Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Summary: Markets were spooked late Friday by news that Russia would not resume gas flows through the Nord Stream 1 pipeline, pressuring the outlook for the European economy as governments grapple with soaring energy costs and scramble to cap prices and ration power to get through the upcoming winter. The euro weakened toward the cycle low versus the US dollar and equities tumbled. Today, US markets are closed for Labor Day.
US equities actually rallied on Friday in the wake of the US jobs report, likely as US treasury yields moved lower in the wake of the data after a recent march higher in yields that had clearly pressured equity market sentiment. But later in the session the Russian pipeline news in Europe spooked sentiment and equities reversed lower, trading not far from the lows of the cycle ahead of the three-day-weekend (no cash session today in the US due to Labor Day holiday). The focus in the S&P 500 is the key support just above 3,900, the last notable area ahead of the June lows, and similarly the Nasdaq 100 focus is on the recent 12,000 area lows.
Hong Kong and mainland China stocks retreated, Hang Seng Index -1.3%, CSI300 -0.4%. A Bloomberg report, citing people familiar with the matter, said that the Biden administration is considering to impose restrictions over US investments in Chinese technology companies. In addition, the U.S. Trade Representative said that it received requests from more than 350 American companies to plead for keeping the “Section 301” tariff on goods imported from China. Chengdu, the largest city in western China, extended its pandemic control lockdown for another three days. BYD (01211:xhkg) fell 5.4% as exchange filing showed that Berkshire Hathaway sold 1.72 million BYD shares on Thursday, trimming its stake further down to 18.87% from 19.02% of BYD’s H-shares. August Caixin China Services PMI came in at 55.0, edging down slightly from 55.5 in July but above market expectations.
The US dollar traded in choppy fashion on Friday but was generally weakening as US treasury yields pushed lower in the wake of the US jobs data. But US yields were thrown from the driver’s seat in favour of risk sentiment, which soured badly on the news that Russia will not resume deliveries of gas through a key pipeline. The risk-off took EURUSD back lower and to new lows for the cycle today below 0.9900 as Europe suffers the fallout from the darkening outlook on energy/power that ECB rate tightening can do nothing to address. Elsewhere, GBPUSD plunged to a new low below 1.1500. Focus this week may intensify on China, as USDCNH held relatively steady last week but jumped to new highs today well above the former 6.93 high.
USDJPY was capped after another run higher on Friday as US treasury yields pushed back lower after the US jobs report and then sharply lower still in reaction to the Russian pipeline news in Europe. But the USDJPY pair remains above the 140.00 level, elsewhere in JPY crosses, the drop in yield brought some more sustained relief for the JPY in the crosses as EURJPY reversed sharply back below 140.00 and even AUDJPY was capped after a poke toward the cycle highs on Friday. JPY crosses are likely to remain a proxy for global sovereign bond yields.
... after Gazprom on Friday announced the Nord Stream pipeline will remain shut indefinitely. While an oil leak at the last compressor unit still in operation was used as explanation, the surprise decision came shortly after the G7’s announcement to initiate a price cap on Russian oil. The energy war has therefore escalated further, and Europe look set to lose around 30 mcm/d or 4% of its gas supply. While storage levels across the Euro area have grown rapidly in recent weeks due to surging imports of LNG, the prospect for rationing and further initiatives to curb demand for gas and power prices will be the focus this week. In addition, demand destruction from soaring prices has already lowered demand, but more is needed, especially if the winter turns out to be a cold one. Dutch TTF gas (TTFMV2) down 37% to €215/MWh last week on assumption supply would return jumped by around 30% on the opening to trade around €280/MWh.
