Head of FX Strategy
Summary: As markets keep running ahead of themselves to price in a recession, we believe inflation will still remain the key pain point in H2. While a short-term break in commodity super cycle may be warranted with markets pricing in demand destruction concerns, the structural supply issues still remain at play. US Treasuries started the second half on front foot, while the dollar gains returned.
As we step into H2, it is prudent to look at the record losses in key indices for H1 and be prepared/cautious of the further strains to come. The Fed is tightening at its fastest pace since the early 1980s, with 150bps of rate hikes already in the kitty and another 175bps priced in by the markets for this year. This comes along with quantitative tightening, which is taking out liquidity from the system. We believe inflation will remain higher-for-longer, and the central banks will have to remain aggressive to fight it.
The second key risk to the markets comes from the upcoming earnings season, which despite 70% of the companies issuing negative EPS guidance, continues to see analyst estimates running high. This is the perfect recipe for disappointment, and more pain in the equity markets.
Markets remain overly gripped by recession fears as US data suggests a technical recession may be coming. With the Wall Street closing in the red, Asian equities were offered in the morning as well, while gains in oil prices also weighed. Japan’s Nikkei (NI225.I) led the losses in Asia, which was down close to 0.9% at lunch. Utilities were the largest drag on Nikkei as Tokyo Gas (9531) and Osaka Gas (9532) were both down 7-9% amid news of President Putin signing a decree to transfer the Sakhalin-2 natural gas plant to a new Russian entity, a move that could force the companies to exit their investment in the key energy project.
China’s CSI300 (000300.I) was in loss of 0.3% but led the region with gains for the month and the quarter. China Big Tech stocks have bucked against the bearish trend of global equities especially its US mega cap tech peers. Hong Kong’s markets are closed for a holiday marking the 25th anniversary of Chinese rule. Australia’s ASX200 was the lone index in green, up 0.3%, but down 12% for the second quarter. Singapore’s STI (ES3) stayed flat-to-down with Wilmar leading the gains.
Treasuries began the second half of the year on the front foot as concerns continued to mount that Federal Reserve rate hikes will lead to a recession. After slipping below 3% overnight, UST 10-year yields dipped further below 2.95% in the Asian session, with the move spreading to local bond markets as well. Australia’s 3-year yields plunged 21bps ahead of the RBA decision due next week.
The new quarter has begun with strong USD bids against commodity pairs in the Asian session after a big slide in the USD overnight. AUDUSD and NZDUSD making new lows, breaking 0.685 and 0.620 respectively. USDJPY retraced to 135 as US 10-year yields slid further below 3%. AUDJPY was the biggest mover, down 1.5%.
Crude oil prices had their first month in red since November, suggesting the pace of consistent gains we have seen for over six months may be coming under pressure. OPEC+ committed to increasing production to 648k barrels per day in August, unchanged from the agreement earlier, but there is little confidence this can be achieved. Meanwhile, it was disappointing that the group delayed the September guidance to August 3 meeting. While we believe the supply constraints will mean the bull run will continue in the medium-to-long term, but short-term headwinds may continue to be seen as markets price in demand destruction concerns.
U.S. personal spending for May fell to 0.2% m/m from 0.6% m/m in April, below consensus of 0.4%. This has resulted in the Atlanta Fed GDPnow model tracking an economic contraction of 1.0% in Q2, which would imply a US “technical” recession of two consecutive quarters of negative real GDP growth. Still, we do not think that the US is heading into a broad-based recession, even as the Fed will likely continue to chase inflation. US PCE Price Index, the preferred inflation gauge monitored by the Fed was unchanged at 6.3% y/y, below its all-time high of 6.6% y/y recorded in March but still stuck near the highs supporting our view of higher-for-longer inflation.
Japan’s Tokyo CPI came in at 2.3% y/y for June, coming in below expectations but core was as expected at 2.1% y/y. Gasoline subsidies have helped to keep the acceleration in check, but consumers are getting hurt with rising food prices and chip supply shortages which are raising the prices of household appliances. Energy prices also remained elevated at 21.7%. Meanwhile, Tankan survey showed a deterioration among Japan's large manufacturers in Q2, while small manufacturers remained in negative. The outlook is also fragile, with price pressures seen rising further from here. Japan’s inflationary pressures, but more so inflation expectations, will remain a key input if the Bank of Japan has to capitulate at some point.
China President Xi made his first international visit since the pandemic began as he to Hong Kong for the 25th anniversary. He laid out a future for Hong Kong, embedded firmly within the goals of the central government on the mainland. He also swore in Hong Kong’s new leader, John Lee Ka-chiu. The July 1 celebrations mark the halfway point of China’s 50-year promise to maintain Hong Kong’s liberal institutions and capitalist markets until at least 2047 under a framework called “one country, two systems.”
Micron Technology (MU) reported earnings for the fiscal third quarter ended June 2 last night and guided for weaker-than-expected revenue and EPS for Q4 at $6.8b to $7.6b vs $9.14b and $1.43 earlier and $1.83 vs $2.57 earlier respectively. It also flagged weakened consumer demand, signaling the negative sentiment we have been flagging for the PC and smartphone segments, but sustained demand for memory and storage.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
