China's manufacturing slows down, German inflation is in focus

Tuesday is likely to be a mixed day for European stock markets, as investors get back from the holiday period and take a close look at the economic outlook for the year ahead.

German unemployment and inflation data for December, as well as the UK manufacturing PMI for December, are expected to provide further evidence of Europe's economic slowdown.

As expectations grew that US interest rates would rise at a slower pace this year, most Asian stock markets rose on Tuesday. However, the uncertain reopening of China's economy and a warning of a potential recession limited gains. Analysts predict that the Chinese economy will eventually rebound from an economic reopening this year, but will face near-term pain as COVID-19 cases increase rapidly.

Caixin Manufacturing's Purchasing Managers Index (PMI) read 49.0 in December, up from 48.8 forecasts, but weaker than the 49.4 previous reading. December marks the fifth consecutive month where the manufacturing PMI is in contraction territory, as a reading below 50 indicates contraction. The data was largely in line with government data released last week, which also showed that the nation's manufacturing sector shrank in December. Considering China's massive exports, the manufacturing sector is a leading indicator of the country's economic health.

However, regional stocks may benefit from a slow rate hike this year as expectations grow that the Federal Reserve will hike rates at a slower pace. Recent economic readings indicate that inflation in the country has likely peaked, so central bank rhetoric should be less hawkish.

Minutes of the December Fed meeting, as well as data on non-farm payrolls, provide detailed information about monetary policy. Asian stocks ended the year 2022 in negative territory as a result of rising US interest rates. As of now, market participants are pricing in the possibility that the Fed will hike rates by an even smaller 25 basis points in February, with a probability of over 90%.

Since the start of 2023, the dollar index, a measure of the greenback against six major currencies, has been subdued, falling 0.029% to 103.610. During the last year, the dollar index rose 8%, marking its most significant annual increase since 2015. The Fed raised interest rates to fight inflation, which led to an 8% growth in the index. There is a chance that the dollar index will consolidate as market activity ramps up in the coming weeks.

There is an expectation that the Bank of Japan will be moving away from its ultra-easy monetary policy in the near future, leading to the yen skyrocketing to a seven-month high against the U.S. dollar on Tuesday. As a result of the BOJ widening the yield cap range for 10-year Japanese government bonds (JGBs) last month, speculation arose that the central bank would begin to shift away from its ultra-loose policy, and a Nikkei report that revealed on Saturday that the BOJ planned to increase its inflation forecasts in January to show price growth close to the BOJ's 2% inflation target by fiscal 2023 and 2024 fuelled this speculation. There is a clear sentiment in the market that tinkering with the yield curve is not a one-time thing. There was a cautious tone in the market about whether there might be additional tweaks to the yield curve control settings soon.