Possible Market Implications for Chinese Balloon

The big story over the weekend, at least as far as social media was concerned, was the Chinese balloon. The US claims it contained spy equipment, China says it was a weather balloon that went off course. The incident has plenty of political fodder, and has heightened tensions between Washington and Beijing. The first policy impact was US Secretary of State Blinken suspending a trip to China.

The incident has been both entertaining and worrying, depending on perceptions. But what does it mean for the markets? What can we trade here?

Is there more than just chips?

Even before the balloon was shot down, the issue of advanced semiconductors was already being discussed. Recently, the US, the Netherlands and Japan agreed on new restrictions on supplying technology to manufacture advanced semiconductors to China. Presumably, a spy balloon would need a substantial amount of chips to gather, process and retransmit information.

The main reason given for shooting down the balloon was to retrieve the payload. The analysis of the contents could reveal what kind of chips were used, and if they were supplied by the US or allies. The potential consequences imply another round of export curbs, particularly relating to advanced chips, on China. This is already an issue of growing tension between Taiwan, the US and China, since Taiwan is the world’s pre-eminent manufacturer of advanced semiconductors, which in many cases are used by the US’ defense mechanisms. (The Sidewinder missile used to take out the balloon likely had guidance chips manufactured in Taiwan).

Isolated incident or escalation?

China claims that it’s a meteorological balloon that drifted off course. There have been reports of other balloons entering Latin American airspace, as well. Taiwan had previously reported similar balloons traversing its airspace, suggesting they were military meteorological balloons. China contends that it’s a civilian balloon.

Both the US and China have announced they have “reserve the right” to take actions in response to what both are calling violations of international norms. However, beyond suspending a diplomatic trip, neither country has taken more concrete measures. With the balloon already shot down, internal US politics could overshadow the entire incident.

Possible next steps

The increased tensions between the world’s two largest economies could contribute to some risk aversion in the near term. Particularly in the context of major central banks having just raised rates a few days ago.

Beyond that, the question is what happens if or when the payload is analyzed. The balloon was shot down over US territorial waters, and the debris are in relatively shallow waters that should allow at least some of the components to be recovered. However, analysis could take several months, meaning the incident could be revived in the future depending on what kind of components are found.

With global growth uncertain as China reopens from covid, potential of further export curbs could hurt risk appetite. Beyond that, the incident could end up being much more consequential to social media than to the currency markets.

Fourth-Quarter GDP Print to Ease Sterling Problems?

Last week was dominated by the US, particularly the impressive data releases on Friday. Other regions could steal the limelight this week, particularly the UK where developments across the board are not encouraging. Friday’s fourth-quarter GDP figure could potentially offer some respite, but will this be enough for sterling to recover some of its recent losses?

UK issues remain unsolved

The UK continues to be seen as the problematic child of Europe. It remains a laggard among developed countries in terms of output recovery since the breakout of the COVID pandemic and it is currently facing the strongest and most stubborn inflationary pressures. The various rate hikes by the Bank of England have yet to slow the inflation momentum suggesting that: 1) the BoE has not been aggressive enough in the current hiking cycle, fearing it will cause a recession, and 2) the impact from Brexit is complicating the economy’s reaction to the higher price of money. The BoE is tasked to solve the hardest puzzle among the key central banks, and it cannot rely on any help from the fiscal side of the equation. The UK government under PM Sunak has set priorities that include halving inflation, reducing debt and growing the economy. These intentions appear sensible, but Sunak remains hamstrung by the Conservative party backbenchers, a powerful portion of the government’s members of parliament that have essentially ousted the previous two prime ministers. If we add the fact that the opinion polls show a significant lead of the opposition Labour party, it looks like the current government has a mountain to climb to return the country to solid economic ground. Inevitably, this fluid political environment is not inspiring confidence in the UK economy, as seen at the recent performance by sterling.

Key piece of data on Friday

On Friday morning the ONS will publish the preliminary GDP figure for the fourth quarter of 2022. The Reuters poll points to 0% quarter-on-quarter growth with the year-on-year figure dropping to just +0.4%. Confirmation of these forecasts would not bring a smile to sterling fans, but could instead offer some consolation that the pessimistic expectations of a technical recession do not appear to have materialized. Having said that, the outlook is not encouraging. The recent IMF forecasts showed the UK is forecast to be the only advanced key economy contracting in 2023. In this context, on Thursday morning we have the usual visit of BoE Governor Bailey et al at the Treasury Select Committee. Provided that the participating members of parliaments do not feel the need to ask tougher questions on the Bank’s perceived inability to tackle inflation, the message from the oral testimonies is unlikely to be much different from last Thursday’s press conference.

