European markets managed to eke out a positive finish yesterday in a day that saw UK and US bond yields surge, with the UK 10 year rising to its highest level since 2011 and closing the gap with its US counterpart to the narrowest since April 2016.

The sell-off in UK gilts appears to have been predicated on the premise of billions of pounds of fiscal support that is expected to be announced tomorrow by new Prime Minister Liz Truss as she attempts to keep a lid on surging energy costs, for UK businesses and consumers, which are driving inflation through the roof.

The fear is that while these measures are likely to keep a lid on inflation now, the trade-off is a higher level of headline inflation over a longer period of time, which is likely to mean higher rates for longer. Ultimately there are no easy solutions with any action taken this week needing to be weighed up against the costs of doing nothing, and the long-term damage to the economy of not acting. 

US markets had a slightly different day of it yesterday, closing lower after a strong ISM services survey for August which served to heighten the prospect that the Federal Reserve could go for another 75bps rate hike when it meets in two weeks’ time. It’s somewhat surprising that markets are still under-pricing the probability of the Fed doing this given recent pronouncements from various Fed members about front-loading.

Last night’s weak US close looks set to translate into a lower European open, although today’s weak Asia session has also played a part after some disappointing China trade data.

It’s becoming increasingly difficult to feel optimistic about the outlook for the Chinese economy as we head into the winter months. With 21.5m people already locked down in Chengdu, and new restrictions being imposed in places like Guiyang, in Guizhou province, as well as Shenzhen, it’s hard to see a scenario for a significant economic pickup much before next year.

This morning’s latest trade numbers for August merely serve to underscore how weak domestic demand still is, and how far away that end of year GDP target of 5.5% is. The target may well have been downgraded to an aspiration only last month, but its further away than ever after today’s data and we could be lucky to see half that number at this rate. Imports data has been weak for several months already, rising 2.3% in July, up from 1% in June. Today’s August numbers suggest a continued lack of confidence in the part of the Chinese consumer as well as a lack of demand, slowing to a weaker 0.3%, well below expectations of 1.1%.

Exports have been slightly more resilient recovering to 18% in July, and beating expectations after a weak Q2, helping to push the trade surplus ever higher. These also disappointed in August, coming in at 7.1%, well below expectations of 13%.

On the data front today, the latest EU Q2 GDP is expected to be confirmed at 0.6%, while we also have another central bank rate decision.

The Bank of Canada shocked the market in July by taking the unexpected move of hiking rates by 100bps from 1.5% to 2.5%, as well as saying that there was more to come.

There is already increasing evidence that wages are starting to rise in response to this recent inflation surge. The Canadian Federation of Independent Business last month said that several members of their organisation were planning on raising wages significantly in response to worker shortages.

BOC governor Tiff Macklem also indicated that more rate increases are coming, and with the Federal Reserve set to lay down another marker in two weeks’ time we can expect to see another 75bps move by the Canadian central bank later today.

Wages are already rising at an average of 5.4% against a headline CPI rate of 7.6%, although that is down on the recent peak of 8.1%.

It’s also worth keeping an eye on the Japanese yen after the declines seen in the past few days. There has been some chatter about the prospect of some form of co-ordinated intervention to stem the bleeding so to speak.

The Bank of Japan will certainly be concerned; however, they really shouldn’t be too surprised given that it is their policies that are causing this meltdown. Their current monetary policy stance is very deliberately at the opposite end of what every other central bank is doing. If they want to stop the slide in the yen, the answer is quite simple and can be summed up in one word, pivot.

EUR/USD – another marginal new low at 0.9864 keeps up the pressure for a move towards 0.9620. In the absence of a move through the recent peaks at the 1.0120 area, the risk remains for lower levels as we head towards the 0.9000 area. 

GBP/USD – ran out of steam at the 1.1600 area yesterday, but while above the March 2020 lows at the 1.1410/15 area, there is potential for a short squeeze towards resistance at the 1.1750/60 area.  

EUR/GBP – fell back to the 0.8560/70 area having failed to move above the 0.8680 area at the start of the week. We need to see a sustained break below 0.8560 to retarget the 0.8480 area.  

USD/JPY – having broken above 140.00 last week the US dollar has made rapid gains as it looks to head towards the 145.00 area, breaking above 141, 142 and 143 in quick succession. While above the 140.00 level the next significant resistance is at the 1998 highs at 147.70. 

FTSE100 is expected to open 65 points lower at 7,235

DAX is expected to open 151 points lower at 12,720

CAC40 is expected to open 70 points lower at 6,034

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