Markets Are Waiting For PMIs | Daily Market Analysis

Key events:        

• Australia – GDP (QoQ) (Q4) 0.5%
• UK – Manufacturing PMI (Feb)  
• UK – BoE Gov Bailey Speaks     
• USA – ISM Manufacturing PMI (Feb)
• USA – Crude Oil Inventories

After a very favorable beginning of the year, with two consecutive months of gains, European markets performed surprisingly well amid a sharp rise in interest rates. In contrast, U.S. markets closed lower, giving up some of their January gains.

For the year, the DAX rose 10.3%, and the FTSE100 rose 5.7% on sharply higher interest rates in Germany and the United Kingdom amid stronger-than-expected inflationary pressures.

These gains have inevitably sparked speculation about how sustainable they are, and so far the progress we have seen so far looks solid and stable. Much will depend on how high rates end up being, and there are many opinions on this issue.

Markets continue to focus on the prospect that rates will eventually come down to lower levels, and few investors are willing to accept the idea that rates are likely to remain high for some time or even longer.

Much will depend on how high sticky inflation is, and current data shows little indication that it is slowing, which means we could see at least 2-3 more rate hikes in the coming months, and rates could stay at those levels through 2024 and into 2025.

Today's final PMIs for manufacturing in Spain, Italy, France, Germany, and the UK will indicate a mixed outlook for economic activity. Manufacturing indicators are expected to improve to 49 and 51 in Spain and Italy and decline to 47.5 and 46.3 in France and Germany, respectively.

Yesterday, inflation in France hit a record high of 7.2% in February, driven by higher food and services prices, while in Spain it rose again to 6.1%. While we have seen a slowdown in energy prices, which usually helps the manufacturing sector, the response to a milder winter has been different. Italy and Spain look more resilient, but France and Germany seem to be headed in the wrong direction.

One reason for this is rising inflation. Today's German consumer price index for February is expected to fall only slightly to 9% from 9.2%, but there is a risk of an upside surprise given yesterday's data from Spain and France. The solid inflation outlook is already shifting expectations for a rate hike for the ECB and a possible 4% pause.

We also have economic data from the UK, where consumers are also under pressure from rising prices and some deficits. The PMI for UK manufacturing is expected to be confirmed at 49.2, up from 47.

Mortgage approvals are also declining amid a slowing economy and falling home prices. Approved applications fell to their lowest level since May 2020 at 35,600 at the end of last year and are expected to rise slightly to 38,500 in January, but it is clear that rising rates are putting pressure on demand for mortgages as well as real estate.

Net consumer lending has slowed from the levels we saw in the summer, dropping to £500 million at the end of last year. January may see a modest rise to £800 million.

Turning to the U.S. economy, we have the ISM manufacturing index, which will be a good precursor to Friday's services report, which helped reinforce the hawkish tilt we saw after January's Payrolls data.

The ISM in the manufacturing sector is projected to improve slightly to 48, but is still in contraction, along with the goods and services price gauge, which is currently in disinflation at 44.5.

European markets look set to start the new month higher after Asian markets received support from the latest Chinese manufacturing and services PMI data for February, which showed that manufacturing activity jumped to its highest level since 2012 at 52.6. The services business activity index also improved to 56.3, adding strength to the story of China's opening after a slow start since the easing of restrictions in December.