The housing sector is another worry for sterling fans

The January Halifax house price index will be published on Tuesday. The housing sector is especially crucial for the UK economy as property wealth is almost 30% of the total household wealth. The overall negative economic sentiment along with the numerous interest rate hikes by the BoE have put the sector under significant pressure. This is pretty evident by the various indicators measuring price changes. However, the short-term outlook is seen as even more negative due to the recent crash in mortgage approvals. The December print dropped to levels seen during the COVID pandemic breakout in 2020 and amidst the 2007-09 economic crisis.

First taste of January retail sales

Additionally, on Tuesday morning we will get the first real data of consumers’ behaviour in the post-Christmas period as the January BRC retail sales figures will be released. The December year-on-year print showed a promising 6.5% increase, but we have yet to see this figure translating into a similar change in the overall retail sales data. A gap between these two data series has been developing since April 2022. A similar situation was seen during the first part of the COVID pandemic, with retail sales growth eventually recovering aggressively to match the BRC prints in the later part of 2022. However, it could be a while before we see a similar recovery this time as consumer confidence, depicted below using the GfK Consumer confidence index, is close to record lows.

Sterling fans under severe pressure

It has been 11 months since EURGBP touched 0.8200, the lowest level since June 2016, but it probably feels like ages for sterling followers. The continued underperformance of sterling against the euro currency has pushed the pair to the 0.8950 area, testing the September 2022 highs. The latest upward move has been somewhat aggressive, but mostly justified by the momentum indicators. However, there seem to be signs of rally exhaustion developing, which could dent the sterling bears’ appetite at this juncture. A drop towards the 0.8860 would be welcomed by the sterling bulls, but a move closer to the 0.8720 area looks to be more important as it could potentially result in a short-term trend reversal.

Dollar Extends Rally

The US dollar continued where it left off on Friday when it surged higher after the US jobs report came out much stronger than expected, catching many people by surprise. While the additional gains have been limited so far, the dollar’s recovery is likely to be the main focal point in the first few days of the week given the lack of any significant news.

Why is the dollar finding support?

Well, because of strong data. That surprise 500-thousand-plus job gains we saw on Friday means the market may gravitate towards “higher for longer” narrative which may help provide support for the dollar on the dips, while keeping a lid on precious metals and potentially stock markets too. Investors are realising that the Fed may, after all, have to maintain a contractionary monetary policy in place longer than expected in order to dampen inflationary pressures that could arise from a tighter labour market. This is why we have seen the probability of another 25-basis point rate hike in March rise to almost 100%, while that of another 25 bp hike in May has jumped to 67% from about 40% a week ago.

GBP/USD heading to 1.20?

The greenback is also benefitting from a dovish-leaning Bank of England, which has caused the GBP/USD to turn negative on the year. The cable looks like it wants to test the 1.20 handle as it was just 30 pips away from there at the time of writing.

USD/JPY turns positive on the year

Meanwhile, the USD/JPY has turned positive on the year. The yen fell overnight on reports that Bank of Japan’s Masayoshi Amamiya, seen as leaning on the dovish side, was approached by the government to become the next BoJ governor. The report has raised speculation that there won’t be any massive changes in the BoJ’s ultra-loose monetary policy.

EUR/USD bulls have not bought Lagarde’s hawkish remarks

The only currency that has the potential to outshine the dollar is the euro, after Christine Lagarde came across as being quit hawkish last week – although the market has not bought it yet. “This is the highest in all the time that core inflation has been in our part of the world. So, I get it, headline inflation has gone down … but underlying inflation pressure is there, alive and kicking, which is why we are committing as we intend in this monetary policy statement, and this is why I say we have more ground to cover, and we are not done.” So far however, we haven’t seen any signs of a recovery in the EUR/USD, after the exchange rate failed to hold above 1.10 handle last week, before plunging to below 1.0760ish. There was some mixed data out of the Eurozone this morning. German factory orders rose 3.2% m/m vs. 2.1% expected, while Sentix Investor Confidence on the Eurozone improved to -8.0 from -17.5 previously (vs. -12 expected). But Eurozone retail sales fell by 2.7% m/m, which was worse than expected.

Dollar bottoming pattern

Additionally, the dollar is likely to find support on technical buying after several major currency pairs formed topping patterns last week. Momentum-chasing traders are thus likely to be looking for opportunities to fade any short-term dips on the dollar.

