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Equity markets in Asia are enjoying some decent gains overnight, with China and Hong Kong the obvious outperformers, while Europe is also enjoying a positive start on Wednesday.

Choppy trading conditions are still evident this week although the latest Chinese PMIs have provided some cause for more optimism. It was already believed that the transition from zero-Covid to living with it was going smoothly but this survey data suggests businesses are now extremely optimistic about the future.

That bodes well not just for China but regionally as well, as strong demand boost trade and a resurgence in tourism restores the battered industry. There's still a long way to go and there could be setbacks along the way but investors will no doubt be encouraged by these early signs.

Those with close economic links with China have seen their currencies perform well in the aftermath of the releases, while the yuan is also trading much stronger on the day. While the initial reopening data may be noisy, a strong rebound will be very welcome after a very challenging 2022.

PMIs a big positive for oil

It's not just equities that have been lifted by the PMIs, oil is also rallying today on the prospect of a stronger Chinese recovery and resilient global demand. While this was just one survey, the breakdown of the surveys was undoubtedly encouraging and that's lifting Brent and WTI in early trade.

All we need to see now are signs of cooling price pressures and perhaps less heat in the labour market in order for crude to potentially break higher. Higher interest rates forcing a hard landing remains the main downside risk for crude prices which has driven the consolidation we've seen in recent months, and recent data has only fed those fears.

But with China transitioning well and survey evidence indicating resilient demand, all we're missing is the removal of that downside growth risk. We may need to wait a little longer though as the data points traders will be most focused on for that are released over the next few weeks. A repeat of January could come as quite a shock.

Creeping higher

Gold is quietly heading for a third day of gains, boosted by a softer dollar today as other currencies react favourably to the Chinese survey data. The yellow metal fell almost 8% from its highs in February, coming close to key support around $1,780-$1,800. With momentum fading on approach, it would not come as a shock to see it pare those losses ahead of crucial US data over the coming weeks. Of course, it's reliant on yields not spiking again and some improvement in risk appetite wouldn't do it any harm either.

A timely boost

Not one to miss out on a bump in risk appetite, bitcoin is trading more than 2% higher this morning. It appears to have consolidated around late-February lows in recent days after failing to break key resistance - $24,500-$25,500 - in the middle of the month. That could be a sign of weakness, at least in the short-term, although ultimately it's hard to imagine that occurring if we do see risk appetite continue to improve.

EURNZD is coming nicely down, a perfect reaction from the upper side of an ending diagonal pattern which suggests that wave C is done. In fact, a reaction lower is very strong and may not be over yet as normally wedges cause a reversal all the way back to starting point of that pattern. In our case that's near 1.6666. Intraday rally can be an opportunity to catch the weakness.

Things are looking up in the euro area with business activity ticking higher in the first two months of 2023, easing concerns about an imminent recession. Falling energy prices, improving supply chains and a relatively mild winter have all contributed to staving off a major economic downturn. However, the euro has been unable to break new ground in its uptrend and has been drifting lower since the beginning of February. Have the upside risks been already fully priced into the euro or is this just a waiting game until the March policy decisions when both the Federal Reserve and European Central Bank will update their policy outlooks.

Euro loses its shine

The euro rallied about 15% from its low point in September 2022 to its peak in February this year. The gains were driven mainly by the ECB taking an increasingly hawkish stance as well as speculation that the Fed is nearing the end of its tightening cycle. These expectations were supported by the comparative data on the two economies, as European indicators kept beating the forecasts, while the American economy displayed signs of a sharp slowdown towards the end of 2022.

However, the tide seems to be shifting again as the US economy has not only regained some growth momentum, but also the rate of decline in inflation is moderating. Investors have had to price in at least two additional rate increases for this year since December as the Fed’s ‘higher for longer’ policy stance finally started to sink in. But expectations for the ECB’s terminal rate have risen too as the euro area outlook has brightened. Yet, even after the latest repricing, the euro has been unable to make much headway.

One way of looking at it is that the gap between the positive surprises in European data versus the US has narrowed and so the boost to the currency from this particular source has started to fade. At the same time, the spread between US and Eurozone yields has started to widen again, increasing the attractiveness of the US dollar over the euro.

