Financial Markets Today: Quick Take – July 25, 2022
Saxo Strategy Team
Summary: Recession fears are riding high after preliminary July PMI surveys out Friday suggest that the Eurozone economy is on the brink of recession and that the US services sector is in contraction. US treasury yields tumbled all along the yield curve late last week as the market lowers the anticipated peak Fed funds rate and sees easing inflation. Equities finally rolled over in Friday’s session after their recent squeeze higher as investors weigh recession risks and ahead of a slew of earnings reports from the largest US companies this week and the FOMC meeting on Wednesday.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I). US equity futures rolled over Friday from new local highs after the recent squeeze higher that was driven in part by excessively negative sentiment. While a sharp drop in treasury yields late last week has brought some relief as the peak Fed Funds rate was marked lower, the recession fears driving the drop in yields are a concern for corporate earnings, which were also challenged in the second quarter for US companies by the very strong US dollar. A slew of major US companies are set to report earnings this week (see overview below.)
Hong Kong’s Hang Seng (HSI.I) and China’s CSI300 (000300.I) retreated nearly 1%. Economists have recently been revising down this year’s GDP forecasts for China and analysts have been lowering earnings forecasts for Chinese companies. Among the latest, Goldman Sachs trimmed their 2022 EPS growth forecast for MSCI China from 4% to 0%, much below the street consensus of 8%.
USDJPY and EURUSD ahead of FOMC meeting this week. Following weak preliminary July US PMIs on Friday, Treasuries rallied and USDJPY slid to 2-week lows of 135.57. UST yields will be on watch this week, with the Fed expected to go for a 75bps rate hike. While there are some expectations that the pace of rate hikes will slow from here, the inflation problem will possibly make the Fed stay hawkish. That could mean USD gains could return, and another run higher in USDJPY, with EURUSD potentially heading back for another test of parity and beyond, given the fresh existential concerns for Europe as Italy potentially heads toward a right-populist government after the late September Italian election.
Crude oil (OILUKSEP22 & OILUSSEP22). Oil prices fell on Friday on a weakening global demand outlook and the resumption of some Libyan crude oil output as well as Russia’s gas flows to Europe. Further weakness was seen in the Asian morning as WTI futures slid below $95/barrel and Brent futures were below $104. With the FOMC meeting scheduled for this week, expectations are that the Fed will continue to guide for aggressive rate hikes to bring inflation under control, suggesting more room for USD gains and further fears of demand destruction.
US Treasuries (IEF, TLT). US yields dropped all along the curve late last week on weak US economic data. This week, the focus will be on the heaviest week of corporate earnings reports for the quarter and the FOMC meeting on Wednesday as the market eyes a 75-basis point rate hike from the Fed this week. The 10-year treasury yield benchmark has retreated to the 2.75% yield area, a significant zone of resistance since back in late April.
What is going on?
US preliminary July Services PMI enters contraction territory. US flash July PMIs largely disappointed, despite manufacturing coming in above expectations at 52.3 (exp. 52.0, prev. 52.7), as services printed 47.0 (prev. 52.7), well below the expected 52.6 and also falling into contractionary territory for the first time since May 2020 as the post-pandemic rebound faded. The composite dropped to 47.5 from 52.3, its first contraction in 26 months. Together with the weakness in Philly Fed survey and initial jobless claims seen last week, there are hints that economic weakness will only gather pace into the third quarter.
European PMIs hint at recession risks. The flash PMI surveys released Friday for the Eurozone suggest the economy is set to contract in the third quarter as business activity slipped into decline in July. The Manufacturing PMI slid to 25-month lows of 49.6 in July from 52.1 previously, with producers reporting increases in inventory levels due to lower sales. Services PMI was also substantially weaker at 50.6 in July from 53.0 in June with composite PMI tumbling to 49.4 in July. Business expectations have also fallen to record lows, as energy crisis continues to strain the economy. ECB’s 50bps rate hike last week, and another hike expected in September will also weigh on the economic outlook.
Saudi Arabia expects to reach its peak oil production in 2027. During U.S. President Joe Biden’s visit in Saudi Arabia, Prince Mohammed Bin Salman announced his country will likely reach its peak oil production in five years at 13 million barrels per day. This is a major announcement given the Kingdom is the second largest global oil producer behind the United States and the one with the largest oil reserves. If it no longer manages to increase its production within five years, it is doubtful the world’s oil supply will be able to keep up with the ever-increasing demand in the years to come. This is a significant change of tone from Saudi Arabia. Until now, the country has been very confident in its abilities to increase production (until recently, it has claimed it was able to reach a production level of 15 million barrels per day and maintain it at that level over several decades. We were quite skeptical about it). We even actually wonder whether Saudi Arabia, which now produces about 11 million barrels per day, will be able to reach the 2027 target of 13 million barrels per day. The oil market is likely to remain unbalanced in the coming years.
Concerns around Monkeypox outbreak. The World Health Organization (WHO) has declared the monkeypox outbreak a public health emergency of international concern. With the key concern being the lack of response to the disease, international concern paves the way for stepped-up global cooperation. The US — which may also declare an emergency — can contain the disease with a combination of testing and vaccinations, White House official said. Currently, the US is reporting over 2,800 probable or confirmed monkeypox cases in 44 states, and there are over 16,500 cases reported in 74 countries globally.
