European Markets Set For Firmer Open, As U.S. Dollar Slips Back

Despite a decent rebound on Friday, European and US markets both found themselves finishing the week lower, as sentiment ebbed and flowed on a day-to-day basis.

While the rebound on Friday was a welcome relief, it didn’t change the fact that markets are increasingly pricing the prospect that the global economy is heading for a sharp slowdown, and that the overall trend remains one of selling rebounds.

Today’s European open looks set to continue this firmer theme, with a slightly weaker US dollar helping to support sentiment, as commodity prices also rebound from recent lows.

Over the last few weeks commodity markets have been falling back sharply, oil prices finishing lower for the fifth week in succession, and hitting their lowest levels since February, while copper prices have performed even more poorly. Since their March peaks, copper prices have fallen over 25%, hardly a sign of a booming economic outlook.

Add into the cocktail, concerns over political risk in Italy and the collapse of the government there, as well as concern over valuations as US earnings season gets underway in earnest, and the picture so far looks slightly unsettling, especially with inflation still on the up.

Last week’s blowout US CPI report for June raised concerns that the Fed might do a 100bps hike when they meet next week, and while some of that fear has gone away after interventions from two of the most hawkish FOMC members in Fed board governor Christopher Waller and St. Louis Fed President James Bullard, the events of the last meeting are still fresh in the memory.

Both indicated that a 75bps hike should be enough, given the 75bps move in June, and that has helped pull the US dollar off its highs, and equity markets rebound.

On that occasion, we saw the FOMC adopt a sharp policy pivot on rates during the blackout period, from 50bps to 75bps in a move that saw officials come under fire for tearing up their guidance playbook.

Nonetheless, the unexpected decline in University of Michigan 5–10-year inflation expectations, to a one-year low of 2.8% was just what was needed to assuage some of those concerns that the Fed might go down the 100bps route next week, especially after the Bank of Canada surprised the market with a 100bps rate hike of its own.

This week, attention turns to the European Central Bank and more notably how it plans to convince the markets it has a tool to keep Italian bond yields in check, when they start to raise rates this week.

At the moment there is widespread scepticism that any such tool even exists, other than in the ECB’s imagination.

We also have the latest headline |inflation numbers from the UK, in a week that has seen some of the Conservative leadership candidates question the Bank of England’s record in tackling inflation, which has provoked some debate in political circles.

While these interventions have raised some eyebrows, they are only echoing the concerns that many people in the City of London have had over the last ten years. The reality is that the Bank of England's record on inflation over the last 25 years has been patchy at best, too quick to cut rates and too slow to raise them.

This week UK CPI is expected to rise to a new record high of 9.3% and possibly even higher, and isn’t likely to come down soon, with the Bank of England saying that it expects it to peak at 11%.

While for the most part there isn’t a lot that the MPC can do about most of the high inflation due to the effects of the war in Ukraine, a lot of people were calling for the central bank to start raising rates a year ago, due to evidence of rising prices, and were ignored, as policymakers airily dismissed their concerns as transitory effects, and nothing to worry about.

We’re all worried now.

EUR/USD – rebounded from the 0.9950 area but needs to move through the 1.0130 area to retarget a move back towards the 1.0220 area. We need to see a move back above 1.0340/50 to stabilise and delay the prospect of further weakness.

GBP/USD – have seen a modest rebound off 1.1760 but need to move back above 1.1970 to stabilise, and push through the 1.2040 level. The 50-day SMA is also a key level which needs to be overcome in order to delay a move towards 1.1500.

EUR/GBP – rebounded from the 0.8400 level but has thus far struggled to get above the 0.8520/30 area. A move through here and the 50-day MA argues for a move towards 0.8600.

USD/JPY – continues to get drawn towards the 140.00 area, with short-term resistance currently at 139.40. A break of 140.00 targets the 145.00 area. Support comes in at the 135.80 level, as well as the more solid support at the 134.80 area.

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