Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Summary: After a series of hawkish comments from the Fed lately but lessening fears of a recession, the US jobs data becomes a key focus ahead of US CPI due next week and the earnings season kicking off in full force. China’s infrastructure stimulus helped boost risk appetite, boosting oil, equities and Copper, but reports of Japanese Prime Minister Shinzo Abe being shot in the Asian session today may halt the risk trades.
A fourth day of gains on the Wall Street and China’s stimulus lifted the Asian indices on Friday morning ahead of the key US payroll data due overnight. Fed speaker continue to be hawkish for now as inflation threat looms, but any signs of weakness in the labor market could result in a Fed pivot. Tech stocks gained as did energy amid dip buying. Chip stocks were higher following the Samsung results yesterday, while miners were helped by China’s stimulus. Lastly, crypto stocks also turned positive with the revival in risk sentiment. Japan’s Nikkei (NI225.I) led the gains, up 1.4% in the morning but likely to fall in the afternoon after reports of attack on ex-PM Shinzo Abe. Singapore’s STI (ES3) was trading near neutral. Australia's ASX200 is up 0.5%, 2.2% this week. Today lithium stocks are up the most, getting a boost in sentiment after Tesla (TSLA) charged over 5%. Tesla sentiment pick up ahead of Musk speaking on Saturday at the Sun Valley Retreat. The street is thinking Musk might potentially abandon the $44 billion agreement to buy Twitter, but that remains to be seen. The thinking is that Musk might potentially look at buying a lithium company instead, as he previously warned he would.
Bloomberg report, citing people familiar with the discussions, suggested that China was considering to allow local governments to bring forward 1.5 trillion yuan of special bond issuance quota from next year to the second half of 2022 after this year’s quota of 3.65 trillion yuan having already been used up in the first half. As most of the proceeds of special bonds are designated for spending on infrastructure construction, the news report have triggered risk-on trades since yesterday, bringing commodities, commodity currencies, equities and bond yields higher. China’s Premier Li Keqiang chaired a meeting with top officials from south-eastern coastal provinces and municipalities including Shanghai, Fujian, Jiangsu, Zhejiang and Guangdong and urged these provincial and municipal governments to do more to boost the Chinese economy. Hang Seng Index (HSI.I) and CSI300 (000300.I) gapped higher at the opening but gains were pared during the morning.
Firstly the June CPI read out next Wednesday might either validate disinflationary pressures are easing. If we see that in the number, it would support this broad market rally we are seeing that has been triggered by commodities prices falling off their highs (with Bloomberg Commodity Index down 6% in the June quarter). If CPI is hotter than expected (consensus is 8.7% YOY inflation ) then markets will probably start to unwind this rally. Secondly, markets are also on tender hooks awaiting US Q2 earnings. So far, 16 S&P500 companies reported results, and the majority of those delivered better than expected earnings results; average earnings growth of 11%. From next week, Dow Jones members start to report. The major concerns is that with consumer confidence and credit card spending falling, while rates are rising (causing profit margin compression). So earnings/outlooks could take the market lower. JPMorgan (JPM) reports next week, followed by Goldman (GS), American Express (AXP) Johnson & Johnson (JNJ), Travelers (TRV), and Verizon Communications (VZ) reporting in the W/C July 18.
Crude oil prices reversed higher in the overnight session amid possible short covering and broader dip-buying. EIA inventory data was mixed with a 5.8mn barrel SPR release contributing to a massive 8.2mn barrel build even as production remained unchanged at 12.1mn barrels/day. Gasoline and distillate, however, saw a drawdown in inventories of -2.5mn and -1.3mn respectively.
Cable reclaimed 1.20 handle after reports in the European session on Thursday suggesting UK PM Johnson will be resigning. Gains were extended in Asia, despite a softer dollar, and GBPUSD rose further to 1.2056 highs after printing multi-year lows of 1.1877 on Wednesday. Sterling gains reflect a relief and hope that the new leader will help restore stability to the government and perhaps public perceptions too. EURUSD continued to slide further below the 1.02 handle despite ECB minutes hinting at a jumbo rate hike for July. EURGBP slid to over 1-month lows of 0.8445.
