After a relatively benign start to the month of December we saw sharp falls in European markets last week, with the DAX falling to five-week lows and the FTSE100 to four-week lows, as the fallout from Thursday’s hawkish rate pivot from the European Central Bank rippled through the market.

These concerns were further exacerbated by additional hawkish interventions from ECB insiders doubling down on that same narrative which suggested the prospect of at least another three rate rises of 50bps into Q1 of 2023.

We also saw a sharp increase in borrowing costs across the piste in European bond markets, which in turn prompted some sharp criticism from the likes of senior Italian government officials, as Italian 10-year yields closed the week higher by almost 46bps, just shy of 4.28%.

This has long been the Achilles heel of any ECB interest rate policy, given the impact higher rates have on the more highly indebted parts of the Euro area. Italy is more vulnerable than most due to the size of its bond market and the fact that the country has public debt of over 145% of GDP and needs lower rates to keep its interest bill as low as possible.

US markets also closed the week sharply lower with the S&P500 declining for the second week in a row, although at one point last week, there were hopes that it would be able to reverses the losses of the previous week.

Last week’s central bank meetings quickly put paid to that optimism, although it’s not immediately clear whether markets were spooked by the Federal Reserve’s overly hawkish tone, or the ECB’s.

Purely based on the price action in the bond market, the evidence points to the latter, given that US yields finished the week lower, as did the US dollar, although the greenback did finish well off its lows.

That reaction alone would appear to suggest that markets were more spooked by what the ECB was proposing than the Fed, whose rhetoric, while credible, doesn’t match what the data is telling us when it comes to inflation.

In the US CPI inflation has been falling consistently since June, so even though the Fed is still expected to continue raising rates, there is some doubt as to how much it will do so, with markets pricing in a much lower number than FOMC members would like.

On the other hand, the ECB’s aggressive tone is sparking concerns that the central bank could well compound one economic shock, with another one, just as the economy is sliding into recession.

This last week before Christmas should give investors a last look at whether the confidence of the US consumer is starting to feel the effects of the rising cost of living, after retail sales unexpectedly slumped by more than expected in November. The December consumer confidence numbers tomorrow could be instructive in that regard, along with the latest Core PCE numbers for November.

Core PCE is the Fed’s preferred inflation measure, and if this confirms a further slowdown in price pressures, then that could throw further shade on the Federal Reserve’s inflation narrative.

We also have the latest German IFO business climate survey for December due out this morning which last month showed a modest improvement in line with the rebound that we’ve seen in recent PMI numbers.

If this trend continues in today’s numbers, that will also coincide with a recent sharp fall in PPI inflation and point to some near-term optimism when it comes to a slowdown in rising prices.

In November we saw a rebound from 84.5 to 86.3, and this morning we should see a further improvement to 87.5. Expectations are also expected to be slightly stickier given we are only at the start of winter; however, these are also expected to improve as well.

Markets in Asia have got off to weak start to the week, although the losses have been tempered by pledge by Chinese leaders to focus on boosting the economy next year, even as covid infections continue to rise sharply.

Markets here in Europe look set for a modest rebound ahead of today’s Germany IFO and tomorrow’s Bank of Japan meeting, with the Japanese yen rising in Asia trade on reports that we could be on the cusp of a pivot on their current easy monetary policy, towards a slightly tighter posture, although it’s unlikely to happen much before Q2 of next year.  

EUR/USD – posted a potential key day reversal last week, after pushing up to 1.0735. Slipped below the 1.0600 area which could see a move towards the 1.0520 area, with further support at 1.0330/40.

GBP/USD – saw a bearish reversal on cable last week after failing at 1.2450, with the potential to slip back to the 200-day SMA at 1.2110, having slipped below the 1.2280 area, which should now act as resistance. Below the 1.2100 area potentially opens up the 1.2000 area.

EUR/GBP – having held above the 200-day SMA last week, we saw a retest of the 0.8770/80 area, before slipping back. Above 0.8780 opens up the 0.8830 area, while a break below 0.8540 opens up further losses towards 0.8480.

USD/JPY – held below trendline resistance from the recent highs at 151.95, with a break above the 138.00 area potentially retargeting the 140.00 area. A concerted break below 200-day SMA at 135.50 retargets the lows at 133.60.

FTSE100 is expected to open 24 points higher at 7,356

DAX is expected to open 40 points higher at 13,933

CAC40 is expected to open 27 points higher at 6,479