After a strong start to the day yesterday, with both the DAX and CAC 40 hitting new record highs, European markets lost momentum after first the Bank of England and then the European Central Bank decided to play the Grinch in contrast to the Fed‘s Santa Claus and backtrack on similar rate cut forecasts, with the DAX ending the session lower.
While US yields managed to close near their lows for the day, German yields closed well above their lows for the day, helping to push the euro towards the 1.1000 level against the US dollar.
The contrast between the ECB’s tone and the Fed’s tone could not have been more stark, and yet when you look at the numbers, the divergence becomes even more bizarre.
Here we have a situation where the Fed has announced a dovish pivot with Q3 GDP growth of 5% and headline CPI of 3.1%, while the ECB has maintained its hawkish stance when its two largest economies are in contraction in Q3 and its headline inflation rate is lower.
If anything, the policy stances should be reversed, especially given that the ECB says it is data dependent, which would mean that on that basis it should be leaning towards rate cuts, just as the Fed already is, and yet it isn’t, with Christine Lagarde saying that rate cuts have not been discussed.
This stubbornness on rate policy is likely to be further tested today with the latest flash PMI numbers from Germany and France for November, which are expected to show some modest improvement in economic activity, but still very much in recession territory.
The French manufacturing PMI is expected to rise to 43.3 from 42.9, while the German manufacturing PMI is forecast to improve to 43.2 from 42.6.
Services activity is also expected to improve modestly, with France rising to 46 from 45.4 and Germany to 49.8 from 49.6.
The UK economy is doing slightly better, which may explain why the Bank of England was also hawkish yesterday, keeping rates on hold even though 3 rate-setters voted for another 25bps hike.
In some respects, one can understand the Bank of England’s reluctance to appear too dovish, with headline inflation at 4.6% almost double that of the EU.
In the absence of formal forward guidance, this may simply be the Bank of England’s way of pushing back market expectations of an imminent rate cut and preventing markets from getting ahead of themselves. This is because a weaker pound can slow the disinflation process when it comes to pulling down inflation, which is likely something the central bank will want to avoid. Having 3 hawkish outriders can help keep markets guessing.
Today, the manufacturing PMI is expected to rise to 47.5, while the services PMI is expected to remain in expansionary territory at 51.
US markets also had a strong session yesterday, with another record high for the Dow, although it was notable that the Nasdaq 100 struggled to hold on to most of its gains, closing well off its intraday highs.
With the recent euphoria showing signs of fading, markets in Asia shifted their focus to the latest Chinese retail sales and industrial production figures for November, with European markets set to open slightly higher.
The Chinese economy has given the impression of some improvement if recent economic data is any guide, but the bar remains low in terms of what it is capable of given that domestic prices slipped into deflation last weekend. This economic weakness prompted China’s central bank to inject support into the financial system this morning in the form of one-year loans.
The latest trade and inflation figures continue to point to weak demand and disinflation as the housing problems weigh on the economy while the Chinese authorities wrestle with the problems at Evergrande and Country Garden.
There was a modest improvement in retail sales in October, while industrial production remained steady at 4.6%. After September retail sales ended the quarter with a 5.5% increase, October saw a better-than-expected 7.6% increase, but that number needs to be put in the context of a 0.5% decline in October 2022 when the economy was still in lockdown, so the numbers may have been flattering to deceive.
Chinese consumers do seem to be starting to spend a little more, though, as various European luxury brands can attest, products aren’t flying off the shelves.
Today’s November numbers saw retail sales come in at 10.1%, which was below expectations even though the numbers included Chinese Singles Day sales, and weak comparisons given that much of China still hadn’t come out of lockdown this time last year. Industrial production was better, coming in at 6.6%, the best performance since February 2022.
EUR/USD – This week’s rebound has seen the euro retest the November highs at 1.1015/20, with support now back at the 200-day SMA at 1.0830. A break above 1.1030 has the potential to target the July highs at 1.1275.
GBP/USD – Broke above the 1.2730 area and the 61.8% retracement of the 1.3140/1.2035 move lower. If we can consolidate this move higher, we could see an extension towards the 1.3000 area. Support comes in at the 1.2590 level.
EUR/GBP – Slipped back from the 100-day SMA at 0.8640, with support in the 0.8580 area. A move below 0.8580 targets 0.8520.
USD/JPY – After breaking below the 200-day SMA at 142.50, we could see a move towards 140.00. We now have resistance at 146.00 and a break below could see a move towards 139.20.
The FTSE100 is expected to open 12 points higher at 7,661.
DAX is expected to open 28 points higher at 16,780.
CAC40 is expected to open 13 points higher at 7,588.
