Chinese central bank's move to support economy raises global stocks

World stock markets rallied on Friday after China's central bank moved to support its slowing economy, Chinese services data pointed to positive growth, and Beijing announced a new round of trade talks with Washington. Markets were buoyed by the resumption of trade talks between China and the United States and by encouraging surveys of China's services sector. A slew of weak data had shown China's economy was losing steam.

China's central bank said on Friday it was cutting the amount of cash that banks must hold as reserves for the fifth time in the past year -- freeing $116 billion for new lending as it tries to reduce the risk of a sharper economic slowdown. The boost from China brought some respite to battered markets, with MSCI's world stock index up a third of a per cent and U.S. stock futures around 1.5 per cent firmer. "We're not expecting a major breakthrough [in trade talks] on Jan. 7-8," said Edward Park, deputy chief investment officer at Brooks Macdonald.

"That said, where equity markets are in terms of valuations, if you look at the two core risks - U.S./China trade and the Fed – there’s room for markets to be positively surprised in both of those areas." Global markets have had a rough start to 2019, hurt by a revenue warning from iPhone maker Apple and concern about slowing global economic growth. But on Friday, a rally in European markets gathered steam after a cautious move higher in Asian stocks. Europe's STOXX 600 index rose 1.3 per cent while Germany's DAX jumped 1.8 per cent, and was set for its best day in a month.

In Asia, Shanghai blue chips rose 2.4 per cent, while South Korean shares bounced 0.8 per cent. But Japan's Nikkei skidded over 2 per cent on its first trading day of the year, hobbled by growth worries and the strength of the yen. The yen edged back from its recent surge on Friday on hopes the U.S.-China trade talks would make some progress, but the Japanese currency remains well bid by investors fretting about a global economic slowdown. The yen fell as much as 0.7 per cent against the dollar to 108.45 before recovering some of those losses to trade at around 108.

The euro held above $1.14. The single currency traded up 0.1 per cent at $1.1410 despite a survey showing that eurozone business activity fell to a four-year low in December 2018 and official data showing that inflation in December had slowed by more than expected. The dollar index, which measures the U.S. currency against a basket of rivals, was 0.2 per cent lower at 96.152.

BOND SAFE HAVENS HURT

The improving tone also fed through to Europe's bond markets, pushing yields on safe-haven assets such as Germany's 10-year government bond off two-year lows hit this week. But analysts are unconvinced that the trade talks and subsequent relief rally signal sustained improvements, particularly in a new era of tightening liquidity. "(Central banks) are trying to get markets weaned off the idea that they will come riding to the rescue and people are trying to learn what the new rules of the game are," said Colin Harte, head of research, multi-asset solutions at BNP Paribas Asset Management. Harte added that he was sceptical that the talks would have a meaningful resolution.

"The picture will remain unclear for the first half of this year," he said. German bond yields, while higher on Friday, we're still set for their biggest weekly fall since October - down around 6 basis points. The move is evidence of a key change in central bank expectations, Bob Michele, chief investment officer and head of fixed income at JP Morgan Asset Management said. "With rate cut expectations and a slowdown in the U.S., does it look realistic that the ECB will raise rates at all this year?" he added.

In such a risk-off environment, Michele said the European Central Bank might conceivably return to quantitative easing, which would push bond yields even lower. Money markets are pricing in just a 30 per cent chance of a 10-basis-point ECB rate hike in 2019. The risk of a U.S. economic downturn, or even a recession, has caused a tectonic shift in expectations for interest rates, with investors now pricing in the possibility of a cut. Investors will be looking for any clues from U.S. Federal Reserve Chair Jerome Powell, who is due to speak on Friday, as well as the latest jobs numbers, released later this session.

While the Fed is still projecting two more rate increases this year, the futures market implies the next move will be down with around a 40 per cent probability of a move by year-end. The market is fully pricing in an easing to 2.00-2.25 per cent by May next year, from the current range of 2.25-2.50 per cent. The mounting speculation sent yields on two-year U.S. Treasuries as low as 2.37 per cent, taking them under the effective federal funds rate for the first time since 2008. They were last trading at 2.43 per cent.

Three- and five-year yields were even lower, an inversion that has sometimes heralded recessions in the past. Yields on 10-year benchmark paper dropped to 2.54 per cent overnight, a turnaround from the highs of 3.25 per cent seen as recently as November. Elsewhere, the news of the U.S./China trade talks boosted oil prices, with Brent crude oil was 1.9 per cent higher at 57 dollars per barrel.

(With inputs from agencies.)