The dollar index itself printed THIS beautiful hammer candle on the week chart, although a higher high is still needed for confirmation that the dollar has indeed bottomed.

Overall, there are more supporting factors for the dollar than against it. But the dollar buying does look a little bit overstretched on smaller time frames. A big of a pullback may be needed to encourage more bulls to join the rally.

Futures Decline on Rate Concerns & US – China Tensions

US futures

  • Dow futures -0.50% at 33740
  • S&P futures -0.75% at 4104
  • Nasdaq futures -1% at 12447

In Europe

  • FTSE -0.71% at 7838
  • Dax -0.95% at 15369

Jobs data supports a more hawkish Fed

US stocks are set for a weaker start on Monday, extending losses from the end of last week as investors continue digesting the stronger-than-expected U.S. jobs report, which has prompted investors to rein in optimism surrounding a dovish pivot and as US-China tensions rise.

There are a number of Federal Reserve policymakers who are due to speak across this week and could shed some light on how hawkish the Fed may need to be in order to rein in inflation. Federal Reserve chair Jerome Powell will be the main focus and is due to speak tomorrow.

Separately news of a suspected China spy balloon shot down in US waters is unnerving investors. Investors are weary that this could ramp up pressure on Biden to apply further restrictions on China. Chinese ADR’s such as Alibaba and JD.com trade lower pre-market.

Attention will also be on earnings as earnings season continues and is over halfway through. Companies due to report this week include Disney, PepsiCo. Meanwhile,Tyson Food and Activation Blizzard report today. So far, 69.9% of companies have reported results above expectations. Overall quarterly earnings are set to decline 2.7%.

Corporate news

Tyson food has fallen sharply premarket after reporting a 70% full in EPS to $0.85c as margins are squeezed by rising operating costs.

Dell rises pre-market despite the firm announcing that it will cut 6.5% of the workforce as demand for personal computers falls.

Where next for the S&P500?

After running into resistance at 4195, the S&P500 has eased lower, taking out support at 4150 and is testing 4100 the December high. The RSI remains above 50, and the 50 sma has crossed above the 200 sma keeping buyers hopeful of further upside. Buyers would look for a rise over 4150 and 4195 to extend the bullish uptrend towards 4325. However, sellers could be encourage d by the long wicks on the previous two candles, which suggest that there isn’t much demand at the higher prices. Sellers could look for a fall below 4000/3995 the psychological level, 100 sma and last week’s low to extend the downside to test the 200 sma at 3940.

FX markets – USD rises, EUR falls

The USD is rising, adding to 1% gains last week, as investors re-assess the likelihood of a less hawkish Fed in light of Friday’s strong jobs report. The risk-off mood from geopolitical tensions is also supporting the greenback,

GBP/USD is rising after steep losses last week and as investors digest comments from BoE policymaker Catherine Mann who said that more rate hikes are likely, than not. Huge strike action across the UK highlights the struggles that workers face amid the ongoing cost of living crisis.

EUR/USD remains below 1.08 after a mixed bag of data. While German factory orders rebounded firmly up 3.2% MoM in December, up from -4.4% in Nov and well ahead of the 2% forecast. Eurozone investor sentiment also improved considerably as recession fears eased. However, retail sales were weaker than forecast, dropping -2.8% MoM, below the 2.7% decline forecast.

GBP/USD +0.1% at 1.2070

EUR/USD -0.12% at 1.0770

Oil rises after steep losses last week

Oil prices are edging higher at the start of the week after booking losses of almost 8% last week. Concerns that the Fed may not be able to slow the pace of rate as much as initially expected, after the strong jobs report unnerved the oil market, fueling bets of slowing global growth.

Today those recession fears are being met with optimism surrounding the demand outlook amid the China reopening. The EIA expects half of global oil demand growth this year for come from China and the reopening bodes well for demand if jet fuel demand is anything to go by.

Still, higher interest rates and a stronger USD are keeping oil price gains in check.

WTI crude trades +0.3% at $74.00

Brent trades at +0.7% at $80.45

Looking ahead

N/A

US-China Relations Turn Sour Again

After a period of some improvement in US-China relations since the Xi-Biden meeting in November, the relationship took yet another turn for the worse following the shoot-down of a Chinese ‘spy balloon’ over the Atlantic. Below is a short Q&A on what happened and how we see the implications.

What actually happened?

On Friday last week a large balloon flying over the US started to get media attention. It was suspected to be a Chinese ‘spy balloon’ as it was detected over Montana, a state where the US has nuclear missile sites. US defence officials highlighted though, that it did not present an added intelligence gathering risk relative to what China would be able to gather with low-orbit satellites. According to the US Department of Defence, the balloon had been monitored for some time as it entered over Alaska and Canada before reaching Montana at the border to Canada.