Crude oil reversed higher on Friday following a three-day drop of close to 12 dollars, and the recovery has continued today and is being led by a 4% jump in diesel prices, both in New York (HEATINGOILOCT22) and Europe (GASOILUKSEP22) as the European energy crisis adds further support to gas-to-fuel switching activity. In addition, OPEC+ meets later today in is expected to make no change, but the market is wary following a recent Saudi comment about cutting supply to stabilize then falling prices. An in-theory price bearish G7 plan to cap prices on Russian oil could turn into a “bullish shock” according to Goldman Sach as Russia, just like it has done with gas, may halt shipments to Europe and other Nato buyers. Focus on today’s OPEC+ meeting, China lockdowns hurting demand, gas-to-fuel switch boost to diesel and Wednesday’s Short-Term Energy Outlook from the EIA.
The run-up in US treasury yields last week was reversed in the wake of the US jobs report Friday, perhaps as the report failed to show any new aggravated rise in earnings. The move lower was cemented by an ugly turn lower in risk sentiment in the wake of the Russian natural gas pipeline news. Still, it will take a move back below 3.10-3.00% in the US 10-year yield benchmark to suggest that this run up from the 2.50% area lows of early August is turning more firmly back lower. The upside focus is on 3.50%, should the 3.25% area sticky point of last week fall.
Russian sources claimed a leak was found in the pipeline, although Germany’s Siemens disputed that claim as it is fairly obvious that Russia is using natural gas deliveries as a tool of economic war.The news broke already on Friday and sent risk sentiment plunging across global markets, taking the EURUSD to new cycle lows on Monday below 0.9900 and sending longer yields lower globally.
In August, the U.S. economy added 315k jobs, slightly more than expected, but the 2 prior months of data were revised over 100k lower. The average hourly earnings rose moderately at 0.3 % month-over-month (below the 0.4 % pace of the prior three months). On a yearly basis, the increase is stable at 5.2 %. The unemployment rate rose to 3.7 %, up from its 50-year low of 3.5 %, but this was on the somewhat positive rise in the participation rate (more people seeking work) as the Household Survey showed 442k more Americans were in work in August. Overall, this labor market report is not a source of major concern. It should not weigh much on the monetary policy decision of the FOMC in September. Many economists also pointed out the fact that the August payroll growth is usually subject to higher revision than any other month. Over the past five years, the first release has undershot the third by 119k, compared to an average undershoot of 23k for all months. Therefore, we should avoid over-interpreting past Friday’s figures.
The Commitment of Traders (COT) Report on commodities covering the week to August 30 showed the initial response from hedge funds to Federal Reserve Chairman Powell’s hawkish speech at Jackson Hole. A speech that helped drive the dollar and bond yields higher, and the general risk appetite lower. All sectors except for grains and soft commodities were sold with selling concentrated in natural gas, WTI crude, gold, platinum, and livestock. The few exceptions were Brent crude, corn, sugar, and coffee. More in our weekly update, posted later today on www.analysis.saxo.
Bloomberg cites unnamed sources on this story, with limitations possibly set to come via executive order in the months ahead. After the recent move to limit NVidia exports of AI-related chips to China, the US Commerce Department may look to look to limit export of other AI tech.
EU leaders will powwow this Friday to discuss a cap on energy prices across EU countries to limit the disruptions from soaring and illiquid pricing markets, although given limits on generation capacity, much of them due to Russia’s cutting off of gas supplies - possibly semi-permanently in the case of the Nord Stream 1 pipeline – some sort of rationing plan may be required. See our Christopher Dembik’s look at the difficult choices Europe faces on this issue here.
The RBA is set for a monthly meeting tonight and is widely expected to hike the policy rate 50 basis points at its fourth consecutive meeting, although this is not fully priced in. Besides the headline decision, there will be considerable focus on the bank’s forward guidance as the market anticipates that the RBA will soon decelerate the pace of rate hikes after Tuesday’s decision.
The UK Conservative party will announce the results of its leadership election today, with Liz Truss universally expected to win the vote and become Britain’s next prime minister. Truss has promised tax cuts and rapid action on the UK’s energy emergency, a combination that is likely to leave gaping new holes in the country’s balance sheet at a time when sterling is already collapsing. How will market’s great the next PM’s policy initiatives this week?
The earnings calendar is running light this week. The two earnings releases of importance for the week are DocuSign on Thursday and Dollar Stores on Friday.
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