Battling it out in the economic league table

But what happens from hereon is not clear. Both economies have proved to be more resilient than anticipated against the backdrop of higher prices and rising borrowing costs and both the Fed and ECB have sent strong signals to investors that getting inflation down is their top priority. It could be argued therefore that euro/dollar’s performance will come down to which central bank pauses first and which economy emerges out of the tightening cycle in better shape.

So just how robust are the American and Eurozone economies? There can be no doubt that the US economy went into the energy crisis and broader inflation storm in a much stronger position as it made a swifter recovery from the pandemic. The labour market remains hot despite a cumulative 450 basis points of rate increases. Consumers have started spending again after tightening their purse strings towards the end of last year. Even the manufacturing sector is showing some signs of a rebound.

In comparison, consumption in the euro area has been notably weaker ever since higher energy bills began to bite. Businesses also took a more direct hit from the fallout of the war in Ukraine than their US counterparts. But confidence among both consumers and businesses is returning now that fuel costs have come down from sky-high levels. Moreover, European manufacturers are likely to benefit more from China’s reopening than US exporters.

One less obvious positive about the Eurozone has been the labour market. Although it’s not anywhere near as tight as it is in America, the European jobs market has been booming since the post-pandemic recovery began, and combined with generally higher savings rate than across the Atlantic, this bodes well for future consumption.

The inflation fight is far from over

But what about inflation? In America, the consumer price index peaked lower and was falling faster until January when it appeared to stall. More worryingly, underlying inflation as measured by the core PCE price index crept up to 4.7%. This is still lower than the core metric in the euro area that strips out food, energy, alcohol and tobacco prices, which climbed to 5.3% in January.

Based on the inflation data alone, the ECB has more work to do than the Fed. It’s hard to tell how much of the difference in inflation rates is to do with the Fed having been a lot more aggressive in 2022 and how much of it is because of the Eurozone’s greater exposure to the energy crisis, but the ECB’s more cautious approach to rate increases has left it further behind the curve than the Fed.

Markets are currently pricing in at least another 150-bps worth of rate hikes in the euro area versus another 75 bps in the US. For euro/dollar, however, this may not be much of a game changer. Even though it is very likely that rates in the US will peak higher than in the Eurozone and the latter’s lower tolerance threshold for elevated rates puts the euro at a major disadvantage, what may matter more in 2023 is not so much the end point but who makes the first dovish pivot.

Will the Fed pause before the ECB?

And on that, expectations that the Fed will call time on rate hikes before the ECB does haven’t changed. This provides the euro decent with odds to resume its uptrend at some stage over the coming weeks, potentially as early as the March policy meetings. The ECB meets on March 16 and the Fed on March 22.

As long as the Fed doesn’t sound the alarm bells over inflation taking longer than anticipated to drop back to 2% and the median projection of the terminal rate in the dot plot is revised higher by only 25 bps, this could work in the euro’s favour, especially if the ECB on its part keeps the door open to another 50-bps hike after March.

There is some risk that FOMC members might pencil in a much-higher-than-expected terminal rate to save face from having downshifted to 25 bps too soon. But perhaps the bigger danger is that the March decisions fail to offer significant clarity on how much further tightening is left to go, potentially leaving euro/dollar paralyzed at least until the summer.

The clouds have yet to fully clear over the outlook

By that point, policymakers will probably have a better idea on the amount of additional work needed to tame inflation and whether the major economies have indeed managed to dodge a recession or not. In the scenario that inflation turns out to be a lot stickier than is currently predicted, the dollar is likely to be the winner as the Fed would respond more forcefully than the ECB to persistent price pressures. In addition, the greenback’s safe haven attributes would attract increased flows from heightened uncertainty about an impending downturn.

However, if this setback with inflation’s climbdown slowing down proves to be temporary, there isn’t another wave of rate hike bets being pushed up by investors and policymakers are confident about a soft landing, the euro would be well placed to revisit the $1.10 handle, if not the $1.12 level. The dollar tends to depreciate at times of global risk appetite so even if both the US and Eurozone economies avoid a hard landing, the euro could still notch up fresh gains.

