Europe stumbles as firm Fed reins in China rally

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Europe's markets suffered an early stumble on Thursday as a firm message from the Fed that it won't be cutting interest rates any time soon offset optimism around China's phasing out of Covid-19 restrictions.

News that China's mainland border with Hong Kong will be reopened after three years had sent Asian-Pacific shares outside Japan to a four-month high overnight, but with both the dollar and bond market borrowing costs higher post-Fed, 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 did manage a small rise as better-than-expected numbers from retail giant Next lifted the entire 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 MUFG's Head of Research for Global Markets EMEA, Derek Halpenny.

"Really it's now about payrolls (U.S jobs data) tomorrow," he added, explaining that the labour market will be a big factor in how high inflation remains this year.

"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 clearly being tugged in different directions though.

China has abruptly dropped ultra-strict curbs on travel and activity, fanning hopes that once the infection waves pass, its giant economic motors can start firing again and offset some of the slowdowns being seen in other parts of the world.

Thursday's biggest Asian gains included E-commerce and consumer stocks in Hong Kong thanks to the China mainland border news, which drove the Hang Seng to a six-month high.

The yuan also rose about 0.2% to 6.8750 to a four-month high and also supported other currencies such as the Thai baht which, as Thailand is now expected to see a mass return of Chinese holidaymakers, has surged nearly 14% in less than 3 months.

"China reopening has a big impact...worldwide," said Joanne Goh, an investment strategist at DBS Bank in Singapore, since it not only spurs tourism and consumption but can ease some of the supply-chain crunches seen during 2022.

"There will be hiccups on the way," Goh said, during an outlook presentation to reporters. "We give it six months adjusting to the process. But we don't think it's reversible."

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

China has eased an unofficial ban on Australian coal imports in recent days too and the Australian dollar made a three-week high overnight just below $0.69. It last bought $0.6818.

Oil rebounded too after posting the biggest two-day loss for the start of a year 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 at 0922 GMT, while U.S. West Texas Intermediate crude futures gained $1.02, or 1.4%, to $73.86.

As well as the brighter mood around China an unexpected shutdown of a major U.S. 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 added.

Rates warning

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

Fed committee members noted 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 U.S. 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 inverse 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, following 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 per 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 and the euro was steady at $1.0625.

(Additional reporting by Tom Westbrook in Singapore, Editing by William Maclean)


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