Despite seeing a number of global indices hit new record highs in January, with US markets in particular defying gravity on an almost weekly basis, there was some evidence towards the end of the month that momentum was starting to fade.
The FTSE100 and the DAX were the first to show signs of this fading momentum, after reaching new record highs, as did the Nikkei 225, after touching 26 year highs, despite increasing nervousness that inflationary pressures would start to push bond prices lower and bond yields beyond their recent peaks.
All the while US markets appeared to be showing an almost indifferent ambivalence to those concerns, but even before Friday’s payrolls report one did get a sense, or feeling that a continued improvement in economic numbers might well be the catalyst that prompted a sharp bout of profit taking amongst US investors.
That feeling that we cautioned of in Fridays morning update came to pass in the wake of the January payrolls report, and in particular it was the wages numbers that prompted a further sharp rise in yields across the board, and drove US markets to their worst weekly performance in 2 years, as well as wiping out all of the gains of the previous two weeks.
Friday’s US sell off after European markets had closed saw the Dow close 666 points lower on the day, with the result that the S&P500 and Dow both posted key week bearish reversals, raising the prospect that we could well see further declines in the coming weeks.
January wages rose 2.9%, well above forecasts of 2.6% with a large part of that gain being driven by 18 US states raising their minimum wage level, while the December number was also revised higher, to 2.7%. This sharp rise in wages appears to have shaken up the market consensus about the pace and scope of the Fed tightening cycle.
For a while now investors have assumed that we would probably get another two, or maybe even three rate rises this year. Friday’s data has prompted a readjustment of that calculus with the potential for a fourth, and this change is likely to drive the US 10 year yield back to 3% in short order.
Away from that, the headline payrolls number which came in at 200k was almost a postscript, as the US dollar rallied modestly, however yields surged, with the US 10 year hitting 2.85%, a four year high, posting an 18 point weekly gain in the process.
Despite the surge in wages the US dollar’s response was slightly more modest even though it did finish the day higher, and above its three year lows.
Friday’s sharp US sell-off translated into a similar sell off in Asia this morning and is likely to see markets here in Europe open sharply lower as well.
How US investors react when they return later today could well determine whether Friday’s sell off is a one off, or whether it is the start of a much bigger correction. As things stand US markets look set to carry on the negative from where they left off on Friday.
On the data front we have the latest January services PMI’s and these are expected to support the expectation of further ECB tapering later this year, as well as the prospect of a possible Bank of England rate rise later this year.
Spain, Italy, France and Germany services PMI’s are expected to come in at 55.2, 56.1, 59.3 and 57 respectively, while in the UK the January services number, which is expected to come in at 54.2, should give us a good indication that the UK economy has got off to a decent start in 2018, after a strong end to 2017.
EURUSD – struggled to overcome the 1.2500 area last week drifting back down the 1.2405 area, however while above the 1.2320 level momentum remains positive, with the 1.2600 area the key resistance area, being the 61.8% retracement level of the 1.3995/1.0340 down move.
GBPUSD – was unable to move back through the 1.4300 area last week, prompting a sharp reversal. A move below 1.4080 could well open a move back towards last week’s low at 1.3970. While the 200 week MA at 1.4360 caps we run the risk of a run back towards 1.3850.
EURGBP – continues to find buyers above the 0.8690 area rebounding from 0.8715 last week. We need to sustain a move above the 0.8850 area and 100 and 200 day MA’s to stabilise or risk a move below 0.8690 which would target 0.8640.
USDJPY – Fridays move back through the 110.20 area ran out of steam at the 110.50 area, which raises the prospect of a move back towards 111.00. A move back below 109.70 diminishes the prospect of this happening and argues for a return to the 108.40 area.