Equity markets continue to slide, as focus turns to the Fed

In the space of a few days, markets have gone from optimism that inflation might be on the cusp of plateauing, to rising apprehension that we could not only see higher prices, but that prices might well remain higher for a lot longer than originally thought.

This concern has started to manifest itself into the reaction function of central banks, who appear belatedly to have realised that inflation is starting to run out of control, along with consumer expectations of higher prices.

In the last few weeks, we’ve seen the Reserve Bank of New Zealand, Bank of Canada, and the Reserve Bank of Australia hike rate by 50bps, with the Federal Reserve set to follow suit later this week, although after Friday’s hot CPI report there is some speculation that we could see the Fed hike by 75bps.

The US CPI report on Friday also put paid to any prospect that there might be a September pause to the Federal Reserve’s rate hiking cycle, as inflation jumped to another 40-year peak at 8.6%, sending stock markets sharply lower, the US dollar surging along with yields, a trend that has continued in Asia markets this morning, with the US dollar hitting its highest level against the Japanese yen since August 1998.

US markets posted their worst decline since January, while the DAX and FTSE100 both posted their biggest weekly falls in 3 months, with all of these markets set to open sharply lower.  

The US 2-year yield rose 25bps to close at its highest level since 2008, at 3.06%, as did the US 5-year yield, which rose to close above 3.25% and above both the 10- and 30-year yield, usually a key indicator that a recession is coming.

Friday’s pessimism was exacerbated by a collapse in Michigan consumer confidence for June which fell to a record low of 50.2, while 5–10-year inflation expectations hit their highest levels since June 2008.

Against this backdrop it's hard to make the case for anything but a return to the lows we saw last month for the S&P500 and the Nasdaq 100, and the prospect of further weakness, as we look ahead to another week of important central bank meetings, with the Federal Reserve, Bank of England, Swiss National Bank and Bank of Japan all set to meet.

Of those four, only the Federal Reserve and the Bank of England are expected to raise rates this week, however in both cases the extent of the rate rises now isn’t as clear cut as it was a week ago.

Prior to Friday the case for a 50bps rate hike by the Fed was a nailed-on certainty and it remains so, however in some parts there has been a shift in thinking towards a 75bps move, hence Friday’s sharp moves. This still seems unlikely, based on one month’s data, however there is also an argument that the Bank of England may also have to hike by more than the 25bps that they are expected to move by on Thursday.

The inflation outlook has become much uglier, and irrespective of the Bank of England’s concerns about what a 50bps may do to an already fragile economy, they may well have no choice if they are to re-establish their battered reputation, when it comes to fighting inflation.

Today’s European open looks set to see further weakness, with this week’s focus set to be the central bank meetings, as well as the latest economic data, starting today with the latest UK GDP numbers for April. These are expected to show a weak economy, battered by the big jump in energy prices, with the index of services forecast to grow by 0.1%, after declining -0.2% in March. The headline monthly number which showed a fall of -0.1% in March, will be lucky if we show any growth at all in April, while on a 3 monthly basis we can expect to see a decline from 0.8% to 0.4%.

Industrial and manufacturing production, which both showed declines in March of -0.2%, might see a modest rebound but it’s likely to be feeble at best. The only silver lining is likely to be in tomorrow’s wages and unemployment data, with wage growth set to remain strong and unemployment at near 50-year lows.  

EUR/USD – Having fallen back to the 1.0530 area we look set to for a retest of the lows last month and the 2017 lows at 1.0340/50. This remains a key barrier for a move towards parity. Resistance now lies at 1.0630, as well as trend line resistance from the highs this year at 1.0720.

GBP/USD – Fell below the 1.2450 area which opens up the May lows at 1.2155. The key support lies between 1.1980 and the 1.2000 area. The 1.2450 area now becomes resistance.

EUR/GBP –Has continued to struggle at the 0.8600 area, failing again last week. We need to see a break below 0.8470 to open a move towards 0.8420.  

USD/JPY – This morning the Japanese yen pushed to its lowest level since November 1998, trading at a level beyond the 2002 peaks between 135 and 135.10. A sustained move above 135.00 opens up the 137.00 area. We currently have support at the 133.00 area, with the 50-day MA at 128.40 underpinning upside momentum.

FTSE 100 is expected to open 45 points lower at 7,272.

DAX is expected to open 225 points lower at 13,536.

CAC40 is expected to open 106 points lower at 6,081.