Despite attempts at a modest rebound on Friday, European markets still finished lower for the second week in succession, posting their lowest weekly closes since March.
US markets also finished the week similarly mixed, but also sharply lower, with the S&P 500 posting its worst week since March 2020, ahead of the Juneteenth long weekend.
As we start a new week and the mixed finish last week, European markets look set to start the week on the back foot.
At the end of last month, there had been some optimism that the US economy might be able to achieve some form of soft landing. This prompted a sharp decline in US treasury yields and a rebound in US markets from their lows, as markets started to price in the prospect of a rate pause in September.
The May CPI numbers upended that mindset quite abruptly, sending yields sharply higher, and stock markets back down again, a trend that was exacerbated by a policy pivot by the Federal Reserve, as well as the Swiss National Bank last week.
Not only did the US central bank hike rates by 75bps but more surprisingly the SNB hiked rates as well, choosing to hike by 50bps and move its headline rate from -0.75% to -0.25%.
Last week’s events appear to have prompted a sharp re-evaluation by central banks that far from being a temporary phenomenon that inflation is becoming more entrenched, it is starting to be much more persistent than originally thought, and that radical action is needed to tackle it.
It is clear from last week's Fed meeting, and with the shackles of the blackout period now lifted that many on the FOMC are in no mood to pare back their determination to send a message when it comes to rate guidance.
At the weekend Fed governor Christopher Waller articulated his support for another 75bps rate move in July, saying that he doesn’t care what’s causing the current surge in inflation, it’s the Fed’s job to get it down, that the central bank is “all in” even if it means unemployment rises to 4.5%. He also said that the likelihood of going into a recession is “overblown” which probably means that a recession is coming.
Even Atlanta Fed president Raphael Bostic, who had suggested a few weeks ago that he could have been persuaded about a September pause in rate rises, was unequivocal, saying that the Fed would do “whatever it takes” to bring inflation back to 2%.
Later today St. Louis Fed President James Bullard will also be dropping his own two cents worth into the wider discussion.
It is becoming even more clear now that the Federal Reserve was too slow in tapering its easing program, and the global economy is paying the price now in the form of runaway inflationary pressures.
The risk now is that the Fed will need to be even more aggressive at its next few meetings to put the inflation genie back in its bottle.
This in turn will have spillover effects as it becomes clear that in striving to rid its own economy of inflation the resultant rise in the US dollar will only exacerbate the inflationary impulse across the world. This in turn is likely to result in similar rate-hiking measures from other central banks to support their own currencies.
With few signs that the Federal Reserve is likely to be done on the rate hiking front, it’s likely to be tough going for stock markets in the short to medium term, given the impact that will come from this tightening of monetary policy in terms of slowing the global economy.
This fear also helps explain why crude oil prices suddenly experienced an air pocket on Friday, dropping sharply over concerns over weaker demand and a global slowdown, and posting its first weekly decline in four weeks.
The European Central Bank is coming under increasing pressure to deal with its own inflation problem, with all the attendant risks that it has for countries like Italy whose borrowing costs have exploded higher since the beginning of June, with the 10-year yield briefly pushing above 4% before slipping back.
Today’s German PPI numbers for May are set to be a key case in point when it comes to more aggressive action from the ECB, with today’s numbers expected to edge higher again to a new record high of 33.6%.
Later in the week, we also find out how much further UK inflation has risen in May against a backdrop of last week’s inexplicable decision by the Bank of England to only raise rates by 25bps, when it is becoming increasingly clear they are falling further behind the curve.
By the time, the MPC next meets in August they could well be another 75bps behind the Federal Reserve when it comes to raising rates, potentially pushing the Fed funds rate to 125bps above the UK base rate. That’s quite a move, given the four-month head start the Bank of England had in starting its own rate hiking cycle, at the end of last year.
EUR/USD – last week’s failure to break below the support at 1.0340/50 keeps the prospect of a rebound on the table. We initially need to see a move above 1.0600, as well as trend line resistance from the highs this year, which comes in at 1.0680. Below 1.0330 targets parity.
GBP/USD – having failed to push below the 1.1950 area, we could see a rebound towards 1.2630. We need to push above the 1.2450 area for this to unfold. Below 1.1950 targets the 1.1500 area.
EUR/GBP – currently holding above trend line support from the recent lows in April now at 0.8520. We currently have resistance at 0.8630, with a break below 0 8500 targeting the 0.8420 area and 200-day MA.
USD/JPY – while below the previous peaks at 135.50 the risk is for a return to the 132.00 area. Above 135.70 targets the 137.00 area.
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