500. This keeps the bias towards a return to the 1.1380 area. A move through 1.1500 targets the 1.1600 area A break below support at the 1.1380 area signals a move back towards the 1.1270 area.
GBP/USD – spiked up through the 1.3600 area yesterday to 1.3645, after failing to push below 1.3520, however the gains proved short-lived. As such the bias remains for a move back towards 1.3470. A break below 1.3470 potentially targets a retest of the 1.3400 area, where we have trend line support from the December lows.
EUR/GBP – failed to break below support at the 0.8410/20 area before rebounding. We still have resistance at the 0.8480 area. A move below 0.8400 retargets the 0.8370 area.
USD/JPY – squeezed back to the January highs at 116.35, before slipping back. A break above 116.35 targets the 117.50 area. The bias remains to the upside while above the 114.70 area.
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