On Friday, China’s Foreign Ministry said the balloon was a Chinese civilian airship used for research, mainly meteorological purposes and that it had deviated from its planned course due to the Westerlies and limited self-steering capability. It stated that “The Chinese side regrets the unintended entry of the airship into US airspace due to force majeure“.

On Sunday, when the balloon had moved over the Atlantic, the US shot it down and divers are currently gathering its debris for further investigation. US Secretary of Defence Lloyd Austin stated that the balloon was being used by China to surveil strategic sites and was brought down above US territorial waters. The shoot-down triggered a sharper response from China, saying it was a “clear overreaction” and that “China will resolutely safeguard the legitimate rights and interests of the company concerned, and reserves to make further responses if necessary”

Is China spying?

Whether the balloon was indeed intentionally flying over the US is hard to tell and experts differ in their views on the matter. On the one hand, it seems like a strange gamble at a time when China seems to have moved to a softer foreign policy stance and is trying to get the US-China relationship on a more calm footing. One expert believes technical problems may have caused the termination mechanism to fail, while one meteorologist claimed the wind explanation was plausible and that since it is hard to aim at targets with a balloon, it is less efficient than low-orbit satellites for gathering intelligence. On the other hand, balloons only used for meteorological purposes tend to be smaller suggesting that it had a broader scope for intelligence gathering.

Regardless of the above, the balloon was in US airspace without permission and it would have been easy for China to notify the US that a balloon had gone astray. The fact that they did not do so undermines their credibility. It is also no secret that both the US and China spy on each other using other means such as satellites. The US is also flying lots of spy planes in the South China Sea and has moved closer to the Chinese shore in recent years, something that has increasingly angered China. They have also been accused of tampering with air codesthat are used to identify individual aircrafts.

What are the implications for US-China relations?

In the short term, there is no doubt that tensions will run high again between the US and China. The visit in Beijing by Secretary of State Anthony Blinken scheduled for yesterday and today has been postponed, a meeting where he was also set to meet Xi Jinping in a sign of some thawing in diplomatic relations. However, the State Department stated that Blinken “would plan to travel to the PRC at the earliest opportunity when conditions allow”, indicating that the trip had not been cancelled completely and that the US administration will aim to get diplomatic relations back on track when the time allows. However, in the short-term, domestic politics will not allow Blinken to go. Republicans have used the incident to attack Bidenfor being too soft in his response. Depending on what the investigations of the balloon debris show, the White House will come with a response against China and China will likely retaliate in some way. But after a while things should calm down again.

In the long term, we think this is part of a new normal with a very strained relationship and rivalry between the US and China, that will last for years, if not decades. Over the next year, more incidents are likely to happen. First and foremost, it seems very likely that the new US speaker of the House, Kevin McCarthy, will follow in the footsteps of Nancy Pelosi and visit Taiwan later this year. China’s response will likely be similar to last time, with extensive military exercises around the island and heightened tensions. Early next year (before 20 April), Taiwan goes to the polls and frictions could flare up again around this time. The ruling DPP elected a new leader in January, William Lai, who is a self-described “political worker for Taiwanese independence”. He is DPP’s candidate for President .

What are the market implications?

Chinese offshore stocks declined 2.7% overnight and the CNH weakened somewhat with USD/CNH rising to 6.79 from 6.74. Most likely the market reaction will calm down again from here, though. The incident should not have an impact on the Chinese recovery and as such the underpinning for Chinese stocks, where we still see upside potential.

However, the incident is yet another issue that has damaged China’s image in the West and illustrates the hesitancy by foreign investors to move money into China. Hence, we think risk premia in the offshore markets are likely to stay higher than before China’s image in the West started to deteriorate starting with Covid in 2020 and since then increased with Russian aggression against Ukraine and ongoing human rights issues in Xinjiang. The higher long-term risk premium implies that we do not see Chinese stocks rallying back to previous highs. But given the low levels, Chinese stocks are still cheap in a historical perspective, and we still see room for higher stock prices from here.

