Markets react to European elections

European equity markets are on the front foot again, building on yesterday’s gains, as investors breathe a collective sigh of relief following the European parliamentary elections.

European bourses have firmed as it looked like the political centre ground is holding in the EU despite pressure from right and left, whilst we have some upbeat spin on trade to contend with as we hear about a possible US-Japan trade deal. London and Wall Street will be playing catch up today. Futures in the US point to gains today. 

Euro elections: the centre holds, barely

European elections returned gains for a number of right-wing, Eurosceptic parties as expected, but not enough to really shake the ground from under the centrists. The main blocs have held on to remain just about in control, although for the first time they have lost their combined majority.  

The gains for the right continue to point to a problem for Brussels. But there were also big gains for the Greens. The political landscape is shifting, but it wasn’t a Brexit-like earthquake.

The strength of the League in Italy and National Rally in France is noteworthy and will exert domestic pressure more than at a European level. Expect further confrontation between Rome and Brussels. Indeed, on that note, Italian bond yields spiked, with the 10yr BTP above 2.7% again, amid reports the EU is mulling a $4bn fine for Italy for failure to control debt. For France it simply highlights that Macron’s reformist agenda is under a lot of pressure.

The euro though has been pretty well unmoved although London and New York were shut yesterday and we might see traders coming back in today. EURUSD was steady at 1.1180.

Brexit looms over pound

Ain’t no party like a Brexit Party: In the UK the centre has given way completely, and the pressure on the pound remains firm. The Brexit Party won the day, although the overtly Remain parties did very well with the LibDems and Greens enjoying a strong bump in support. European elections are entirely meaningless of course in terms of the Westminster arithmetic, but the impact on the ruling Tory party is key. 

For markets, we should expect the result to impact the leadership race and already a number of leading candidates have upped the no-deal rhetoric. One can only argue that this will, on the margins at least, push candidates more towards the fringes and see the party go more to the right. Given the Tory membership’s pro-Brexit feelings there is an ever-increasing risk of a no-deal exit at this stage. A lot is priced in but a no-deal would see further downside for the pound.

GBPUSD has found support again around 1.2670 and while there is still a lot of pressure, Thursday’s reversal on the 78% Fib retracement on 1.2610 looks to have placed something of a floor under the pound for the time being.  

Bitcoin 

Cryptos have rallied hard again on strong volumes, taking another leg higher over the weekend. Bitcoin is testing the $9k round number resistance, before a tilt at the 38% retracement around $9640 and then the April 2018 high on $10k. Once this market builds up a head of steam, it’s hard to stop. As previously argued, this is a big momentum play and the more buzz the more traders will pile in behind the rising wave. Standing in front of a steamroller springs to mind, if you are a natural bear. Better to wait and let it fizzle out, which it will eventually. The more it rallies, the bigger the blow-up when it comes. However, we should expect some pullbacks and retracements along the way, so watch for those whenever the rally looks overextended – 14-day RSI approaching 90 has been a pretty good indicator in the past. 

Morning Note: Powell pulls rate cut rug from equities, Europe to open lower

Is the US economy running hot or not? The economy is growing at +3%, but inflation isn’t there. PMIs are softening, but the labour market is as tight as it can be. The yield curve has started to steepen again – the big recession indicator has dimmed. 

For the Fed, the glass is half full, still. That means it sees no need to cut rates this year – markets have been pricing in a 65% chance of a cut before 2019 is out. Now they need to rethink this. As I’ve been saying for some time, the market was mis-pricing where the Fed sits on the economy and inflation and was overly dovish.

Jay Powell last night made it clear the Fed thinks that the low inflation is down to ‘transitory’ factors. This word was key, and has given risk assets a bit of a fright. The Fed’s preferred gauge of core inflation has slipped from around 2% to 1.6% in recent months, but policymakers remain relaxed. If weaker inflation persists, however, the Fed may need to consider a cut.

