Something to cheer about: European stocks hit record as China cuts US tariffs

The big news this morning is that although China has reported an increasing number of deaths from the coronavirus, the markets are looking at the positives: firstly, the prospect of a vaccine sooner than expected, and secondly, news this morning that China would halve the tariffs on some US goods that were levied last year. This move reciprocates one from the US, where Washington is pledging to slash tariffs on some Chinese goods by February 14th. This suggests a warming in relations between the US and China at a critical time for China’s economy, which has taken a severe knock from the Coronavirus. 

Why coronavirus fears will continue to linger 

This news has been positive for financial markets, who seem happy to ignore the elephant in the room – that China’s growth could fall by 20-30% in the first quarter on the back of this virus. The negative economic effects of the coronavirus have spread further than China, Japanese carmaker Toyota warned that it expects to see a dent to car sales when it reports Q1 earnings figures later this year.  The problem for car makers who rely on sales from the Chinese market is that it could cause production problems in Europe and the US, where some cars are made. Thus, workers could be laid off thousands of miles away if Chinese consumers are in no mood to buy cars on the back of this outbreak. Therein lies a major problem with global supply chains. While we expect this disruption to be short term until the virus is brought under control, there will be a hit to global growth on the back of the coronavirus, although it could lead to a bulge in demand and production later in the year. Will stock markets be able to stay strong in the wake of an actual capitulation in Chinese growth, we shall have to see. 

From a trading perspective, the move on tariffs from Beijing is extremely positive for Germany and the Dax, which has also reached a fresh record high today. Considering German growth is reliant on the Chinese market for its exports, the Dax has mostly brushed off fears of the coronavirus, even last week’s blip - where shares fell sharply – didn’t knock the Dax’s rally too far off course. This leads to the question – what is driving markets inexorably higher, is it worth betting on them falling from these peaks, and what will drive the inevitable decline? The first question seems to be the better tone to global economic growth since the start of the year. Will stocks inevitably fall once we know the full extent of China’s economic gloom? We shall have to see. 

Oil price – still looking negative in the short term 

Elsewhere, oil has also picked up from the lows after Brent crude fell to $53.50, the lowest level since the end of 2018. Oil has taken the brunt of fears about the coronavirus on Chinese growth, as a weak China is likely to mean long term negative effects on fossil fuel producers. While $53.50 looks like decent support, the oil price hasn’t managed to sustain a decent rally, it rose as high as $56.60, but encountered decent resistance at this level. We expect Brent crude to settle around $55 per barrel, before investors make a decision about where oil will go next. We are not hopeful that there will be a meaningful rally in the oil price in the coming weeks – with no end in sight for the coronavirus and little understanding of how deep the decline in Chinese growth will be, the oil price is likely to lag behind any recovery in other asset prices, as oil companies rapidly try to ramp down production, which could be negative for the oil price and oil company share prices in the short term. 

GBP strength depends on PM cabinet re-shuffle 

As we mentioned in our week ahead, the pound has been under pressure since the start of this week, as the UK government seems to be taking a hard-line stance towards EU trade negotiations. Later this week PM Johnson is expected to reshuffle his cabinet. This will be the next major test for the pound – will the new cabinet be more or less likely to reach a trade deal with the EU before the end of 2020 deadline? A cabinet that is believed to be able to reach an agreement with the EU on a trade deal is likely to trigger a pound rally, while a less pro-EU cabinet could trigger a collapse in sterling. GBP/USD has taken a hammering this week, it fell 250 pips at its peak, although GBP/USD is now just below $1.30 after finding strong support at $1.2950. On Wednesday, this pair managed to rally to $1.3060, which is key short-term resistance, if it can break above this level then a move back towards $1.32 seems possible. The trouble with sterling is that any move is dependent on politics, which is a hard beast to predict. Who would have thought that the pound would fall so sharply even though the UK’s economic data is looking in good shape for January, which suggests that a rebound in growth in Q1 is now likely after a dismal end to 2019? Thus, to predict the next move for the pound, look at who PM Johnson chooses to manage the country, and particularly who he puts in charge of the EU trade negotiations. Pound bulls should hope that this person is level headed and pragmatic. 

NFP preview: why markets are expecting a big number  

Elsewhere, the US data is also strong. Ahead this week, the key economic figure to watch will be the US Non-Farm payrolls, released on Friday. The market expects a reading of 160k, however the private sector jobs figures, measured by the ADP report, saw a huge rise in jobs growth for January, up 291k for the month, easily beating the 150k expected. That was the highest ADP reading for a year, which has also helped to assuage coronavirus fears and helped US stock markets to reach record highs. The market is now expecting NFPs to beat expectations. If that happens then we could see US stocks close the week with a fresh record high. 

FX view 

On the FX front, safe haven currencies are coming under attack as risk sentiment returns. USD/JPY is attempting to break above 110, if this pair can break above 110.20 then it opens the away to multi-month highs above 111.00. EUR/USD looks weak this morning as the dollar gains strength across the board. It is suffering as European stocks surge, also comments from ECB head Lagarde, who said that the ECB has limited scope to ease monetary policy further and support the Eurozone economy if needs be is also weighing on the single currency. EUR/USD is close to a 2-month low and has fallen below 110.00. Momentum is on the downside, and the technical signals also indicate that this pair is a sell, below 109.50 opens the way to the 108.99 low from last September, which was the lowest level since May 2017. After such an aggressive euro sell off this week, we would expect the downside to start to look stretched, however, buyers may not come in until 109.00-109.50.