Fed Governor Waller reiterated his call for a 75bps rate hike at the July meeting, but added he is probably in favour of a 50bps rise in September, reaffirming our view that the path beyond July will get slower. He also echoed the views we heard in the minutes that hinted that Fed may move to a restrictive setting. Moreover, Waller said he needs to see Core PCE inflation coming down to 2.5-3% by year-end before feeling comfortable on really reducing interest rate hikes, and there is "not a chance" that he'd be okay with 3% inflation. Fed’s Bullard also backed a 75bps rate hike for July, but a possible Fed pivot too into the next year as he added possibility of 'tweaks' including possible rate cut after 3.5%.
ECB minutes confirmed that most members prefer a larger hike at the July meeting and noted a larger increment would be appropriate at the September meeting if the outlook for medium-term inflation had not improved by that time. Still, the lack of a fragmentation tool suggests the hands of the European Central Bank on aggressive tightening may remain tied.
Semiconductors see their biggest gains with two months with AMD (AMD) shares up 5%, NVIDIA Corp (NVDA) up 4.8%, while Taiwan Semiconductor (TSM) led the way up 6.7%; with the Philadelphia semiconductor index up 4.5%. That’s the indices biggest jump in almost two months with 30 members of the index ending in the green. It comes as traders absorbed Samsung’s better than expected earnings; with Samsung reporting a 21% jump in preliminary quarterly revenue. AMD, Nvidia and Taiwan Semiconductor, like Samsung, are all involved manufacturing and designing microprocessors for electronics, computers and mobile phones.
Our view is consumer confidence needs to rise, the services sector needs to see a pick up (US services activity is at a two year low, showing signs of slower growth). We are still a long way off that. We also need to see earnings growth pick up. But we think we will likely see more company downgrades, especially as companies in technology and consumer discretionary sectors being hurt by the rising US dollar. However now, as earnings growth is expected to slow, and interest rate sensitive sectors are likely to report earnings downgrades, we don’t think we’ve seen the bottom. As per our Q3 outlook, we don’t think we’ll see a bottom till later this year, or in the first half of 2023. Separately, as we also wrote on bear market hibernations, we believe the recovery will be a slow L-shape recovery, like similar bear markets. But the key is to picking quality companies who have the ability to outperform, with rising, sustained earnings and free cash flow growth over time (they’ll likely be in energy given the supply shortage)
Compared to the last several months, there’s an increasing amount of investors who have taken a defensive stance on markets, topping up bond exposure, selling some stocks, and using shorts to protect again downside. Clients are also seen using options on stocks they hold, to protect against further potential falls. On FX: there’s also been a pickup in trades in the USDJPY for the two nations variations in rising vs keeping interest rates low. As for tactical trading and invest, Apple (AAPLE) buys picked up after Apple is said to soon be releasing a sports smartwatch, that can rival Garmin, as well as Apple launching a new cyber security feature. Secondly, many clients have buying the dip on oil stocks. Occidental Petroleum (OXY) is one the most bought US oil stocks. And the newly formed 10th biggest oil stock, Woodside (WDS) is the most bought oil stock in Australia, with clients taking a view that the oil price will head higher head higher after a few months.
After initial jobless claims remained steady for this week despite widespread media reports of layoffs, the focus is now shifting to the non-farm payroll due in the U.S. session today to gauge if the labor market is still tight and can whether the Fed tightening. Wage metrics will be closely watched as well, before focus shifts to June CPI data due next week. While USDJPY seems to be stuck in a range for now despite Fed’s hawkishness, it appears that any big miss in payrolls today could mean a potential run lower in the pair as recession fears result in haven flows. A beat on the jobs data will however be more detrimental to EURUSD and push it further closer to parity.
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