Worst Week for GBP/USD Since Truss’s September Budget

Asian Indices:

  • Australia’s ASX 200 index fell by -25.6 points (-0.34%) and currently trades at 7,532.50
  • Japan’s Nikkei 225 index has risen by 223.71 points (0.81%) and currently trades at 27,733.17
  • Hong Kong’s Hang Seng index has fallen by -500.22 points (-2.31%) and currently trades at 21,160.25
  • China’s A50 Index has fallen by -275.79 points (-2.01%) and currently trades at 13,472.14

UK and Europe:

  • UK’s FTSE 100 futures are currently down -23 points (-0.29%), the cash market is currently estimated to open at 7,878.80
  • Euro STOXX 50 futures are currently down -28 points (-0.66%), the cash market is currently estimated to open at 4,229.98
  • Germany’s DAX futures are currently down -100 points (-0.64%), the cash market is currently estimated to open at 15,376.43

US Futures:

  • DJI futures are currently down -81 points (-0.24%)
  • S&P 500 futures are currently down -51 points (-0.4%)
  • Nasdaq 100 futures are currently down -14.25 points (-0.34%)

Earnings:

UK earnings: DMO – Santander, United Utilities, Oxford instruments, AMC – Tata Steel

* BMO = Before market open, DMH = During market hours, AMC = After market close, TNS = Time not specified

The yen was the weakest major overnight on reports that the BOJ approached a very dovish candidate to take over from Kuroda in April, bolstering beliefs that the BOJ are no closer to removing their ultra-loose policy

Friday’s employment numbers – which saw over 500k jobs added to the US economy – has seen Fed fund futures imply a 97% chance of a 25bp hike in March and another 25bp in May

US-Sino relations are a tad strained after the US military shot down an alleged ‘spy balloon’ belonging to China, off the coast of South Carolina on Saturday

The unexpectedly strong jobs growth and strained US-Sino relations weighed on the equity sentiment overnight

Index futures markets are lower for US and Europe to imply a weak cash market open

GBP/USD 1-hour chart and stats:

GBP/USD fell -2.8% last week during its worst week since September (back when the pound has ‘Truss’ issues thanks to a disastrous budget). However, it managed to find support at the 200 and 20-week EMA’s, which can be tough nuts to crack initially. Therefore I see the potential for prices to drift higher within last week’s range before printing a lower high, then resuming its bearish move. So for now, bears can seek evidence of a swing high before seeking bearish setups and eventual break below 1.2000.

Economic events up next (Times in GMT)

Stocks and Bonds Down, Dollar Up

Markets

Friday was all about exceptionally strong US payrolls and a sharp rebound in the services ISM. The former showed a 517k job creation in January with details strong across the board. The unemployment rate fell to a 54-y low of 3.4% while the participation rate edged higher to 62.4%. Earnings rose 0.3% to 4.4% following an upward revision for the month before. Some referred to seasonal factors explaining the consensus smashing outcome but even if that has something to do with it, the labour market is simply on fire. The services ISM in January rebounded from 49.2 to 55.2, well beyond the 50.5 analyst consensus and suggesting the sudden sub 50 drop in December was an outlier. The gain was supported by business activity and new (export) orders both jumping above (or close to) 60. Employment narrowly escaped from contraction territory (50 from 49.4). It was a one-two blow for US Treasuries and investors doubting the Fed’s inflation commitment. Yields shot up 6.7 bps to 18.4 bps with the curve’s inversion deepening again. German yields rose in the slipstream, supported by a slew of hawkish central bank speeches and comments (Vasle, Simkus, Kazimir, Muller, Rehn). They added 5 to 12.5 bps with the long end underperforming. A risk-off equity environment (WS up to -1.6% lower) and the front end rate differential gave wings to the dollar. DXY rose towards the 103 resistance area (2020 panic high), up from 101.83. EUR/USD tested 1.0942 going into the payrolls before sliding into a 1.0795 close. USD/JPY soared from 128.68 to 131.19. Sterling lost out, especially against the USD. GBP/USD dropped from 1.222 to 1.205. EUR/GBP rose from 0.892 to 0.895. UK gilt outperformance and risk-off (in US dealings) were the main factors. Bank of England chief economist Pill said the central bank needs to seek a balance in setting monetary policy and said they must “guard against” doing too much. He added that markets interpret the BoE’s guidance correctly, implying an end to the tightening cycle soon.

Asian markets start the week on softer footing. The US downing the alleged Chinese spy balloon adds to geopolitical uncertainties. An upcoming trip to China by Secretary of State Blinken has been postponed because of the matter, dampening hopes for a thaw in US-Sino relations. Stocks in China drop up to 3%. The Japanese yen underperforms on FX markets (cfr. infra). Core bonds extend Friday’s decline this morning with US cash yields dropping up to 5.9 bps at the front. The economic calendar is all but empty. The strong batch of US eco data on Friday served as a wake-up call that may continue to set the tone today in a way that’s reminiscent of much of 2022: stocks and bonds down, the dollar up. Geopolitics will linger as well. From a technical point of view, the US 10y yield weekly close above 3.50% is a positive sign. We look out for core bond yields to bottom out further. Support/dollar resistance in EUR/USD is located at 1.0735.

