Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: US equities surged on Friday to post a strong close to the week, with the S&P 500 posting a strong new all-time high, while the Nasdaq 100 index has yet to break free of the recent range. US treasury yields dropped ahead of this week, in part after a huge miss on the initial US University of Michigan sentiment reading for August, as the delta variant outbreak may be weighing on confidence. Gold surged as the dollar dropped with crude oil trading lower on the current virus threat to demand.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - interesting to note that the S&P 500 index surged late last week and posted a strong new all-time high on Friday, while the Nasdaq 100 index moved in directional sympathy late last week without managing to take out the cycle highs above, in part on a couple of laggard mega caps of late, particularly the gut-punch to Amazon after its most recent earnings report. It is remarkable to see how the US market continues to shrug off worsening delta-variant concerns.
USDJPY– is trading in obvious sympathy with US treasury yields, which posted a huge reversal back lower in the wake of US CPI data last Thursday and the shocking initial August University of MIchigan sentiment reading on Friday (more on that below). The price action in USDJPY tumbled from the high of 110.80 early in the week to a close on Friday of 109.55, with the price action nudging a bit lower still to start the week in Asia. The next key chart area is the sub-109.00 levels posted just ahead of the strong US July payrolls jump the week prior, although the pair has yet to post a close below 109.00 since May.
EURUSD – the supermajor tested the 1.1706 low of 2021 last week before surging on Friday, in part on the steep drop in US treasury yields and on weak US consumer sentiment data. The rally is not yet large enough to label a bullish reversal, but will begin to look like one if more of the price action from the recent 1.1900 area is erased, for example, on a rally and close above 1.1850. Meanwhile, the focus has been on that 2021 low, a sell-off below which could trigger a further slide to 1.1600, if not 1.1500.
Gold finished last week on a firmer footing after a much weaker than expected University of Michigan sentiment (see below) helped deflate some of the buildup taper angst with Treasury yields and the dollar traded lower ahead of the weekend. Both paused their retreat overnight with gold and silver drifting lower as a result. A major band of resistance has emerged between $1790 and $1815 while support needs to hold around the $1750 area. Following last Monday’s flash crash, speculators slashed their gold and silver net longs by more than 50% leaving the market exposed to fresh buying on a break higher. This week the market will be watching a speech by Fed chair Powell, as well as minutes of the Fed’s last meeting.
Crude oil (OILUKOCT21 & OILUSSEP21) trade lower for a third day with Brent back below $70 after key oil consumer China released weaker than expected retail sales and industrial production data and following Friday’s very weak sentiment reading. These developments support IEA’s latest downgrade to demand for the months ahead as a resurgent delta coronavirus variant is impacting demand across the world. Also, in the US there are signs shale producers are ramping up activities with the number after the number of rigs last week rose by 10 to 397, marking the biggest jump since April.
What is going on?
US University of Michigan sentiment reading plunges to lowest since 2011 - the initial reading for August on Friday was a shocking 70.2 versus 81.2 expected and 81.2 in July, and may be down to the spread of the delta variant or in part to the humiliation of the US presence in Afghanistan. The expectations component dropped a whopping 13.8 points to 65.2, worse than the readings posted in the heart of the initial pandemic outbreak last year.
Global congestion increases. According to the latest data released by Kuehne+Nagel, one of the world's leading logistics companies, more than 392 vessels of the major carriers are anchored off ports, as many ports on every continent are facing disruption in their operations. Global congestion is likely to severely increase in the short term following the shutdown of a container terminal in China’s Ningbo where Covid-19 cases were detected last week. This will continue to push upward transportation costs at the global level.
BHP Group in talks to divest oil business amid climate concerns. The increased focus on climate change and the recent IPCC report are making it tough for companies to be engaged in intensive carbon businesses. BHP Group, one of the world’s largest mining groups, is in talks with Woodside Petroleum to take over its energy assets spanning Australia and Gulf of Mexico. The miner had said it will focus on materials used for renewable energy and electrification.
Economic growth in China continues to slow, with the July Industrial production figure released overnight showing only 6.4% year-on-year growth versus 7.9% expected, while Retail Sales only advanced 8.5% year-on year vs. 10.9% expected. Like nearly every other country, China is dealing with the delta variant of Covid, leading to targeted lockdowns and disruption of travel as well as cancellation of some events involving mass gatherings.
The weekly Commitments of Traders report covering the week to August 10 saw money managers cut bullish bets in energy and industrial metals due to growth worries related to the current virus surge. Investment metals suffered with gold and silver seeing their net length more than halved in response to last week’s flash crash, while adverse weather across the world gave a further boost to both grains and soft commodities. Overall, the total net long across 24 major commodity futures was cut by 4% to 2.2 million lots with selling of crude oil, gas oil, gold, silver, and copper being only partly offset by demand for sugar, soybeans, corn, and wheat.
What are we watching next?
Fate of US stimulus packages. The US Senate has passed a $1 trillion stimulus package with heavy bipartisan support as seen in the 69-30 vote, although only a bit over half of that package would involve new spending, with the remainder funded by unused Covid stimulus. The scale of the package is modest in terms of the immediate impact if it is able to proceed through the House and become law, given that it will be spread over five years. The bigger question looming is whether President Biden’s more comprehensive $3.5 trillion stimulus “budget resolution” sees the light of day, as it will have to rely entirely on Democratic votes. The Senate on Friday passed a vote on the framework of the budget resolution on purely partisan lines, a first step in a long process for whether the huge expansion of social spending measures in the stimulus is able to survive the difficult process of becoming law.
RBNZ meeting on 18 August – Expect the Reserve Bank of New Zealand to hike rates by 25bp this week and later this year. This move has been fully priced in by the market. The economy is back to normal and the recent release of the 2Q unemployment data (with unemployment dropping to its pre-Covid level at 4.0%) were the last evidence needed to start the hiking cycle.
Snap election in Canada set for September 20 - Prime Minister Justin Trudeau has called an election, hoping to capitalize on strong polls and achieve an outright majority in parliament that would give his party a mandate to set the agenda and policy focus for another four years.
‘Earnings to watch today. Today’s earnings focus is on Meituan, one of China’s largest e-commerce companies, which is down for the year due the ongoing technology crackdown by the government. The recent outlook from Baidu suggests a softer economy, so Meituan might disappoint as well on the outlook.
Economic calendar highlights for today (times GMT)
1230 – US Aug. Empire Manufacturing
1230 - Canada Jun. Manufacturing Sales
1300 – Canada Jul. Existing Home Sales
0130 – Australia RBA Minutes