The S&P 500 beat a hasty retreat on Powell’s comments – slipping 0.75% on the day to close at 2,923.73. Bonds were sold and yields climbed. Powell is not listening to Donald Trump and his 1% cut + QE idiocy.  

Why the market is surprised by the commentary from Powell is not really clear. The minutes from the last meeting showed sill that the bias remains mildly towards tightening – I.e. the way policymakers read the economy progressing suggests still another hike before a cut. The market is still not pricing in the chances of a rate hike this year. 

The word ‘transitory’ has done the damage – once again Powell has found a way to make what should have been a fairly innocuous presser quite interesting.  

European markets are seen lower on the open – taking their cue from Wall Street and its risk-off moves. The FTSE 100 is seen opening around 7357, while the DAX – coming back from the May Day holiday – is seen at 12,347 on the open.

The dollar managed to pare losses as Powell’s comments were digested. EURUSD gave up the 1.12 handle and remains below this in early morning trade.  

Having rallied as high as 1.31 at one brief moment ahead of the Fed statement, GBPUSD has retreated to 1.3050. Lots of strong horizontal support now around 1.3030/40.”

Mayday, mayday: SPX record high ahead of Fed, euro higher

The S&P 500 closed out at a new record high yesterday as the market shrugged off the Alphabet earnings miss and instead chose to focus on the positives – namely a dovish Fed, apparent progress on China trade talks and a humming US economy. Aside from Alphabet the earnings season so far has been a positive surprise.

Apple earnings after the bell were upbeat (see earlier note), whilst a softer dollar was a tailwind. Dow industrials enjoyed positive earnings from Merck, Pfizer and McDonalds. GE also delivered an earnings beat. The Nasdaq finished lower as the Alphabet earnings disappointment weighed. Apple should deliver a boost to the index today. 

The euro is trading at a one-week high against the dollar, whilst cable has also sought to raise its head above the 1.30 mark again. We should be careful about reading the rites on the dollar rally thought – month end rebalancing has been pinned on some of yesterday’s losses for USD.  

Nevertheless, there was some boost as EZ GDP data printed higher than expected and German CPI was also on the upside. German inflation rose to 2% year on year, after leaping 1% month on month in April. I would still caution that other macro data are pointing to ongoing weakness. Leading indicators don’t look so clever with PMI data indicating a slowdown in Q2.   

Euro at week highs

As far as EURUSD goes, Friday’s indecisive candle was an indicator of a short-term rally but the longer-term trend remains to the downside. Trend resistance is coming in around the 1.12650, with April highs horizontal resistance beyond at 1.1320. This suggests we could get a little more upside in the near term before the rally hits a roadblock. EUUSD was last holding above the 1.1210 level. Expect thinner liquidity today as it’s the May Day holiday on the continent with the major European bourses shut.  

FOMC on tap

Coming up later today of course is the FOMC decision. Don’t expect the Fed to tie its hands to anything conclusive right now – there are just too many moving parts and policymakers are split over where they think the economy is heading. I would expect that the Fed retains its slight hiking bias – discussions around the possibility of cuts may take place but the Fed should stick to its patient, data dependent mantra. Declining two-year yields and stable 10-yrs has produced a mild steepening in the yield curve, which may show greater market confidence in the economy and a sign that perhaps the much-talked-about recession is not about to hit.

Markets are still underestimating likelihood of a hike this year –  Currently the market indicates a 65% chance of a cut this year and zero chance of a hike. Whether that would be a mistake or not it not the point. Policymakers will have to acknowledge the impressive Q1 GDP print, as well as booming consumer spending. Softer inflation and earnings numbers mean there is no pressure to raise rates though. Of course, Trump will keep his foot on Powell’s throat and continue to jawbone in favour of cuts. The big question vis-a-vis this meeting and the market response is whether Powell chooses to sound dovish or hawkish in the press conference. Evens. Powell doesn’t have to do anything this time.”