European markets closed higher again last week, with the DAX rising for the sixth consecutive week and the FTSE100 returning to levels last seen on October 19th after the latest US jobs report came in better than expected, with unemployment unexpectedly falling to 3.7%.
US markets also ended the week strongly, with the S&P500 pushing past its summer highs to close at its highest level of the year, and the Nasdaq 100 not far behind, with the technology sector once again responsible for most of this year’s outperformance.
The catalyst for the strong close was a solid US employment report, which showed that 199,000 jobs were added in November, while the unemployment rate fell to 3.7%. With the labor force participation rate back up to 62.8% and wages holding at 4%, the idea that the Federal Reserve will be forced to cut rates aggressively suffered a bit of a setback and yields moved sharply higher as expectations for a rate cut in 2024 were scaled back.
The apparent resilience of the US economy against the backdrop of a sharp decline in inflation expectations from the latest University of Michigan confidence survey has helped to create a narrative that despite the sharp rise in interest rates over the past 18 months, the US economy will be able to avoid a severe recession.
This scenario poses some problems for the Federal Reserve when it comes to managing market expectations about the timing of rate cuts, as the recent sharp decline in global yields points to a widespread expectation that rates may well be cut sharply by 2024.
As far as the US economy is concerned, aggressive rate cuts at this stage look a little less likely than elsewhere where we’ve seen a sharp slowdown in the pace of CPI inflationary pressures.
Earlier this month, the latest EU inflation figures showed headline CPI slowing to 2.4% in November, while German CPI was confirmed at 2.3% as prices fell 0.7% month-on-month, the second consecutive month of negative CPI.
Germany isn’t unique in this either, as PPI inflation had already given plenty of indication of where price deflation was headed.
In China over the weekend, headline CPI also went negative in November, only in this case at an annualized rate of -0.5%, for the second month in a row and the third month out of the last 5.
PPI inflation also remained in negative territory at -3% for the 14th consecutive month as the world’s second largest economy struggles with deflation and slowing domestic demand.
This deflationary impulse appears to be already making itself felt in Europe, and to be honest, has been for some time, the only surprise being how blind certain parts of the European Central Bank have been to it.
While these concerns about deflation are slowly being acknowledged, they don’t seem to be being taken seriously at the moment, although in a welcome change we did hear ECB Governing Council member Isabel Schabel admit that she had been surprised by how quickly prices had slowed in recent months, even as economic activity had stumbled badly.
Consequently, this week’s meetings of the Federal Reserve, the European Central Bank and the Bank of England are likely to be crucial in managing expectations about the timing and pace of rate cuts that markets can expect to begin now that we know the peak is in.
Of all the central banks, the Fed probably has the easiest job as it has more time to assess how the US economy is responding to the tightening seen in recent months.
The ECB has no such luxury, given that the two largest economies, Germany and France, may already be in recession, and where prices may continue to fall as we head into 2024.
The fear for central banks is that much of the slowdown in inflation has been driven by the recent collapse in crude oil and natural gas prices and may well be transitory in nature, and with wage inflation still elevated, they will be reluctant to signal the “all clear” too soon.
The Bank of England has a similar problem, although the UK economy isn’t showing the same weakness as France and Germany, and inflation in the UK is almost double that in Europe, with wage and services inflation even higher.
As we head into a new trading week, and probably the most consequential of the month, European markets look set to open slightly higher as investors look back at the weekend’s inflation figures and extrapolate that 2024 may well be the year that interest rates start to fall, with the main risk being overestimating how far they will fall.
EUR/USD – Slipped down towards the 200-day SMA on Friday, stopping just short of 1.0724, with a break below 1.0700 targeting the prospect of further losses towards the November lows at 1.0520. We need to see a move back through 1.0830 to stabilize.
GBP/USD – Slipped to the 1.2500 area but remains above the 200-day SMA for now, with only a break below 1.2460 signaling a broader test of the 1.2350 area. Resistance currently at 1.2620.
EUR/GBP – Still range trading between the 0.8590 area and last week’s lows at 0.8550. While below the 0.8615/20 area, the risk remains for a move towards the September lows at 0.8520 and possibly further towards the August lows at 0.8490.
USD/JPY – The pair has found support at the 200-day SMA at 142.50 after last week’s sharp decline. We need to see a daily close below the 200-day SMA for a test of 140.00 and then on towards 135.00. Resistance back at 146.20.
FTSE100 is expected to open 7 points higher at 7,561.
DAX is expected to open 25 points higher at 16,784.
CAC40 is expected to open 11 points higher at 7,537.