News and views

Japanese newspaper Nikkei reported that the Japanese government approached BoJ deputy governor Amaniya to succeed current governor Kuroda after his term ends in March. Amaniya is considered the candidate who’ll opt for continuity in the BoJ’s ultra-easy monetary policy given that he’s a long term Kuroda ally and architect of some the policy instruments. The report was later denied by the Japanese government, but can’t prevent the Japanese yen from losing ground this morning despite risk-off market sentiment. Ever since the BoJ unexpectedly widened the 25 bps corridor around the 0% target for the 10y yield to 50 bps, the market has been trying to frontrun next normalization steps. USD/JPY hovers around 132. On Friday, JPY already suffered a serious beating on rising US interest rates.

 Australian inflation-adjusted retail sales (volumes) declined by 0.2% Q/Q in the final quarter of last year (vs -0.5% expected). Retail volumes fell for the first time since Q3 2021 with volumes falling across all non-food industries as consumers tightened discretionary spending in response to mounting cost of living pressures. Retail prices remain high, but price growth slowed to 1.1% Q/Q in December due to flat food retailing prices and additional discounting during Black Friday sales. This was the smallest rise in retail prices for 2022. In a separate release, Melbourne Institute monthly inflation numbers rose by 0.9% M/M with the Y/Y-reading rising from 5.9% to 6.4%, the highest on record. Today’s data are the final input before tomorrow’s RBA meeting which is expected to deliver another 25 bps rate hike (to 3.3%).

Market Dynamics Change at the Wake of the Monstrous NFP Beat

US NFP printed 517’000 last Friday. More than half a million.

It’s a monstrous gap with the 185’000 expected by analysts. And even if the seasonal factors may have affected the January report… 517’000 jobs, is quite a STRONG number for a monthly NFP report.

The unemployment rate unexpectedly fell to 3.4%. That’s the lowest level since 1969.

And the wages growth has been parallel to the 0.3% expectation by analysts on a monthly basis, and fell from last month’s 4.8% to 4.4% on yearly basis. But that 4.4% was, again, higher than the 4.3% expected by analysts.

So, Friday’s jobs report was a monstrous beat, from all perspectives. It was a monstrous slap on the Federal Reserve (Fed) doves’ face, as the latest US jobs data was nowhere close to an economy that’s supposed to be slowing down, and eventually enter recession and call for a rate cut.

And it’s another reminder that the huge layoffs in big companies, and especially in big tech stocks remain the exception to the rule.

Strong jobs is bad news for the market, at least until the next US CPI release

Now, it’s too early to say whether the latest jobs data is good or bad news for the market.

It is bad news for the Fed, which is trying to loosen the US jobs market, which wouldn’t loosen.

But it would be less bad news if the impact on inflation isn’t significant.

To tell whether the latest jobs data is bad news, because the tight labour market continues boosting inflation, or good news, inflation remains on an easing path despite the rock-solid jobs market, we will have to wait until next Tuesday, when the US will reveal the January CPI report. Until fresh news, Friday’s jobs data is bad news for the market. Even more so, as the latest tech earnings, including Apple, Amazon and Google easily missed expectations.

In the FX

The latest US jobs data will likely support the US dollar bulls this week, as we don’t have much on the economic calendar that could temper Friday’s monstrously strong NFP read, and remind us that the US economy is still slowing.

Fed Chair Jerome Powell will speak at an event in Washington on Tuesday, and he will probably sound hawkish faced with the latest jobs report, if he says anything about it at all.

Plus, the fresh selling pressure on the Japanese yen will likely give an extra hand to the Fed hawks, on weekend news that the potential new Bank of Japan (BoJ) Governor, Masayoshi Amamiya will be dovish.

In the light of the latest macroeconomic developments, a revision to medium term outlook is necessary.

The dollar-yen’s latest jump above the 130 mark could be sustainable in the short to medium run, and the recovery could extend past the 50-DMA (132.60), into the 133 level, the minor 23.6% Fibonacci retracement on October to January decline, and into the 136.67, the major 38.2% retracement and which will distinguish between the actual bearish trend and a medium term bullish reversal. I still don’t expect the dollar-yen to reverse the medium-term bearish trend, but the upside potential is interesting before the major Fibonacci level is challenged for a real change in sentiment.

