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The day after the big sell-off

European stocks are headed sharply lower start thanks to the weak lead given to them by Wall Street. The FTSE 100 is set to open just above its December lows. The next day after an unusually big sell-off is always a big test of a market’s strength. A repeat of anything close to the 2% decline seen in US indices on Friday could trigger a prolonged period of risk-off sentiment. Last week the S&P 500 dropped -3.8%, with the energy sector leading the declines. After gains of 6% in January, the first few days of February were always going to be at risk of profit taking.

 

China services data push up bond yields

The sudden rise in treasury yields in response to the US jobs data was all equity investors needed to lock in some January gains. Changing dynamics in the bond market are making supportive economic data a double-edged sword for markets. More good data in Asia has pushed 10-year Treasury yields back toward 4-year highs, up two basis points on Monday. The China Caixin services PMI for January showed a jump in activity, rising to 54.7 from 53.9. Together with the rise in manufacturing already reported, the China composite PMI has hit a 7-year high. It is more evidence of synchronised growth from the world’s three largest economic areas; Europe, the US and China.

 

The ‘Constitutional crisis’ memo

Friday’s sell-off was likely exacerbated by President Trump agreeing to release a classified GOP memo despite suggestions it could cause a ‘constitutional crisis’. The memo indicates the FBI knowingly used a dossier paid for by Democrats to spy on the Republican candidate for President. The memo’s accusations sounds very Watergate. Possible bias at the FBI on top of Russian meddling is another blow to confidence in the US electoral system.

 

Euro still just shy of 1.25 before PMIs

European PMIs and Eurozone retail sales are on the docket for the European trading session. PMIs across Europe are expected to show robust service sector activity and cast more doubt over the need for monetary stimulus from the ECB. Retail are dragging in Europe, like other parts of the world. Retail sales figures are expected to show a slowdown in year-over-year growth in December to 1.8%. The euro held its ground better than other major currencies when the dollar strengthened after US earnings data, and is now edging back towards 1.25 on Monday.

 

Dollar eases back from NFP highs ahead of ISM

The US dollar pulled back from Friday’s high, reached after the release of non-farm payrolls data. Wage growth has taken on more meaning in recent months than the headline jobs number and this past report was certainly no exception. The unexpected jump in annual wage growth triggered fears of a ramp up in inflation that the Fed would need to cool with a faster pace of rate hikes. The earnings data saw the market price in a bigger probability of a 4th rate hike this year.

 

We think new Fed Chair Jerome Powell is probably as, if not more sensitive than Janet Yellen to the market response to the Fed shrinking its balance sheet. We still expect three hikes or less from the Fed this year. Monday sees the release of the January US ISM non-manufacturing PMI. It’s importance is amplified by being one of the first forward looking pieces of economic data for the new year. Expectations are for an increase in service sector activity to take the January figure to 56.3 from 56 in December.

 

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