Economics back in focus as trade deals and NFPs drive markets

It’s hard to avoid Brexit if you trade the financial markets, but the latter part of this week gives everyone the chance to shift the focus from the latest Brexit developments, to the state of US/ China trade relations and economic data. Both of these things are far more important for the direction of asset prices in the medium to long term as they will determine global growth. 

Indices start Q2 on a high note 

So far this week, growth has started to show signs of life and stock prices have reacted in a positive fashion, particularly in Europe, where stocks are close to 7-month highs. This comes on the back of stronger retail sales data in the currency bloc, a fall in global bond yields, which suggests that investors are happier about global economic growth, and signs that the US and China are near a trade agreement, ending months of uncertainty. 

Why the US yield curve inversion is no big deal 

Investors have also calmed down about the inversion in the US yield curve that we mentioned last week. Long term yields had fallen below short-term yields in the US, however, whereas traditionally this indicates a recession is looming, there could be another reason for this phenomenon occurring at this stage in the economic cycle. Some analysts have pointed out that years of quantitative easing and cheap money from the world’s largest central banks have artificially depressed long-term yields, so a relatively small decline in yields can cause the yield curve to invert. Thus, rather than be a sign that a recession is looming, it may in fact indicate a sweet spot for the economy: low interest rates at the same time as growth is not too hot, or too cold. 

If this assessment of the US yield curve is correct, then global stocks may return to recovery mode, and continue to erase the Q4 2018 losses. The German Dax has been a particularly good performer this week, and we would expect it to continue to make gains especially if there is a breakthrough in the China/ US trade deal. Germany, a big exporter to both the US and China, with a large production base in both countries, would benefit from a release of global trade tensions and a better trading relationship between the world’s two largest economies. Thus, we may see the Dax break through the 12,000 mark and potentially return to September 2018 highs at 12400-12500 in the coming weeks. 

China and US economic data boosts sentiment 

Economic data has also boosted global stocks. An improvement to China’s manufacturing PMI has outweighed any concerns about the French and British service sector PMI’s falling into negative territory. Right now, the main global financial markets – stock indices, commodities and FX- are interested in the data points from the world’s largest economies, the US and China. If they can show signs of improvement as we move into Q2 then the market will expect other economies to play catch up. We do, however, think that positive economic signals from China and the US could boost European stocks, in particular, which are trading at lower valuations than their US counterparts and thus could attract bargain hunters. 

Aside from developments regarding the US/ China trading relationship, the next major focus for traders is the US labour market report on Friday. The latest ADP report, which measures private sector payrolls in the US suggested that job growth is slowing in the US, the ADP showed 129k jobs for March, lower than the 173k expected. The relationship between the ADP report and the NFP report has improved in recent years, thus this report suggests that the bias is for a lower NFP on Friday. However, an unexpectedly strong report could boost the US dollar, as US yields start to rise. It may also give US stocks a boost into the end of the week as strong growth signals combined with the Fed remaining on hold is fertile territory for stock market growth. Read our NFP preview on Thursday to find out more. 

Market reacts well to latest Brexit development 

Of course, we can’t ignore Brexit completely. Sterling and the FTSE 100 have both reacted positively to the Prime Minister May’s decision to ditch the Eurosceptic in her party, and to cross party lines and reach out to Labour leader Jeremy Corbyn to try and hatch a softer Brexit deal. This has apparently been welcomed by big names in the UK business community, even if the Chambers of Commerce weren’t happy with this latest development. 

It is well-known that UK asset prices have reacted well to any signs of a soft Brexit, or no Brexit, and this is playing out right now. GBP/USD rallied back above $1.32, and the FTSE 100 is at its highest level since October. However, the shine has come off the pound as we progress through Wednesday, although it was a bold move from PM May, the future relationship between the UK and Europe is still not clear. Will May try to rush through a fourth vote on her original Brexit plan with Labour support before the 10thApril EU leaders’ summit, or, will she be forced to ask for a lengthy extension at this meeting? Either way, we believe that current developments are more favourable for sterling than the threat of a no-deal Brexit later this month. 

Can oil break above key resistance?

It is also worth mentioning oil, Brent crude has been pushing towards the critical $70 per barrel mark, the highest level since November 2018, on the back of stronger global growth, Opec’s commitment to production cuts and sanctions against Venezuela and Iran threatening supply. $70 is a key resistance level for Brent, thus we may need a firm breakthrough in the China/ US trade negotiations and a strong NFP report from the US before oil will break through this critical level, which may not be reached until late this week. 

For now, economics, US-China trade relationships and oil are in focus for traders, with Brexit at the back of everyone’s minds.