The EURUSD was hit last Thursday after the European Central Bank (ECB) lifted the interest rates by 50bp as expected, but the number of other 50bp hikes to come was reduced from ‘many many’ to ‘one more’ at Lagarde’s press conference following the meeting. So the softening ECB hawks after the ECB decision, and the confused Fed doves after the US jobs report sent the EURUSD below the 1.08 mark in more than two weeks. And because the EURUSD hit the psychological 1.10 mark just before the ECB decision, many traders were and will be happy to call it a good trade and retreat to the sidelines. We will likely see some support between 1.0685/1.0750 area, which shelters the 50-DMA, the positive trend base, and the minor 23.6% retracement on the September to last week rally. But the EURUSD will remain in the positive trend as long as it stays above 1.0475, the major 38.2% retracement. And I don’t see the pair sink below 1.05 with the information we have in hand today.

For Cable, things look ugly. Anyone who looks at the price chart could easily tell that this pair is under a decent selling pressure and it’s just a matter of time before the pair slips below the 1.20 mark. The next major technical level stands near 1.1950, including the 200-DMA, and the major 38.2% retracement on September to January selloff. A decline below that level could smash the last sterling bulls. But at least, the falling sterling helps the FTSE 100 to hit fresh all-time highs.

Elsewhere, the Adani selloff enters the third week, and things go from bad to worse as in increasing number of banks don’t accept Adani holdings as collateral anymore.

The Chinese spy balloon that was flying over some strategic points in the US, and that has been shut down, and that resulted in Blinken cancelling his trip to China is a sign of renewing tensions between US and China, and that could throw a floor under the gold’s selloff. But the price of an ounce will likely see a strong resistance into the $1900 level.

Red Hot US Labour Market Report

Market movers today

After a very busy week, this week should be much slower, at least in terms of scheduled events and data releases. Today, we have a few data points out from the euro area, namely retail sales for December and Sentix investor confidence for February, and also December factory orders in Germany. Probably more importantly, we will have the postponed German CPI data for January out Thursday.

Other highlights this week are the rate decision from the Reserve Bank of Australia, where we look for a 25bp hike but markets price a small probability of unchanged rates, the University of Michigan consumer survey in the US including inflation expectations, and an EU summit on Thursday-Friday that will discuss Europe’s response to the US IRA, but probably not reach any firm conclusions.

Thursday we have the Riksbank meeting in Sweden where we look for a 50bp hike.

The 60 second overview

US data: The US labour market report came in red hot on Friday with 517k in the NFP figure, vs. consensus of below 200k. The unemployment rate continued to decline to 3.4%, from 3.5%. Also the ISM report was strong, in particular new orders. Also prices paid remained elevated. Markets reacted strongly to Friday’s non-farm payrolls report and the rebound in ISM services. Both indicated a surprise rebound in the underlying consumption engine of the US economy: the wage sum soared back to post-Covid trend lines and new services orders rebounded sharply to levels above 60. Both support the notion that it is far too early for the Fed to declare victory against elevated inflation. This was also reflected in the market reaction with 2Y USD swap rates rose 16bp on both markets pricing in more short-term hikes as well as markets removing some of the cuts embedded into the curve post summer. EUR/USD fell sharply by 1.5 big figure returning the cross to the levels of early-mid January below 1.08.

ECB: After the strong market rally on Thursday on the back of the ECB meeting, we saw a number of governing council members affirming the 50bp in March view and also a hike in May. Only Holzmann said that they may only reach the policy rate in Q3.

Euro area data: Euro area PPI inflation continued to decline to 24.6% in December (from 27.0% in November 2022), mostly due to energy. But PPI for core consumer goods edged up a tad again (9.3% after 9.2% in November), which suggests that cost-push inflation for core inflation is not yet done, although a peak for goods inflation should come probably fairly soon. In a new piece; Euro macro notes – From recession to stagnation, we revise our view of the near-term prospects of the euro area economy which have brightened amid a more balanced risk picture.

BoJ: During the weekend, BoJ deputy governor Amamiya was rumoured to take over from Kuroda later this year. If chosen, he would probably continue the current monetary policy setting.

Geopolitics: While the US shot down the Chinese ‘spy baloon’ during the weekend, this is yet to be noted in financial market pricing of the Asian trading session.

FI: Markets corrected higher in yields Friday morning reserving some of the massive rally on Thursday’s ECB induced rally. The US labour market report came in very hot and sent yields significantly higher which left 10y US treasuries 15bp higher on the day. That took European rates higher and 10y German yields ended 12bp higher, and is now broadly unchanged compared to the level pre-announcement. Intra-euro area spreads were broadly unchanged on the day amid bear steepened in the curves.

