Summary: Risk sentiment got a strong boost yesterday from falling treasury yields, with Fed rate hike bets for early next year at their lowest in two years after a rising swell of questions from influential sources on whether the Fed is taking its tightening regime too quickly and a soft September US ISM Manufacturing data point. Overnight, Australia’s central bank, the RBA, surprised many with a hike of only 25 basis points.
US equities bounced back yesterday as the US 10-year yield fell to 3.64% with S&P 500 futures rallying 2.5% and extending another 1% this morning in trading around the 3,726 level; this is just a few points below the obvious short-term resistance level and a break above this level could push S&P 500 futures higher. The moves across markets likely reflect short covering and that the market was getting too stretched in the short-term and the bond market for now wants to sit idle and wait for more data on US inflation.
USD and US yields/risk sentiment
The US dollar weakened on the usual combination of falling treasury yields after soft US data yesterday and as the market took treasury yields, particularly at the long end of the curve, sharply lower yesterday. The move is still within the range in many key USD pairs, with 0.9900+ at minimum needed for a bear-market-neutralizing reversal in EURUSD. And AUDUSD dropped overnight on the Australia’s reserve bank only hiking 25 basis points (more below) Elsewhere, the strength in GBPUSD is far more sterling related (see more below on Chancellor Kwarteng’s reversal of the most controversial of his tax cuts) and USDJPY is curiously bid near the top of the range after Japan’s September core, ex Food and Energy Tokyo CPI came in at the highest level in years. The status of the US dollar this week will likely be clear only after the release of the September jobs report on Friday.
Gold (XAUUSD) and especially silver (XAGUSD) jumped on Monday
… with support coming from multiple sources. A softer dollar and US ten-year bond yields slumping to 3.6% after hitting 4% last week leading to some speculation that we may in fact have hit peak hawkishness, meaning the FOMC faced with recession worries and calls for action to curb the dollar may start easing the tone going forward. Whether or not will be data dependent, but in the short term, these developments and worries about what Putin may do next has been enough to trigger short covering across the investment metal sector, not least in gold where the net short held by money managers reached a near four-year high last Tuesday. Silver is looking at resistance at $20.88, the August high and trendline support in XAUXAG around 81.20
Crude oil (CLX2 & LCOX2) extends gains on OPEC+ chatter, weaker USD
Crude oil trades higher ahead of Wednesday’s OPEC+ meeting in Vienna as the alliance is considering a production cut of more than 1 million barrels/day to support prices following a 25% slump during Q3 2022. That would be the biggest cut since the pandemic with OPEC+ slashed production by 10 million barrels/day as demand collapsed. WTI futures rose above $83/barrel while Brent was close to $90. With several OPEC+ producers, including Russia, producing below target, only Saudi Arabia may be able to limit production without a loss in additional market share. Meanwhile, expectations of an earlier Fed pivot also stabilized demand weakness expectations.
US treasuries (TLT, IEF)
US treasury yields fell all along the curve yesterday, as the market pushed Fed hike expectations for early next year toward the lowest in two weeks and yields at the longer end of the curve fell sharply on the release of a weak September US ISM Manufacturing data point. The fall in yields already has the important 3.50% yield level for the 10-year treasury benchmark coming into view after 3.56% traded yesterday. The next important data points include tomorrow’s September ISM Services survey and particularly the September jobs report on Friday.
What is going on?
Fed’s NY President John Williams repeated inflation is too high, and the Fed's job is not done, also saying that the monetary policy is still not in restrictive zone, pushing back on some calls for an earlier Fed pivot. He acknowledged signs of a slowdown in the housing sector or the consumer and business investment spending, but nothing that could deter the Fed from fighting inflation. On forecasts, he sees inflation likely down to 3% by next year (median view for Core PCE 3.1%), and the US is likely to see unemployment rise to 4.5% by end of 2023 (median view 4.4%). Thomas Barkin (2024 voter) made the case for more inflation in the post-pandemic world, noting that the Fed must consider global developments, but the focus is on the US.
RBA hiked less than expected, signaling peak hawkishness could be behind it
The RBA hiked rates by just 25 basis points (0.25%) rather than the 50 bps (0.5%) many expected, which takes the cash rate to 2.6%. The RBA’s hiking power has been diminished as household spending is dropping, along with forward looking projections. We know it typically takes around nine months for central bank policy tightening to felt in the economy, and the RBA said that higher inflation and interest rates are putting pressure on households, with the full effects yet to be felt. The RBA said that although consumer confidence and house prices have fallen, the central bank is still focused on slowing inflation which it sees increasing ‘over the coming months ahead’. In addition, the RBA expects unemployment will continue to fall over the months ahead, before rising. This means, the RBA could slow the pace of hikes after December onwards.
