Fed euphoria starts to fade as we head into the weekend

After getting off to a strong start yesterday, with both the DAX and CAC 40 trading up at new record highs, European markets lost momentum after firstly the Bank of England, and then the European Central Bank decided to play the Grinch in contrast to the Fed’s Santa and push back on following a similar rate cut outlook, with the DAX finishing the session lower.

While yields in the US managed to finish close to their lows of the day, German yields closed well above their daily lows, helping to pull the euro up 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 starker, and yet when you look at the numbers the divergence becomes even more bizarre.

Here we have a situation with the Fed announcing 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 2 largest economies are showing a contraction in Q3, and its headline inflation rate is lower.

If anything, the policy stances should be in reverse, especially given the ECB says it is data dependent, which would mean on that basis it really ought to be leaning towards rate cuts in the same way the Fed already is, and yet it isn’t, with Christine Lagarde saying that rate cuts were not discussed.

This stubbornness on rate policy is likely to face further scrutiny today with the latest flash PMI numbers from Germany and France for November which are expected to point to some modest improvement in economic activity but still very much in recession territory.

French manufacturing PMI is expected to edge higher to 43.3, from 42.9, with German manufacturing forecast to improve to 43.2 from 42.6.

Service sector activity is also expected to see a modest improvement as well with France rising to 46 from 45.4 and Germany, 49.8 from 49.6.

The UK economy is faring slightly better which may help explain why the Bank of England was also hawkish yesterday, also keeping rates on hold even as 3 rate setters voted for another 25bps rate hike.

In some respects, one can understand the reticence of the Bank of England to come across as too dovish given that headline inflation is almost double the level of EU inflation, at 4.6%.

In the absence of any formal forward guidance this could simply be the Bank of England’s way of pushing back on market expectations of an imminent rate cut and stopping markets getting ahead of themselves. This is because a weaker pound can slow the disinflation process when it comes to pulling inflation lower and is likely something the central bank will want to avoid. Having 3 hawkish outriders can help keep markets guessing.

Today’s manufacturing PMI is expected to edge up to 47.5, while services is forecast to remain in expansion territory at 51.

US markets also underwent a strong session yesterday, with another record high for the Dow, although it was notable that the Nasdaq 100 struggled to hang onto most of its gains closing well off their intraday highs.

With the recent euphoria showing signs of petering out markets in Asia shifted their focus to the latest Chinese retail sales and industrial production numbers for November, with European markets set to open modestly higher.

The Chinese economy has been giving the impression of some level of improvement if recent economic data is any guide, however the bar remains low in the context of what it might be capable of given that last weekend saw domestic prices slip into deflation. This economic weakness prompted the Chinese central bank to inject support in the form of one year loans into the financial system this morning.

The recent trade and inflation numbers continued to point to evidence of weak demand and disinflation, as the problems in the real estate weigh on the economy as Chinese authorities wrestle with the problems posed by Evergrande and Country Garden.

In October there was a modest improvement in retail sales while industrial production remained steady at 4.6%. Having seen September retail sales end the quarter with a 5.5% gain, October saw a better-than-expected rise of 7.6%, however this number needs to be set in the context of a 0.5% decline in October 2022, when the economy was still in lockdown, so the numbers may well have flattered to deceive.

Chinese consumers do appear to be starting to spend a little more, however as various European luxury brands can attest the products aren’t flying off the shelves.

Today’s November numbers have seen retail sales come in at 10.1%, which fell short of expectations despite the numbers including Chinese Singles Day sales, and weak comparatives given that a lot of China still hadn’t come out of lockdown measures this time last year. Industrial production was better coming in at 6.6% the best performance since February 2022.   

EUR/USD – the rebound this week has seen the euro look to retest the November peaks 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 peaks at 1.1275.

GBP/USD – broken above the 1.2730 area, and the 61.8% retracement of the 1.3140/1.2035 down move. If we can consolidate this move higher, we could see an extension towards the 1.3000 area. Support comes in at the 1.2590 area.

EUR/GBP – slipped back from the 100-day SMA at 0.8640, with support at the 0.8580 area. A move below 0.8580 targets 0.8520.

USD/JPY – having pushed below the 200-day SMA at 142.50 we could see a move towards 140.00. We now have resistance at 146.00 and while below that we could push towards 139.20.