USDJPY is struggling to surpass the 38.2% Fibonacci retracement level of the downward wave from 151.90 to 127.25 at 136.66, where also the 200-day simple moving average (SMA) lies. Any movements above these obstacles could open the door for more positive actions.

Technically, the MACD oscillator is strengthening its momentum above its trigger and zero lines, while the RSI is flattening near the overbought region, suggesting that the market may be overstretched. In trend indicators, the 20- and the 50-day SMAs posted a bullish crossover in the preceding sessions.

If the price overcomes the aforementioned key levels, it may reach the 138.15 resistance and the 50.0% Fibonacci at 139.60. Any moves higher could shift the short-term outlook to a more bullish one, testing the 61.8% Fibonacci at 142.50.

Alternatively, the bears may take the market until the 134.75 immediate support before resting near the 23.6% Fibonacci at 132.95 and the 20-day SMA. Slightly lower, the 50-day SMA at 131.80 may be a turning point for traders. However, more losses could switch the outlook back to bearish, hitting the 129.80 support.

To sum up, USDJPY is looking bullish in the near term and any attempts above the 200-day SMA could endorse this view.

The FTSE 100 tumbles as record high grocery inflation in the UK fans fears of higher interest rates. The index failed to hold on to the 30-day SMA (7870) after hitting resistance at 7950. A correction could be taking shape following a stellar rise since the beginning of the year. The RSI’s oversold condition has brought in some bids but that may not be enough to stage a meaningful recovery in the short-term. Instead, a fall below 7850 may prompt more buyers to bail out, triggering a liquidation towards the daily support at 7710.

The Canadian dollar softened after the economy unexpectedly stalled in Q4. On the daily chart, the pair is looking to come out of its five-month long consolidation, but stiff selling pressure has kept the price below the top band and January’s peak of 1.3680. A bounce off 1.3530 is a sign of follow-up interest. Further down, the confluence of the previous swing low of 1.3440 and the 20-day SMA is a significant support. A decisive break above 1.3680 would trigger a runaway rally and resume the uptrend in the medium-term.

The Swiss franc fell after the annual GDP barely avoided a contraction in Q4. On the daily chart, a close above January’s high of 0.9400 and a bullish MA cross show that sentiment is turning around. Now that the direction is skewed to the upside, traders see pullbacks as opportunities to buy at a discount. The latest retracement came to a halt at 0.9340 and 0.9260 over the 20-day SMA is the second layer of defence. A close back above 0.9430 would pave the way for an extended rally towards the supply area around 0.9500.

Markets

Unexpectedly accelerating inflation in France and Spain set the tone right at the start of European dealings. Core bonds slid with European bonds evidently underperforming US Treasuries. German yields rose 6.2-7.6 bps across the curve with a slight underperformance at the belly. The 10y yield closed above 2.57% resistance to set a new cycle high. US yields added 2.5-3.9 bps at the front end and less than 2 bps elsewhere (excluding the 30y; -1 bps). The 10y yield over there continues to test important resistance around 3.95%. Both European and US bond yields finished off intraday highs though, following an unexpected decline in US Conference Board consumer confidence (from a downwardly revised 106 to 102.9), on the back of a worsened expectations component. But that doesn’t change the evolving market narrative towards hawkish central bank policy to remain in place for longer. In the EA, money markets are gradually pricing in a peak policy rate of 4%, the US is shifting towards 5.5-5.75% with a rate cut no longer fully priced in at the end of the year. Equities, both in Europe and the US, tried a comeback after initially being whipped by the yield rise but in the end finished with some losses still. The dollar took the lead on currency markets. EUR/USD closed near recent lows below 1.06, the trade-weighted DXY (104.869) erased about half of the losses incurred on Tuesday. Sterling’s Windsor Framework boost already faded, as sentiment on equity markets took a turn for the worst. EUR/GBP rebounded from an intraday low at 0.8755 to 0.8798.

Asian stocks this morning get a boost from the ongoing Chinese PMI rebound. The non-manufacturing gauge rose well into expansion territory (56.3). The manufacturing PMI came in at 52.6, lifting the composite figure to 56.4. Details were strong. The Chinese yuan’s comeback enters its third day. USD/CNY falls to 6.90 with some sentiment-driven dollar weakness at play too. Strong Chinese data also supports currencies Down Under (AUD, NZD). EUR/USD oscillates around 1.06. US yields add less than 2 bps across the curve. German yields face a higher opening as well.