Tesla shares plunged in a strong US session
With US equities rallying 2.5% yesterday high beta and growth stocks were expected to lead the gains, but our bubble stocks basket was up only 1.5% and Tesla shares fell 8.6%. The EV-maker reported Q3 deliveries of 343,830 vs estimates of 357,938 which Tesla said was due to logistical issues in its supply chain. However, the move yesterday in Tesla indicates that investors are beginning to doubt the growth in 2023 that is priced into the price as the lithium continues to be prohibitively expensive and the cost-of-living crisis is lowering demand.
Sterling made a strong recovery, but can it last?
Cable was seen advancing above the 1.13 handle in Asian hours on Tuesday as it extended Monday’s gains following announcement by Chancellor Kwarteng of the intent to scrap the most controversial – and least impactful on the budget – recently announced tax cut for the highest income earners. A softer dollar also supported sterling’s gains amid a slide in US Treasury yields. Elsewhere, EURGBP also dropped into the old range below 0.8700. Still, the political situation in the UK remains volatile, the bulk of the fiscally aggressive tax adjustments and energy cap proposals remain in place, so the lack of trust in the new UK government cannot be ignored. Focus now on the BOE meeting on November 3 where 115bps rate hike is priced in, lower than last week’s pricing of 150bps. However, a full-budget statement will be released before then and will offer a further sentiment test for sterling.
The Eurozone and the UK PMIs confirm the risk of a recession
The manufacturing PMI indexes for September are out. There is no good news. In the eurozone, the final estimate was revised down to 48.4 from 48.5 and 49.6 in August. This is the biggest monthly contraction since June 2020 (when the eurozone was getting out from the Spring lockdown). There is no surprise regarding the main reasons behind the drop. This is related to soaring energy bills which limited production across all eurozone member countries and higher cost of living pushing demand lower. Firms are getting prepared for a tough winter and are starting to discuss the opportunity of lower job hiring (very soon the talk will be about cutting jobs). In the United Kingdom, the manufacturing PMI index is also in contraction territory, at 48.4. It was 47.3 in August. This was a 27-month low. However, it is unlikely to get back into expansion anytime soon, in our view. These indicators tend to confirm there is a material risk of a recession both in the eurozone and in the United Kingdom this year.
US ISM manufacturing disappoints
The headline for September’s US ISM manufacturing came in weaker than expectations at 50.9 from the prior month’s 52.8 and expected 52.2. Both employment and new orders both dropped into contractionary territory printing 48.7 (exp. 53.0, prev. 54.2) and 47.1 (prev. 41.3), respectively. The report showed that higher interest rates are starting to weigh on business investment sentiment, at least in the interest rate sensitive sectors. Still, the inflationary gauge of prices paid declined to 51.7 (exp. 51.9, prev. 52.5) falling for the sixth straight month. Supplier delivery times suggested some easing on the supply chains, but overall the report indicated the case of a slowdown in the US economy as rapid Fed tightening continues.
What are we watching next?
Risk sentiment brightens – how far can it extend?
A hole in the clouds yesterday as US yields dropped on the weak ISM Manufacturing survey and as a rising tide of observers are concerned that the Fed is tightening policy too rapidly, including one heavily covered tweet from the influential WSJ “Fed whisperer” Nick Timiraos noting that Greg Mankiw, the influential former Chairman of the Council of Economic Advisers under George W Bush had expressed approval of economist Paul Krugman’s view that the Fed is tightening too quickly. Hard to see this as more than a tactical turning point for markets, perhaps on overextended short positioning. The Fed’s tune has not changed, and the strongest pushback of developments over the last couple of sessions would be strong US data, including the September ISM Services tomorrow and the September jobs report on Friday.
Earnings to watch
The earnings season officially starts next week with the first group of US financials reporting but in the meantime a few earnings are worth watching this week. Biogen reports Q3 earnings (ending 30 September) today with analysts expecting revenue growth of -11% y/y and EBITDA at $847mn down from $959mn a year ago. While the current financial performance of Biogen is volatile and weak, the latest news about its breakthrough in Alzheimer’s with a drug that can slow down the disease is what analysts will focus on in terms of gauging the outlook. On Wednesday, Tesco is in focus as the UK largest grocery retailer is at the center of the current food inflation and insights from Tesco will be valuable from a macro point of view.
Economic calendar highlights for today (times GMT)
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