European PMIs and US jobs report in focus on Friday

Good morning,

• European indices seen slightly lower following big sell-off in the US on Thursday;

• US sell-off this week may not be something to be too concerned about;

• VIX action may provide insight into whether we’re about to see larger correction;

• Chinese PMI readings help boost sentiment overnight;

•  European PMIs and US jobs report in focus on Friday.

European indices are expected to open slightly in the red on Friday following a major sell-off in US equities on Thursday and a fairly negative session in Asia overnight.

The Dow plunged more than 300 points yesterday to record its largest days losses in six months which has given many people the difficult job of trying to explain exactly why we’ve seen such a U-turn from investors. There were plenty of small things that could have weighed on sentiment yesterday such as the Adidas profit warning which was driven by the crisis in the Ukraine, the Argentine default or even disappointing earnings. Some people, in a desperate attempt to explain the sell-off, even highlighted the employment cost index rise to 0.7%, suggesting that higher wages could prompt a more hawkish response from the Fed.

The simple fact of the matter is that it was probably a combination of a number of factors, along with the fact that the markets can act a little irrationally at month end. The important question now is whether this was just a one-day sell-off or the start of a more significant correction. Well, as it stands European futures are only pointing to a slightly weaker open while US indices are seen opening a quarter of a percentage point higher so I’m not overly concerned yet.

On top of that, with indices currently deep in negative territory this week, it’s worth looking at the last few times we’ve seen a week like this. Of course, with the jobs report being released today, this could all change. But, assuming it doesn’t, it is worth knowing that each time we’ve seen a week like this in the Dow this year, it’s turned out to be quite a bullish signal. In January, we saw a little more selling before the upturn but on the last two occasions in March and April, we saw an immediate reversal.

One thing worth watching in the coming weeks will be the VIX as this spiked significantly higher this week to a three and a half month high. The VIX is known as the fear index and the way it responds in the coming weeks could provide insight into whether we’re seeing a brief sell-off or a more significant correction. In the past, these spikes in volatility have tended to be followed, not always immediately, by a gradual decline back towards the previous lows. Should we not see this, or if it creates a new higher low, this could be a warning sign of worrying times to come.

An improvement in the official Chinese manufacturing PMI helped lift sentiment in Asia overnight, although it wasn’t quite enough to push indices there back into positive territory. The 51.7 reading though was the highest recorded since April 2012 which is an encouraging sign given that at time this year, people have genuinely been concerned about whether growth could fall to 5% this year, while some have predicted even worse outcomes.

There’s plenty more data being released today, so we could be in for another day of volatile markets. The Eurozone manufacturing PMI readings will be released throughout the early part of the session, followed by the UK reading at 9.30. Once again, people will be looking for further evidence of a slowdown in the euro area, as well as signs that the German economy is genuinely suffering as a result of the Ukrainian crisis and the sanctions against Russia. This has already been confirmed by Adidas’ profit warning yesterday but these PMI readings could provide further insight into how much confidence is deteriorating in the eurozone’s largest economy.

Finally today we’ll have the jobs report from the US, which will be followed extremely closely. There are so many pieces of data being released at 1.30 and all of them make up some piece of the jigsaw that is the Fed’s outlook for monetary policy. In the past we’ve been able to focus on a couple of pieces such as the unemployment rate or the non-farm payrolls number but it isn’t that simple any more. Now data such as wage inflation and hours worked are very important as they provide insight into the amount of slack still in the economy. Also, we have the Fed’s preferred measure of inflation, the personal consumption expenditure price index, being released at the same time, so I expect to see a lot of volatility in the markets as traders attempt to make sense of all these releases.

Ahead of the European open, the FTSE is expected to open 17 points lower, the CAC 13 points lower and the DAX 26 points lower.