German CPI numbers are key to watch in European dealings today. A first regional publication came in at 0.1% m/m and 8.5% y/y (North Rine Westphalia). With the recent methodology change it’s tricky to draw firm conclusions for the national number though (expected at 0.7% m/m and 9% for the harmonized figure). In any case we look out for the German 10y yield to confirm yesterday’s break higher. That would improve the technical picture, opening the way towards 3%. The focus shifts to the US in the afternoon with the publication of the manufacturing ISM, seen bottoming out from 47.4 to 48. While we see some upward surprise risks, the leap higher in the 10y yield here might be tricky with the services gauge still due on Friday. As ever, EUR/USD’s daily momentum depends on the overall risk sentiment. The likes of stocks have been proven resilient recently, especially in Europe, providing a bottom for the euro while it lasts. 1.068 is a first resistance.

News and views

Australian GDP grew by 0.5% Q/Q in the final quarter of 2022, down from 0.7% growth in Q3 and below 0.8% consensus. Y/Y-growth slowed to 2.7%. Total consumption (0.4% Q/Q) and exports (1.1% Q/Q) were the main growth engines. Changes in inventories subtracted 0.5 percentage points from GDP growth while private gross fixed capital formation fell 1.7% Q/Q. The Bureau of Statistics said that continued growth in household and government spending drove the rise in consumption, while increased exports of travel services and continued overseas demand for coal and mineral ores drove exports. The contribution from households is losing momentum though, with a 4.3% Q/Q decline in imports adding to that picture. On top, the household saving ratio fell from 7.1% to 4.5%, the lowest level since Q3 2017. Compensation of employees increased 2.1% Q/Q, pointing to the tight labour market. The GDP implicit price deflator rose by 1.6% Q/Q and 9.1% Y/Y. Monthly January CPI inflation, released as well this morning, slowed in Y/Y-terms from 8.4% to 7.4%. The Aussie dollar initially dipped to the recent lows against the greenback (AUD/USD 0.67), but soon rebounded on strong Chinese PMI’s and the ebullient risk sentiment.

UK shop price inflation rose to another record high (8.4% Y/Y from 8%) in February as retail prices across the board continued to react to the impact of soaring energy bills, higher running costs and tougher trading conditions brought about by the war in Ukraine. Details from the British Retail Consortium’s indicator showed overall prices rising by 0.8% M/M, with both food (1% M/M; 14.5% Y/Y) and non-food (0.7% M/M; 5.3% Y/Y) contributing.

Daily Pivots: (S1) 163.18; (P) 163.76; (R1) 164.92; More...

Intraday bias in GBP/JPY is turned neutral as it retreated after hitting 165.99. Some consolidations would be seen but further rally is expected as long as 161.18 support holds. As noted before, corrective fall from 172.11 should have completed at 155.33 already. Break of 165.99 will target 169.26 resistance first, and then 172.11 high.

In the bigger picture, corrective decline from 172.11 medium term should have completed at 155.33. With 38.2% retracement of 123.94 (2020 low) to 172.11 (2022 high) at 153.70 intact, medium term bullishness is retained. That is, larger up trend from 123.94 (2020 low) is still in progress. Break of 172.11 high to resume such up trend is expected at a later stage.

Daily Pivots: (S1) 143.48; (P) 144.48; (R1) 145.07; More....

EUR/JPY retreated after rising to 145.46 and intraday bias is turned neutral first. But further rally is expected as long as 142.13 support holds. Corrective fall from 148.38 has completed at 137.37 already. Break of 145.46 will resume the rally from 137.37 to 146.71 resistance and then 148.38 high.

In the bigger picture, as long as 55 week EMA (now at 139.42) holds, larger up trend from 114.42 (2020 low) is still in progress for 149.76 long term resistance. However, firm break of 55 week EMA will bring deeper fall to 38.2% retracement of 114.42 to 148.38 at 135.40. Sustained break there will raise the chance of trend reversal, and target 61.8% retracement at 127.39.