China stimulus potential is modest. With key political events ahead, China is unlikely to roll out new stimulus measures before things have been settled. The Politburo of the Chinese Communist Party (CCP) is scheduled to meet this week. The market will be looking for hints and signals about China’s economic policy in the second half of the year from the readouts and statements coming out from the meeting. President Xi and other senior CCP officials are expected to go to Beidaihe, a seaside summer resort 300km east of Beijing, after the Politburo meeting to meet up with retired party elders to discuss about party leadership arrangement and other matters in preparation of the national congress of the CCP this late October or early November. It is unlikely to have major policy measures being announced before these important political events.
What are we watching next?
US yields and US dollar as FOMC to deliver another 75 basis point hike Wednesday. Guidance from the Fed is key after recent data suggests headwinds for the economy are picking up, even if inflation remains the Fed’s chief focus. The reaction of US yields to Fed policy will be key to watch this week after a run lower on Friday after the PMIs disappointed and raised recession concerns. If Powell stays more hawkish than expected, which is needed to bring inflation back down, it could mean another run higher in yields and the US dollar, weighing on risk assets and commodities. The possibility of weaker signals on economic growth in the week also possibly hints at further yield curve inversion this week, after this month saw the US 2-10 yield curve inverting the most (below –20 basis points) since 2000.
New IMF study on the economic impact on European countries of Russian gas cut off (see here). While Russia did restart deliver of natural gas through the Nord Stream 1 pipeline late last week after scheduled maintenance, it has threatened to reduce deliveries as son as this week. The IMF study look at the varying impact of a complete cessation of Russian supplies. That impact depends crucially on whether there is rationing in markets (this is unknown at that stage). However, some of the worst-hit countries could see GDP shrink up to 6 % (Hungary and Slovakia, for instance). Mitigating measures could be decided, such as securing alternative supplies and energy sources, easing infrastructure bottlenecks, encouraging energy savings and expanding solidarity agreements to share gas across European countries. This won’t be easy, nonetheless. At the end of the day, it will also depend on the harshness of the upcoming winter.
Italian election and EU peripheral yield spreads. Italy will hold an election on September 25 after Prime Minister Mario Draghi’s resignation on Thursday last week, the very day that the ECB announced a new tool to control peripheral spreads (with Germany Italy widening sharply to above 225 basis points despite that announcement due to the concerns for the Italian political environment). Polls suggest a right-populist government led by the Brothers of Italy party will win the election. More to come.
Busiest earnings week: 30% of S&P500 companies report. Reports will have to beat expectations to support the recent equities rally. Poor tech outlooks weighed on Wall Street last week far with SNAP and Twitter guiding for a slowdown in marketing spending. This week’s blockbuster of 175 of companies reporting will likely show how much corporate America’s balance sheets have been restricted in Q2 by higher costs and higher rates, logistics issues, and how much the higher US dollar will impact forward earnings. We will be watching to see what companies guide for 2022; and how much these factors will continue to bite into in 2022. The market will need to see results not as bad as expected, if the S&P500 and the Nasdaq are to continue to rally. If results are weaker than expected, then the market will remain vulnerable to a sharp pullback. Stalwart names like Coca-Cola (KA) and McDonald’s (MCD) roll out earnings first on Tuesday July 26th. While in tech, Microsoft (MSFT) and Alphabet (GOOGL) kick off mega-cap tech earnings on Tuesday. We will likely see pressure from weaker PC demand, a slowdown of hiring and rising costs pressures, while Alphabet’s business, YouTube is expected to fare better than other social media platforms.
Earnings Watch Calendar
This week we will see results from an enormous variety of companies and some heavy mega-cap hitters that could set the tone for global markets.
Today: NXP Semiconductors, Kuehne + Nagel, Philips, Ryanair
Tuesday: Alphabet, Visa, LVMH, Coca-Cola, McDonald’s, UPS, Texas Instruments, Raytheon Technologies, Unilever, Christian Dior, General Electric, UBS Group, General Motors, Archer-Daniels-Midland, Southern Copper, DSV, UniCredit
Wednesday: Microsoft, Meta, Bristol-Myers Squibb, Qualcomm, Equinor, GSK, ServiceNow, Rio Tinto, Mondelez, Boeing, Airbus, 3M, Kering, Humana, Mercedes-Benz, Ford Motor, Kraft Heinz, Shopify, BASF, Danone, Fanuc, Enphase Energy, Spotify, Garmin
Thursday: Apple, Amazon, Nestle, Pfizer, Merck, L’Oreal, Shell, Comcast, Intel, Linde, TotalEnergies, Sanofi, Honeywell, Anheuser-Busch InBev, Keyence, Volkswagen, Air Liquide, Schneider Electric, Banco Santander, Valero Energy, Stellantis, Neste, BAE Systems, Arcelor Mittal, Mastercard
Friday: Exxon Mobil, Procter & Gamble, Chevron, AbbVie, AstraZeneca, Sony, Colgate-Palmolive, BNP Paribas
Economic calendar highlights for today (times GMT)
- 0800 – Germany Jul. IFO Business Climate
- 0800 – Switzerland Weekly SNB Sight Deposits
- 1230 – US Jun. Chicago Fed National Activity Index
- 1430 – US Jul. Dallas Fed Manufacturing Activity
- 2350 – Japan Bank of Japan Minutes
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