Markets falter once again, as fears mount

It’s been a rollercoaster ride for asset prices this week, after a huge sell-off on Monday, Tuesday showed signs of recovery, however, that may have been a false dawn as European stocks have faltered on Wednesday. US/ China trade, faltering economic growth, geopolitical tensions between the US and Iran and Brexit votes all seem to be riling investors in the middle of this week. 

Fundamentals are back, baby

The FTSE 100 is struggling to adjust to life above 7,260 – Tuesday’s high, as upward momentum failed to gather pace across the European indices. The main driver for Wednesday’s weakness appears to be concerns about China and Germany’s growth outlook. China posted weaker than expected retail sales and industrial output, retail sales rose at a 7.2% annual pace, which is the weakest rate of growth since 2003. The details of the report are worth noting, clothing sales fell for the first time since 2009, suggesting that Chinese consumers are growing more concerned about the escalation between the US and China trade tensions. 

Why Chinese economic data matters 

Consumers in China are not only cutting back on the big-ticket items like luxury cars, but also everyday items including cosmetics. Overall, the China data suggests that the economy is losing momentum as we move into Q2, after a surprisingly upbeat Q1. This suggests that China is facing a consumer slowdown, an industrial slowdown, weak exports and weaker investment all at the same time, which does not bode well for the world’s second largest economy, or for global economic growth as a whole. The escalation in the US/ China trade spat could not come at a worse time. Until this is resolved once and for all, deteriorating economic fundamentals suggest that the path of least resistance for global equity indices could be lower. 

Economic fears spread to Europe 

Germany’s economic fortunes are a key measure of the health of the global economy, due to the industrial and export-led nature of its economy. The weakness in Chinese consumer data is a major concern for the future of German growth. Even though German GDP rose by 0.4% in Q1, bringing to an end the economic stagnation in the second half of 2018, the 10-year German bond yield slipped to its lowest level for 2 years on Wednesday to -0.094%. Investors remain concerned about Germany because of its sensitivity to issues that could impact free trade, which may hurt growth later this year. In Germany’s case, a negative bond yield is unlikely to lead to a lending boom, instead it reflects deep concern about a possible slowdown in Europe’s largest economy. This is also reflected in the weakness in the Dax, it is down more than 8% this month, and the index has slipped below the key 12,000 level. If the index falls below 11,900 then the index could fall further towards 11,600. 

The US is not off the hook 

The US may not be immune to growth fears either. Fed officials are now on the lookout for a boost to inflation, as retaliatory Chinese tariffs are likely to feed through to higher prices for US consumers. Thus, Chinese tariffs could act like a stealth tax on the US consumer, with some estimates saying that US retailers could push up prices on Chinese consumer goods by 3-8%. Although US retailers may try to become less reliant on Chinese imports as a result of this trade war, this will take time, until then it appears that US consumers will pay the price. 

If US inflation is pushed higher because of the US/ China trade war, where does this leave the Fed? Will the US central bank continue to maintain its dovish bias and keep rates on hold, or will rising inflation force its hand to resume its rate-hiking cycle? If the Fed was to start raising interest rates in the middle of a global trade war, this is likely to be a defining moment for markets and may cause a global rout in risky assets. Thus, we expect risky assets to remain sensitive to US economic figures, and any pick-up in inflation data could see risk appetite suffer. 

What we are watching USD/JPY and GBP 

We have mentioned in previous notes that USD/JPY is the main barometer of risk during this period of uncertainty. This key pair remains below 110.00, and we believe that any rallies will be temporary until risk appetite recovers. USD/JPY has traded within a tight range of 30 points on Wednesday, as the market waits to gauge US risk sentiment. If risk sentiment picks up and stocks manage to rally then USD/JPY stands a chance of recovering, although we believe that 110.00 is a key resistance level, and we would need to see a significant shift in sentiment to push this pair above this level. Alternatively, if risk sentiment sours, then a move back to Monday’s low at 109.00 is on the cards. If, as we expect, markets are in pause and reflect mode, then we expect a 30-50 pip range in USD/JPY around the 109.50 mark to persist. 

GBP takes another stumble  

GBP/USD has fallen to its lowest level since February, as the market digests news that the PM will put her Brexit deal to another parliamentary vote in June. Overall market fears are also starting to bite, and technical factors are also weighing on GBP/USD, which has fallen below its 50, 100 and 200-day smas. There could be room for more downside as GBP/USD doesn’t look oversold at this stage and momentum is to the downside. The next key support level to watch is 1.2745 and then 1.2610 – the low from 3rdJanuary. As the pound falters, the FTSE 100 has picked up from its lows, as the negative correlation between the pound and the FTSE 100 reinstates itself. 

Overall, market sentiment remains fragile, however, indices will eventually settle and could move into range trading mode by the end of this week, however, any negative news-flow is likely to see investors rush to the exit.