Europe to follow US markets lower

Europe to follow US markets lower

As US investors returned from the Labour Day Bank holiday to face escalating tensions with North Korea, the prospect of another hurricane and dovish comments from a top Federal Reserve official, risk-off mode was clearly back on, which will set the theme for trading in Europe this morning.

Tuesday was US investors first chance to react to the North Korean claims of a successful hydrogen bomb test. Riskier asses such as the US equity indices traded in the red, although loses were modest, the Dow Jones finished down 1.1%, the S&P down 0.8% however flows into safe havens remain noteworthy. The Swiss France gained 0.5% versus the dollar, whilst the yen has also been moving higher.

Gold futures continued to soar, gaining over $14 dollar on Tuesday and testing $1350, its highest level since September last year. Should reports that North Korea is moving another intercontinental missile towards the West Coast in preparation for another test launch, then we could expect to see gold retest this level and a move towards $1400 might not be out of the question.

Fed Official Brainard warns over further rate raises

It wasn’t just North Korean concerns that were weighing on sentiment. Gold was also reacting to comments made by Federal Reserve Official Lael Brainard. Brainard was the first official to hit the airwaves, following last week’s GDP revision up to 3% and labour market disappointment. She was clear in urging caution over any further rate rises until inflation was clearly on track to hit the Fed’s target of 2%.

Her comments served to highlight the Fed’s concern over stubbornly low inflation, causing investors to reassess the probability of another US rate hike before the end of the year. Combining the Fed’s concerns over inflation, with the economic damage caused by Hurricane Harvey and add into the mix the prospect of more damage from Hurricane Irma and any chances of a US rate hike look serious diminished. The result has been a selloff in the dollar and a rally in US treasuries. The yield on the US 10-year treasury fell 10 basis points to 2.06, its lowest level since just after the US Presidential election.

The economic data points for today include US ISM service data and the Fed’s Beige Book, which despite recent turmoil is expected to paint a solid picture of US economic activity.

ECB starts to move into focus

On a quiet day for the eurozone economic calendar, investors will turn their attention towards the ECB policy meeting tomorrow. The ECB is on the cusp of announcing the winding down of its €60 billion a month quantitative easing programme, as the eurozone economy continues to show a robust recovery; however, the strength of the euro could delay the central bank’s plan.

The euro has been in rally mode since the French Presidential elections put an end to Marine LePen’s bid to take Presidency. Eurozone political risk diminished and the euro surged over 14%, reaching $1.20 versus the USD. This is problematic for the ECB because a higher currency means inflation will tend to remain low and eurozone inflation is failing to shift towards the ECB’s 2% target.

The advance of the euro has put Mario Draghi in a difficult situation. How the euro will react to Thursday’s meeting will depend very much on the line that Draghi will chose to take. The most bullish outcome for the euro would be if Draghi & Co. were to suddenly surprise the market with an announcement regarding QE tapering whilst simultaneously down playing any concerns over the strength of the euro. In this scenario, we could expect to see the euro take another step higher. Meanwhile the most bearish scenario for Thursday would be if Draghi were to talk down any tapering and spend a large portion of his press conference discussing the risks that the highly valued euro poses to ECB policy goals being reached.