Subdued sentiment across European markets before ECB and US payrolls

Sentiment across European financial markets was relatively subdued Tuesday as investors cut exposure to risk ahead of key events in the latter half of this week while digesting macro reports released earlier in the session.

Equity markets fell in Europe on Tuesday as market participants took cash off the table following recent strength in which global benchmarks like the UK’s FTSE100 and Japan’s Nikkei 225 reached 15-year highs.

In the US on Monday, the tech-rich Nasdaq Composite followed the UK and Japanese national indices by pushing past the key 5,000 level to trade at 15-year highs too. The S&P500 on the other hand demonstrated resilience again by registering a new record high as it remains firmly in a bullish uptrend that started some 18 months ago.

FX markets are in focus with the Aussie dollar overnight jumping some 0.8% against its US counterpart following a surprise resistance to cut rates further by the Reserve Bank of Australia. Though the RBA hinted at more rate cuts in the future, the central bank held back from quenching the markets’ thirst for aggressive easing measures. The RBA’s decision is in contrast to the Chinese central bank, which finally cut rates this weekend amid growing calls for more stimulus to support growth in the world’s second largest economy.

In major FX pairs, the euro was subdued, changing hands at 1.1187 against the US dollar. The greenback, however, continued to advance ahead of Friday’s key non-farm payrolls report for February, which is expected to show the US economy created around 240,000 jobs with the unemployment rate edging lower to 5.6% from 5.7%.

Meanwhile, in the fixed income markets, peripheral bond yields continue to decline with Portugal, Ireland and Germany all printing yields at record lows. The suppression of yields comes ahead of the European Central Bank’s monthly meeting this Thursday.

Barclays economists expect the ECB to keep interest rates unchanged at 0.05% on Thursday, “but the central bank likely will release the execution details of its asset purchase program with actual buying starting in early March, possibly the week following the ECB meeting.”

ECB QE also weighs on Greek bond yields however the country’s bond prices are largely being dictated by growing confidence in the market that a third rescue package will be agreed by the country’s anti-austerity government and euro area policy-makers.

That led to a rally in Greek government bonds on Tuesday. Greece’s 10-year yield fell 11 basis points to 9.45% after rising 94 basis points over the previous four days. The yield on three-year Greece’s bonds dropped 75 basis points to 13.86%. The moves suggest that Greece's bond market lenders are feeling more confident about being repaid.

The market remains transfixed with events surrounding the current negotiations between Greece and euro area politicians to prevent an exit of the country from the 17-nation bloc. Spain’s finance minister Luis de Guindos said EU and Greek officials were negotiating another bailout of between €30bn and €50bn. However, EU officials said there were no such talks and Greek officials declined to comment.

Despite heavy resistance by Greece’s new government to reject future bailouts, the view amongst policy-makers is that Greece inevitably will have to seek another bailout to cover its financing needs.

Elsewhere, war-torn Ukraine was in the spotlight for other reasons than the ongoing conflict with Russia. The Ukrainian central bank boosted its benchmark interest rate to 30% from 19.5% in a bid to prop up the value of its currency. The central bank also maintained its requirement for exporters to convert 75% of their foreign-exchange revenue.

The move comes after Kiev approved new budget austerity measures on Monday designed to secure access to a $17.5bn rescue package from the Washington-based International Monetary Fund. Midday in Europe, the Ukrainian hryvna was trading at 24.2268 versus the US dollar.

In other news, the European Banking Authority delayed another stress test this year and instead announced it will start preparing for the next exercise in 2016. That gives European banks a bit of breathing space to get balance sheets in order before next year’s tests – the developments come at a time where large banks such as Barclays and Credit Suisse have had to increase provisions to cover legal costs, forcing them to rebuff capital ratios as a result.

In terms of data, Swiss GDP was up at 0.6% in the fourth quarter of 2014, beating forecasts of 0.3% while third quarter growth was revised up to 0.7% from 0.6% previously. Analysts say the improvement in growth is on the back broad household consumption and cross-border trade in goods and services. Growth in the fourth quarter helped to keep the year-over-year growth rate at 1.9%.

In the UK, data from compiled by Markit/CIPS indicated that the rate of growth in the UK construction sector picked up to its highest in four months in February on the back of increased workloads and higher client spend. UK construction purchasing managers’ index (PMI) rose to 60.1 in February from 59.1 in January, as it continues to rebound from the 17-month low reached in December. The strong reading mimicked Monday's release of estimate-beating manufacturing PMIs out of the UK.

Meanwhile, German retail sales rose 2.9% in January from December, defying expectations for a 0.3% decline and contributing to a 5.3% on-year gain that marked the largest such gain since June 2010. Recent data from Germany shows the labour market recovering strongly, which raises hopes other nations like France can ride on the coat tails or rising Germany consumer demand.

Elsewhere, producer prices in the Eurozone fell 0.9% on the month in January, and were down 3.4% on the year. That compares with expectations for 0.7% and 3.4% declines, respectively, and marks an acceleration in the deflation of this indicator of wholesale prices from December, when the producer price index was down 2.7% on-year. Ex-energy, the PPI was down 0.2% on the month and by 0.9% on the year.

Looking ahead, attention turns to Federal Reserve Chair Janet Yellen who will speak at the Citizens Budget Commission's Annual Awards Dinner. Yellen is expected to maintain a similar tone to that which was demonstrated in last week’s testimony on Capitol Hill in which she was straight in the middle between hawk and dove, emphasising that the central bank will keep interest rates low for the foreseeable future.