Weekly Outlook: a big week for financial markets

This is a big week for financial markets. We have monetary policy meetings from the Bank of Canada, Reserve Bank of Australia, Bank of Japan (BOJ) and European Central Bank (ECB). Of these, it is the latter two which are of greatest importance. Last week a story in Reuters said the ECB was hoping to delay announcing any further reduction in its Asset Purchase Programme which is currently expected to finish this September. In the absence of any clear reference in its statement, the ECB President Mario Draghi is bound to quizzed on this in his subsequent press conference.

Unexpectedly, last week BOJ Governor Haruhiko Kuroda announced that the central bank would begin planning an exit from its monetary stimulus programme around April next year. He went on to say there could be a policy change before the BOJ’s 2% inflation target was reached. Previously, Mr Kuroda has refrained from any comments concerning monetary tightening. Japanese investors took fright and the Nikkei ended Friday’s session 2.5% lower. It lost a further 0.6% during Monday’s session while the yen continues to rally with resistance for the USDJPY now coming in at 108.00 – previously key support.

Last week there were some highly significant moves which saw the major US stock indices break below important support levels. Of note, despite a late rally on Friday, the S&P 500 closed below both the 50% retracement of last month’s sell-off and the 100-day simple moving average at 2,695. From a technical perspective, this suggests that US equities could struggle to recover more of February’s losses. Traders are debating if the old reliable “buy the dip” strategy is now finished.

Yesterday saw members of Germany’s SPD party vote overwhelmingly in favour of going into coalition with Chancellor Merkel’s CDU/CSU political grouping. This is unequivocally good news as it means that Germany will now have a functioning government after a five months gap since the General Election. The euro rallied initially as the alternative would have been a fresh election with all the uncertainty that would have caused - not just for Germany but for the European Union. But the rally was short-lived as traders reversed their positions as the results of the Italian General Election filtered through. As expected, there’s no clear majority for any one party although the anti-establishment 5-Star Movement appears to have won the biggest share of the vote. However, 5-Star are refusing to go into coalition so we can now expect weeks of wrangling as parties try to form a workable government and agree to key appointments.

At the beginning of last week, the dollar rallied sharply as new Fed Chair Jerome Powell delivered what was largely considered to be hawkish testimony in Washington. Many observers left convinced he was hinting that the Fed could raise rates by 100 basis points in 2018, up from the 75 basis points forecast by the FOMC in December. On Thursday New York Federal Reserve President Bill Dudley stated that four 25 basis-point rate hikes “would still be gradual”, further boosting the greenback. But later that day the dollar sold off sharply after President Trump said that he would be instigating tariffs on US imports of steel and aluminium in a move which many expect will result in an all-out trade war.

This Friday brings the latest update on US Non-Farm Payrolls. The consensus expectation is for an increase of 204,000 – just a rounding error above last month’s 200,000 reading. But traders will really be focusing on Average Hourly Earnings. It was last month’s +2.9% reading (way above the 2.6% expected) which triggered inflation fears and catalysed a jump in volatility and the stock markets’ corrective sell-off. Another strong number will add weight to the argument that the Fed will opt for four 25 basis-point rate hikes this year. This is likely to boost US Treasury yields and weigh further on global equities.