EEuropean markets managed to draw a positive conclusion yesterday in a day that saw UK and US bond yields soar, with the UK 10-year rising to its highest level since 2011 and narrowing the gap with its US counterpart narrowest since April 2016.
The sale of Britain’s gilts appears to have been based on the premise of billions of pounds of fiscal support expected to be announced tomorrow by new Prime Minister Liz Truss as she tries to rein in soaring energy costs, for businesses British. and consumers, who are pushing inflation through the roof.
The fear is that while these measures are likely to contain inflation now, the trade-off is higher headline inflation over a longer period, which likely means higher rates for longer. Ultimately, there are no easy solutions, with any action taken this week having to be weighed against the costs of doing nothing and the long-term damage to the economy of not acting.
US markets had a slightly different day yesterday, closing lower after a strong ISM services survey for August, which bolstered the prospect that the Federal Reserve may opt for another 75 basis point rate hike when it will meet in two weeks. It is somewhat surprising that markets are still underpricing the likelihood of the Fed doing this, given recent statements from various Fed members on frontloading.
Last night’s weak US close should translate into a lower European open, although today’s Asian session weakness also played a role after some disappointing trade data from China.
It is becoming increasingly difficult to be optimistic about the outlook for the Chinese economy as the winter months approach. With 21.5 million people already locked down in Chengdu and new restrictions imposed in places like Guiyang, Guizhou Province, as well as Shenzhen, it is hard to see a scenario of meaningful economic recovery long before the year. next.
This morning’s latest trade numbers for August only underline how weak domestic demand still is and how far off the year-end GDP target of 5.5% is. The target may have been downgraded to an aspiration just last month, but it’s further away than ever after today’s data and we could be lucky to see half that number at this rate. Import data has already been weak for several months, rising 2.3% in July from 1% in June. Today’s August figures suggest a continued lack of Chinese consumer confidence as well as a lack of demand, slowing to 0.3%, well below expectations of 1.1%.
Exports were slightly more resilient, rebounding 18% in July and beating expectations after a weak second quarter, helping to push the trade surplus ever higher. These also disappointed in August, coming in at 7.1%, well below expectations of 13%.
On the data front today, the latest EU GDP for the second quarter is expected to be confirmed at 0.6%, while we also have another central bank rate decision.
The Bank of Canada shocked the market in July by taking the unexpected 100 basis point rate hike from 1.5% to 2.5%, while saying there was more to come.
There is already growing evidence that wages are starting to rise in response to this recent inflationary spurt. The Canadian Federation of Independent Business said last month that several members of their organization planned to raise wages dramatically in response to labor shortages.
BOC Governor Tiff Macklem has also signaled that more rate hikes are ahead, and with the Federal Reserve set to set another marker in two weeks, we can expect to see another 75 point move. basis from the Canadian central bank later in the day.
Wages are already rising at an average of 5.4% against an overall CPI rate of 7.6%, although it is down from the recent high of 8.1%.
It is also worth keeping an eye on the Japanese yen after the declines seen in recent days. There have been discussions about the prospect of some form of coordinated intervention to stem the bleeding, so to speak.
The Bank of Japan will certainly be affected; however, they really shouldn’t be too surprised given that it is their policies that are causing this collapse. Their current monetary policy is very deliberately the opposite of what all other central banks are doing. If they want to stop the yen’s slide, the answer is quite simple and can be summed up in one word, pivot.
EUR/USD – Another new marginal low at 0.9864 keeps the pressure on for a move towards 0.9620. With no movement through recent highs in the 1.0120 area, risk remains for lower levels as we head towards the 0.9000 area.
GBP/USD – faltered in the 1.1600 area yesterday, but although above the March 2020 lows in the 1.1410/15 area, there is potential for a brief squeeze towards resistance in the 1.1750/60 area.
EUR/GBP – fell back into the 0.8560/70 area having failed to break above the 0.8680 area earlier in the week. We need a sustained break below 0.8560 to retarget the 0.8480 area.
USD/JPY – After breaking above 140.00 last week, the US Dollar has made rapid gains as it looks to head towards the 145.00 area, breaking above 141, 142 and 143 in quick succession. While above the 140.00 level, the next significant resistance is at the 1998 highs at 147.70.
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