European markets slip as Fed rains on China parade

European markets stumbled early on Thursday as a firm message from the US Federal Reserve that it won’t cut interest rates soon offset optimism about China phasing out Covid-19 restrictions.

News that China’s mainland border with Hong Kong will be reopened after three years sent Asian-Pacific share prices outside Japan to a four-month high overnight. Still with the dollar and bond market borrowing costs higher after the Fed’s comments, Europe couldn’t keep up.

The pan-European Stoxx slipped 0.3% after gaining more than 3% in its first three sessions of 2023 and Wall Street futures prices were pointing to a similar fall later.

London’s FTSE 100 managed a small rise as better-than-expected numbers from retail giant Next lifted the European sector, but that couldn’t make up for the broader falls in Frankfurt and Paris .

“Everyone expected a hawkish message, and that is what we got,” said Derek Halpenny, MUFG head of research for Global Markets EMEA. “Really it’s now about payrolls [US jobs data] tomorrow [on Friday].” The labour market will be a big factor in how high inflation stays this year, he added.

“A strong print tomorrow and I think you are going to get a fairly rapid repricing for a 50 bps hikes at the next (Fed) meeting.”

Markets are being tugged in different directions though. China dropped strict travel and activity curbs abruptly, fanning hope that when infection waves pass its giant economic motors can start firing again and offset some of the slowdowns in other countries.

Thursday’s biggest Asian gains included e-commerce and consumer stocks in Hong Kong thanks to the news from the Chinese mainland driving the Hang Seng to a six-month high.

The yuan also rose about 0.2% to 6.8750/$, a four-month high, and also supported other currencies such as the Thai baht, which surged nearly 14% in less than three months. Thailand is expected to see a mass return of Chinese holidaymakers, 

“China reopening has a big impact … worldwide,” said Joanne Goh, an investment strategist at DBS Bank in Singapore. China spurs tourism and consumption, but can also ease some of the supply chain crunches of 2022, she added.

“There will be hiccups on the way,” Goh said. “We give it six months adjusting to the process. But we don’t think it’s reversible.”

China’s central bank said overnight it will step up financing support to spur domestic consumption and key investment projects and support a stable real estate market.

The country eased an unofficial ban on Australian coal imports in recent days too, and the Australian dollar hit a three-week high overnight at just below $0.69. It last bought $0.6818.

Oil rebounded after posting the biggest two-day, start-of-the-year loss in three decades, driven by worries about the risk of a global recession this year.

Brent crude was last up $1.22, or 1.6%, to $79.06 a barrel, while US West Texas Intermediate crude futures gained $1.02, or 1.4%, to $73.86.

In addition to the brighter mood about China an unexpected shutdown of a major US fuel pipeline also lifted prices.

“This morning’s rebound is due to the shutdown of Line 3 of the Colonial pipeline,” said Tamas Varga of oil broker PVM. “There is no doubt that the prevailing trend is down; it is a bear market,” he said.

Rates warning

Wall Street futures were down 0.3%. Minutes from the Fed’s December meeting, published on Wednesday, contained a pointed rebuttal of rate cuts bets that traders have priced in for late in the year.

Fed committee members said that “unwarranted easing in financial conditions” would complicate efforts to restore price stability.

“Translating Fed speak, this is a warning to markets, that being too optimistic may ironically backfire,” said Vishnu Varathan, Mizuho Bank’s head of economics in Singapore.

“That is, insofar that premature rate cut bets drive looser financial conditions, the Fed may have to tighten even more to compensate.”

Fed funds futures pricing shows traders think the benchmark US interest rate will peak just below 5% in May or June, before being cut back a little bit in the second half of 2023.

Benchmark 10-year Treasury yields, which move inversely to price, were fractionally higher at 3.72% in Europe but still down 11 basis points on the week.

Germany’s 10-year government bond yield was last up 3 basis points (bps) at 2.31%. It too though has fallen 25 bps this week after closing out 2022 at its highest level since 2011.

Preliminary inflation data from Germany, France and Spain all showed this week that consumer prices rose at a slower pace in December than November, after an easing in energy price rises.

In currency markets, the dollar has been wobbly as investors navigate between the Fed’s hawkish tone and the support for riskier currencies driven by China’s reopening.

The yen was holding firm at 132.45 a dollar, supported by wagers that Japan’s ultra-easy monetary policy will be finally tightened this year.

In Europe, unseasonably warm weather has disappointed skiers but been a boon for a euro basking in falling gas prices. Benchmark Dutch gas prices fell to 14-month lows overnight. The euro was steady at $1.0625.