FX: Broad based USD rally on Friday after strong US data releases. EUR/USD fell below 1.08 and USD/JPY rose above 130. The later found further support overnight from news that Japanese government may pick current Bank of Japan deputy governor Amamiya for new governor. EUR/DKK rose sharply to around 7.4450 on Friday after Danmarks Nationalbank (DN) widened the policy rate spread to ECB Thursday.

Credit: CDS indices were marginally tighter on Friday following Thursday’s ECB-induced rally. Meanwhile, the primary market was almost quiet, with only Nordea being active in the EUR benchmark segment, printing a 3NC2 EUR1bn SNP deal.

RBA Expected to Hike by 25bp Tomorrow

The RBA are expected to raise interest rates by 25bp to 3.35% tomorrow, which would take rates to their highest level since September 2012. If so, it would be their fourth consecutive 25bp hike and ninth back-to-back hike this cycle – which is their most aggressive in history. Even so, their rates remain well below RBNZ’s 4.25% and the Fed’s 4.75%, which is concerning given both of those central bank started hiking considerably sooner than the RBA, and continue to battle high levels of inflation.

Still, there is evidence that the (relatively low) interest rate is starting to bite on the economy. If we look at data since their last meeting, it could be argued the economy is slowing overall. Manufacturing, services and construction PMI’s have been contracting according to AIG, although their latest report is due tomorrow ahead of the RBA meeting. Retail sales dipped for the first time in a year in Q4 by -0.2% q/q, as consumers cut back spending. This could be taken as a sign from the RBA that their tighter policy is working.

Unemployment is 3.5% compared with the RBA’s 3.4% forecast in November, but this is not likely a large enough deviation for it to matter, and employment numbers are robust overall. Wage prices are on target at 3.1% q/q, but inflation is a fly in the ointment for the RBA.

Inflation is the fly in the ointment for the RBA

Trimmed mean CPI rose 6.9% y/y compared with the RBA’s 6.5% forecast, and inflation rose 8.1% compared with the RBA’s 8% forecast. We will have to wait until Friday’s SOMP (Statement on monetary policy) to see if the RBA have upgraded their inflation forecasts – which would be as good as a rate hike if they do. If this were any other central bank I’d call for a 50bp hike but, based on the assumption they really do not want to hike rates if they don’t need to, I’ll stick with a 25bp hike in February and March.

According to a Reuters poll, 30 out of 31 economists expect a 25bp hike to 3.35% tomorrow, up from 23 out of 27 in January. 19 out of 30 see the cash rate peaking at 3.6%, but I suspect there is a greater chance of it eventually rising above 4% than the consensus currently estimates. US inflation peaked in July yet the Fed are still hiking, and inflation in Australia has not yet peaked. And whilst China’s reopening has brought with it cheers of a soft landing, it is also inflationary which could see CPI reaming higher and stickier than anticipated later this year. And whilst the employment situation remains robust and inflation remains high, it’s a green light for the RBA continue hiking.

AUD/USD daily chart:

The Aussie took quite a battering on Thursday and Friday following the Fed’s meeting and strong NFP report, and fell -3.7% from its YTD high by Friday’s close. There’s been a mild attempt move lower today, but I suspect we’ve seen the meat of the downside move for now, especially with RSI (2) hitting the oversold level. And with the RBA tipped to hike tomorrow, this leaves the potential for AUD/USD to post a countertrend move ahead of the meeting – with its fate to then be decided by the level of RBA tightening.

A surprise 50bp hike could send AUD/USD happily above 70c, although this is not my base case scenario. But a 25bp hike with hint of more to follow should also support the Aussie and help lift it from its current lows. A 15bp hike could signal we are close to the terminal rate and weigh on the Aussie, and likely lift the ASX 200 back towards its record high.

ASX 200 daily chart:

The ASX 200 has all the hallmarks of a strong trend, with higher volumes accompanying higher prices and little in the way of pullbacks. Moreover, the OBV (on balance volume) has broken to a new high which suggests a break to a new record high is on the cards. However, it is rare to see a market simply break through such a milestone level, and the close it gets to 7600 or the 7624.80 high, we have to assume greater odds of a pullback before its trend resumes as investors book profits. Of course, a surprise 50bp hike tomorrow could shake some bulls out of their positions and trigger a pullback, whereas a 15bp hike could potentially send it higher.