MARKET WRAPS

Watch For:

EU Flash consumer confidence indicator; Germany Bundesbank monthly report; no major trading updates expected

Opening Call:

Shares in Europe may open slightly higher tracking Friday's gains on Wall Street. Asian stock benchmarks were higher in holiday-thinned trade with several markets closed for the Lunar New Year; Treasury yields broadly lower; the dollar weakened; oil fell while gold rose.

Equities:

European stocks are seen opening higher even as concerns about the health of the global economy continue to weigh.

Fed governor Christopher Waller, who was an early supporter of rapid rate increases last year, said Friday that the economy and the outlook for inflation were evolving in a way that would allow the central bank to continue slowing the pace of rate rises.

Mr. Waller said he was "cautious about the recent good news, but it is good news. We have made progress." He said he believed the central bank still has a "considerable way to go" toward bringing inflation back to its 2% goal and he expected the Fed would need to keep raising rates.

"It seems like the market narrative is shifting from a focus on the Fed at the end of its hiking cycle to the growth slowdown," said Seema Shah, chief global strategist at Principal Asset Management.

"I just don't see how the Fed could start cutting [rates] as soon as it stops hiking. I don't see why markets consider this an option," said Agnès Belaisch, chief European strategist at the Barings Investment Institute.

"It would have to be a huge recession, which the market isn't pricing in either."

This week, investors will weigh a wide range of fresh economic data, including manufacturing and services activity, jobless claims and consumer spending. They'll also get a reading from the personal-consumption-expenditures-price index, the Fed's preferred inflation gauge.

Forex:

The dollar fell early Monday and analysts said this week's U.S. data would be closely watched for signs of slowing inflation.

U.S. fourth-quarter gross domestic product data on Thursday and the personal consumption expenditures price index on Friday will be particularly closely watched, IG said.

Last week was quiet in FX markets by recent standards, Capital Economics assistant economist James Reilly said.

"But Wednesday may have offered a glimpse of what is to come over the coming months--weak US retail sales and industrial production data pushed both equities and Treasury yields lower, in contrast to the negative correlation between those which prevailed throughout 2022."

He noted that the risk-off mood set the stage for an intraday rally in the dollar, and said CapEcon reckons weakness in the global economy--China aside--will continue to spur safe-haven demand for the dollar.

Bonds:

Treasury yields were broadly lower after gaining on Friday, as investors continue to weigh mixed signals on the economy.

"Slower growth, less inflation, that's good for bonds," Charles Schwab said, pointing to economic data released in the past week that reflected those trends.

Capital Economics said that the negative correlation between the returns from Treasuries and U.S. equities stood in stark contrast to the strong positive correlation that prevailed over most of 2022.

"The retreat in inflation has much further to run," while the U.S. economy may be "taking a turn for the worse," it said.

"That informs our view that Treasuries will eke out further gains over the coming months even as U.S. equities struggle."

UniCredit Bank flagged a cautious tone saying that the direction in trends of economic and inflation surprise indexes in the U.S. pointed to lower U.S. Treasury yields, but bond traders may be getting ahead of themselves.

"However, momentum in USTs (U.S. Treasurys) has also been too extreme, in our view. Right now, three rate cuts are already priced in over the second half of the year and the peak rate has already been scaled down by 25bp," they said.

"This would imply that by the end of the year, the key rate level will be unchanged from now at 4.375% (midpoint)."

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European government bonds have rallied too far and yields are unlikely to drop any lower, UniCredit Bank said.

"A string of sharply negative data surprises and a decline in core inflation would be needed to push eurozone government-bond yields and EUR swap rates lower than their currently rich levels, a situation we doubt will happen immediately," it said.

Since the start of 2023, the yield on the German 10-year Bund is down roughly 34 basis points to last trade at 2.113% while the yield on the France 10-year government bond is down roughly 42 bps to last trade at 2.595% according to Tradeweb.

Energy:

Oil futures were lower early Monday, pulling back slightly from recent gains amid China reopening demand optimism and supply concerns over the upcoming EU ban on Russian oil products.

While some profit-taking pressure could persist in the near term, oil should still offer good investment opportunities in the longer run, Galaxy Futures' analysts said.

China's travel demand during its weeklong Lunar New Year holiday has beat expectations, a sign of fast consumption and activity recovery after the initial post-reopening infection surge, they noted.

That bodes well for solid oil demand after the holiday week and investors could buy crude on dips, they added.

"The talk of the town among oil traders are the usual suspects: China, Russia and the [Federal Reserve]," Velandera Energy Partners said.

"Unless the Fed spooks the market with another 50-bps rate increase, we expect both the Chinese reopening and the Russian sanctions to support oil prices."

However, Commerzbank said "as China embarks on a week of New Year festivities, there will also be no positive impetus from this direction, meaning that prices are likely to trend sideways."

Metals:

Gold prices gained, as the safe-haven commodity continued to track higher and outperform many other assets.

The momentum could be sustained throughout 1Q, SPI Asset Management said.

The precious metal's recent rally has been driven by expectations of slowing growth in the global economy. This should put the dollar under pressure in the coming months and "encourage U.S. investors to buy gold as a hedge," it said.

"There should be ample room for gold to flourish higher on official institutional demand" into the coming months.

"The fact that gold has been able to make such large gains, to now be trading close to its highest level since April, even though another rate hike is near certain when the Fed next meets, continues to surprise. Gold really has caught a fair wind and is sailing ever higher on it," Kinesis Money said.

"The lingering concern remains however that gold has climbed so much already before the Fed, and other central banks, actually hit pause on their rate hikes and this leaves the precious metal highly vulnerable to a sudden price drop if interest rates don't stop climbing as soon as anticipated," it said.

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The most likely driver of copper prices in the short term will be China's post-lockdown bounce, given that the country buys roughly 45% of the global supply, analysts at investment bank Liberum said.

"Everything ex-China looks quiet/boring," they said.

The analysts reckoned that the single most useful China-centric copper signal for investors was China's domestic physical and merchant premia--effectively what buyers there pay on top of the local spot price for immediate delivery of the metal.

At the moment, it is very low, around $30 a metric ton, they said. "If this lifts, a bullish fundamental price driver is emerging (not just the current speculative one)," the analysts say.

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Iron-ore's bull market has been driven by sentiment and optimism, rather than a physical tightening of supply and demand, Morgan Stanley analysts said.

But a tighter market is expected in the months ahead, which should justify the recent rally and extend it into 2Q, they said.

"We are increasingly asked about the sustainability of the current iron-ore rally," they said.

"Our short answer is that recent momentum can only be maintained beyond the Lunar New Year break if supply-demand fundamentals catch up with recent price action, something we still expect to happen." They tip an average 2Q price of $140/metric ton.


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