Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Summary: The relief rally in markets yesterday was cut somewhat short by a resurgence in energy prices late yesterday after US officials stated there were no plans to release oil from strategic reserves, which has helped send oil prices back toward multi-year highs. Elsewhere, US treasury yields rose to new local highs yesterday ahead of a key US jobs report that likely determines whether the Fed kicks off a tapering of purchases at its early November meeting.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - sentiment in equities was strong yesterday until it was capped by a resurgence in oil prices and a breakout in longer US treasury yields to new cycle highs ahead of today’s September jobs report. Strong data could ironically prove negative for equities if the reaction sees yields moving aggressively higher, especially for more yield-sensitive tech- and momentum stocks in the concentrated Nasdaq 100 index. That index hasn’t managed to trade above its 21-day moving average (currently near 15,050) since mid-September, while the S&P 500 index is trading on its 21-day moving average near 4390 after attempting to surge above it yesterday.
Hang Seng (HSI.I) - Chinese equities are pushing higher with mainland investors back from holiday. The CSI 300 futures are up 1.5% and Hang Seng futures briefly touched the 25,000 level before retreating lower again but up for the session. According to statistics the 100 largest real estate developers saw sales plunge 36% in September putting extra pressure on liquidity in Q4. On the positive side, the Caixin China PMI Services figures hit 53.4 in September against 49.2 expected and up from 46.7 in August suggesting that the zero Covid policy quickly got the outbreaks under control allowing the services sector to jump back quickly.
EURUSD – the EURUSD continues to trade very heavily and will likely continue to do so if US data is supports further rises in US treasury yields. Will the slide slow as the big round 1.1500 level rolls into view? Hard to say, but the next level lower that could determine whether the pair faces a full capitulation back to the pandemic outbreak era lows is the 1.1290 level, the 61.8% retracement of the rally from 2020 lows to early 2021 highs.
USDJPY – is perched close to cycle highs again as US treasury yields broke higher yesterday, together with rising oil prices, two factors that are JPY-negative. USDJPY is historically quite sensitive to US data and today’s September US jobs report is the key event of the week that could further aggravate the rise in yields if it is a strong report (note that we also focus on whether earnings are surging as well) and support a break out here that sets USDJPY on the path to the next major resistance level into 114.50+.
Crude oil (OILUKDEC21 & OILUSNOV21) witnessed another rollercoaster day on Thursday with early weakness in response to lower gas prices being reversed after the US Energy Department said it has no plan to tap into its strategic reserves “at this time”. In general, the risk of tightening markets into the winter months have not gone away, and especially the prospect of gas-to-oil switching could add another layer of demand for crude oil. Focus today on the US job report and its indirect impact via the dollar. Next week both OPEC on Wednesday and the IEA on Thursday will publish their latest monthly oil market reports, with supply and demand forecasts. A break higher in Brent could see it target the 2018 high at $86.74.
US Treasuries (IEF:xnas, TLT:xnas). A short-term extension of the debt ceiling has been agreed upon, giving some relief to the bond market and allowing 10-year US Treasury yields to rise in case of strong jobs numbers today. A strong jobs report might wake up bears as a tapering announcement is likely to be delivered in November and the recovery of jobs together with elevated inflation may force the hand of the Federal Reserve into hiking interest rate early, resulting in higher yields across the yield curve. Now that the debt ceiling issue has been resolved, it’s likely that 10-year yields will break above 1.60% entering in a consolidation area up to 1.70%.
European government bonds (VGEA, BTP10, IS0L). The Minutes of the latest ECB minutes showed that some members are concerned about future inflation and that it may be necessary to cut more asset purchases than previously estimated. It leaves European sovereigns in a weak spot today, as US yields have the potential to rise amid the non-farm payrolls data. When looking at Bunds, -0.15% remains a strong resistance level, which if broken will lead to 10-year yields in a fast area with weak resistance at –0.07%. Sovereign bonds with a high Beta, such as Italy, are going to be more vulnerable to the selloff, leading to a short-term widening to the BTPS-Bund spread.
What is going on?
China Sep. Caixin Services PMI out at 53.4 vs. 49.2 expected and 46.7 in Aug. This is a strong reading from this non-official survey of the Chinese economy and is an interesting counterpoint to the negative news on power shortages and the real estate sector of late.
US Senate punts the debt ceiling issue to December 3 – the US Senate voted on a bill to increase the debt ceiling by just under $500 billion dollars until December 3, with the House set to vote on the bill next Tuesday. The Democrats have threatened a maneuver before that next deadline to avoid the Senate “filibuster” as a way to move forward with further increases in the ceiling.
Ireland agrees to 15% minimum tax proposal for corporations, a shift from its former stance as it has maintained a 12.5% rate previously. This announcement comes on the eve of a meeting of 140 countries hosted by the OECD that could alter the global tax landscape for multinational companies.
The global gas market remains very volatile given the prospect of very tight supplies in both Europe and Asia this winter. The price of Dutch TTF gas has stabilized after almost halving from the panic peak seen on Wednesday, a surge that was driven by traders forced to cut positions amid rising margin calls to hold positions. Also, some industries with long term contracts have cut their power demand and sold their quotas back into the market at a major profit. European and Asian consumers meanwhile are watching US gas prices with envy, where are a bigger than expected weekly stock build helped send prices down by 15%. A strong pull from LNG exporters and the risk of cold winter is however likely to keep prices supported.
The UN FAO’s Global Food Price Index hit a fresh ten-year high last month. The index which tracks a basket of more than 90 price quotes across five different categories reached index 130, representing a year-on-year rise of more than 32%. The latest rise was largely driven by higher prices of most cereals and vegetable oils. Dairy and sugar prices were also firmer, while the meat price sub-index remained stable.
What are we watching next?
Earnings season heats up starting next week as we will focus especially on corporate guidance on how supply chain disruptions, inflation and even wage rise demands are affecting financial performance and to what degree companies are seeing these factors impacting margins for the quarter and the level of concern for coming quarters.
Looking for strong U.S. nonfarm payrolls September report today – with the market leaning for greater than 500k jobs added for the month. The US Treasury market is the key to watch for a reaction to the data point as the 10-year yield benchmark rose to a new local high yesterday. Fed Chair Powell made it clear at the most recent FOMC meeting press conference that nothing particularly impressive would be needed from the September jobs report to move forward with a tapering announcement at the next FOMC meeting on November 3. What will really matter is the composition and pace of the tapering, in our view. As well, the average hourly earnings data for September could see more focus if it posts another jump on the scale of the August rise.
Earnings Watch – a quiet week for earnings winds down today, but next week the Q3 earnings season will heat up with US financials. We will write an earnings preview tomorrow.
Economic calendar highlights for today (times GMT)
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