European stocks are set to turn sharply lower on the open as they play catch-up with the heavy losses seen on Wall Street. The FTSE 100 is expected to open nearly one-and-a-half percent lower, taking it beneath 6,700 to a five-week low.
Friday was the worst day for US stocks since June 24, the results day for Britain’s EU referendum. All three major indices fell over 2%. The extraordinarily low volatility was always going to end abruptly. Before Friday, the S&P 500 had gone 43 days in a row without closing up or down 1%.
Stocks in the United States might have sold off the most on Friday but the trigger seems to have been European. Global bond markets, including US treasuries jolted on Thursday when ECB president Mario Draghi said the governing council did not discuss extending its asset purchase program. Bondholders suddenly didn’t like the idea of holding onto a negative-yielding asset which could fall in price if there’s no central banking buying alongside them.
The US benchmark yield looks nowhere near as overpriced as the likes of the German bund, which until Friday, had a negative yield, but is still, in the words of Fed Chair Janet Yellen looking very “stretched.” Global bond yields have fallen together so if this is the beginning of a bigger correction, there isn’t going to be anywhere to hide in fixed income.
AS treasuries sold-off it was the high-yielding “safe” areas of the US stock market that saw some of the biggest declines. Telecoms and utilities dropped more than 3%.
While global central banks are collectively the problem, and the cause may have been the ECB this time, ultimately the biggest worry is surrounding the Fed. The general sense is that Fed hawks have not stepped aside despite signs of a slowdown in the third quarter. Worsening US economic data mixed with ongoing talk of a rate hike is the ‘anti-goldilocks’ for markets.
It was the hawkish Fed talk and big rebound in treasury yields that provided the catalyst for the dollar's strength last week, despite the weaker data. The Fed’s Tarullo offered some of the caution that might have been expected given the data but FOMC voter Rosengren voiced his concerns about waiting too long to normalise rates and Kaplan believes that the case for tightening has strengthened in last few months. Fed governors Lockhart and Brainard will give speeches on Monday.
The ECB didn’t offer up any big plans for new stimulus but the creation of committees to evaluate the asset purchase program and disappointing German economic data was enough to send the euro lower afterwards. Germany’s service sector, industrial production and trade surplus all fell significantly. German inflation data on Monday is expected to show a slight uptick with harmonised CPI rising to 0.35% y/y from 0.1%.
It will be a big week for the pound. Bank of England will decide whether to add to the monetary stimulus added last month and data for inflation, employment and retail sales will be reported.
EUR/USD – The euro is now stuck at 1.1250, the middle of its 1.11-1.14 range. A top or bottom-side break is needed for a directional bias.
GBP/USD – The British pound is still within its 1.28-1.35 range. Its highest close since June last week suggests scope for a bottom to be put in. Possible support at 1.32 then 1.3060 with resistance near the recent peak at 1.3450.
EUR/GBP – the euro-Sterling pair has paused just beneath 0.85 with an inside day pattern. 0.85 then 0.8560 as possible resistance with 0.8340 as support
USD/JPY – Dollar-yen is sitting on its broken long-term downtrend-line at 102.50. 104 is next possible resistance with 101.20 as support.
Equity market calls
FTSE100: to open 100 points lower at 6,676
DAX: to open 231 points lower at 10,342
CAC40: to open 92 points lower at 4,399
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