Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Summary: Equity markets were in for another rocky session yesterday in the US, although a portion of another chunky sell-off was erased by the close. The market was perhaps spooked by the US November producer prices data, which showed a far steeper month-on-month rise than expected and set a new 40-year high for the year-on-year data. This has the market concerned that the FOMC meeting tonight will see the Powell Fed deliver a more hawkish message.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - yesterday was another weak session for US equities and especially technology stocks with Nasdaq 100 futures breaking below the 50-day moving average before rebounding. However, Nasdaq 100 futures are on a slightly weak footing again this morning trading around the 15,920 level with the 50-day moving average at 15,830 being the critical support level again today. Equities are currently weak due to China weakening, the inflation outlook remaining elevated with yesterday’s high US PPI figure, short-term impact from the Omicron variant, and fiscal headwinds expected to kick in next year.
EURUSD – the EURUSD super-major fell again yesterday in the wake of the hot US PPI data release (see more below) after a modest rally attempt but continues to coil within a range as we await the main events of the rest of the year for both the US dollar and the euro in the form of today’s FOMC meeting and tomorrow’s ECB meeting. Whatever the Fed says tonight, the key coincident indicator is the market’s forward prediction of Fed rate hikes, which only rose modestly yesterday and is still about 10 basis points below the cycle highs (for rate expectations by the end of next year). If the FOMC meeting somehow surprises on the dovish side or, at least, fails to impress rate expectations, EURUSD could squeeze up through the consolidation pattern above 1.1350, with an extension if the ECB surprises tomorrow. The downside key is the pivot low of 1.1186.
USDJPY – the pair rose slightly yesterday on the hot producer price inflation data out of the US (see more below), but the important coincident indicator for the pair remains the longer end of the US yield curve, where yields have been bottled up well below the cycle highs of late, muting the prospects for a return above the 115.00 level. However, there could be end-of-year effects that are suppressing US yields only temporarily (parking of any excess liquidity ahead of year end, especially the largest US banks, who are likely looking to reduce balance sheet into year-end to avoid penalties linked to their size). In any case, for now the USDJPY pair may prove less sensitive to a hawkish Fed than other USD pairs if the far side of tonight’s FOMC meeting sees no notable change in US long yields, and if yields drop, USDJPY could be in for a sell-off that takes aim at the 112.50 support. But traders may need to keep a tactical footing, given the possible calendar roll effect noted above (the first week of 2021 saw a very significant spike in long US yields, possibly on the same effects.)
Crude oil (OILUKFEB22 & OILUSJAN22) trades lower on a cocktail of a fast-spreading omicron variant and its impact on major economies like the US and not least China, as well as jitters ahead of today’s FOMC meeting giving its potential impact on the overall level of market risk appetite. The International Energy Agency added to the unease after saying that the market has already returned to a surplus with omicron hurting demand, especially jet fuel. A development backed by the Brent prompt spread after it briefly dipped into contango yesterday. Brent trades near its 200-DMA at $72.85 with the risk of long liquidation on the rise once more. WTI also traded softer after the API weekly stock report showed another healthy rise in Cushing stocks. EIA’s weekly stock report is due later today.
Gold (XAUUSD) trades near the lower end of its current $1760-90 range in response to surging US producer prices. The near 10% annual increase added fuel to expectations of an aggressive response from the US central bank when they meet later today. With risk sentiment taking a knock and US real yields trading higher, gold had nowhere to go but down. The short-term direction will be dictated by whether the market has priced in enough tightening, together with the strength of the general level of risk aversion driving an across market reduction in exposure.
European sovereigns (IS0L). The focus continues to be on the ECB meeting tomorrow. An announcement of the end of the PEPP program in March 2022 is widely anticipated. What is not clear is whether purchases will be compensated by another scheme, such as the APP. It is likely that the ECB will stall as members are torn between inflation and a new wave of Covid infections. If investors feel the support of the central bank is fading, European yields might resume their rise with the periphery and Italian BTPS leading the way. Yet, the move will be mild as yields will remain compressed by covid concerns. Therefore, we do not expect Bund yields to move in positive territory before yearend.
US Treasuries (IEF, TLT). Price action continues to be volatile ahead of the Federal Reserve meeting, where Powell is expected to announce an acceleration of the pace of tapering. The focus is going to be also on the dot plot, where longer term projections might be moved higher, pushing up the long part of the yield curve. However, long-term yields can move higher only that much, as omicron distortions will continue to keep them compressed. Therefore, it looks likely that 10-year yields will continue to trade rangebound between 1.40% and 1.70% until the end of the year.
UK Gilts (IGLT, IGLS). The BOE might not deliver on a 10bps interest rate hike this week as members are divided concerning Covid restrictions. Michael Saunders, one of the most hawkish MPC members, said that he will need to think about it twice before voting for a rate hike. As expectations for interest rate hikes in the UK are the most aggressive among developed economies. It is possible that if the central bank does not hike, the Gilt yield curve will be steeping with short-term Gilts gaining the most as the market pushes back on next year’s rate expectations.
What is going on?
US November PPI rises at new modern record pace - with the month-on-month headline data rising +0.8% month-on-month and ex Food and Energy rising +0.7% month-on-month vs. +0.5%/+0.4% expected, respectively, while the year-on-year data points were at +9.6%/+7.7% vs. 9.2%/7.2% expected and 8.6%/6.8% for October.
The European energy crisis keeps deteriorating with Dutch TTF benchmark gas prices soaring to a fresh record closing high in yesterday’s trading session at €130.5/MWh ($43/MMBtu). Driven by seasonal low supplies from Russia at a time when inventories are running dangerously low into the peak winter period. Russia threatening to invade Ukraine adding to market fears about not only near-term supplies, but also longer-term given the risk of a long delay to the start of the controversial Nord Strem 2 gas pipeline.
Chinese biotechnology stocks on potential US blacklist. Financial Times is reporting that the US Treasury Department is considering placing additional Chinese companies on its blacklist on Thursday which according to rumours will include biotechnology companies. Chinese biotechnology stocks such as Wuxi Biologics, Clover Biopharmaceuticals, Genscript Biotech, Remegen, Wuxi Apptec and Innovent Biologics are all down between 10% and 24%.
China new home prices fell the most in seven years in November. The declines are putting more pressure on the government to stabilize the economy and banks are already lowering their mortgage rates to support the housing market. The central bank has also shifted to easing mode and the government has announced more fiscal stimulus. At the same time, the Omicron variant has been identified in China which could add to supply constraints as China is still pursuing its “zero-case” policy.
Inditex 9M earnings show new record. The Spanish fast-fashion retailer is emerging stronger from pandemic led by e-commerce with nine-month operating profit up 400% compared to the same period last year. Revenue was up 33% in local currencies and the company is reducing the number of stores to 6,657 from around 7,500 at the beginning of 2019.
What are we watching next?
The Wednesday FOMC as the year’s final major macro event risk. The FOMC meeting tonight is set to bring a very different monetary policy statement from the prior statement after the Fed’s clear pivot to inflation fighting mode, with yesterday's fresh modern highs in producer price inflation for November adding a bit of energy to the anticipation of what this meeting will deliver. As well, the meeting will see an update of economic forecasts and interest rate policy forecasts (the “dot plot” in which Fed members forecast where the Fed funds rate will likely be in 2022-24 and in the longer term). Most interesting will be any signaling on where the Fed sees core PCE inflation next year and in 2023 and the degree to which Fed members have raised their policy rate forecasts relative to what the market is predicting, which is for between two and three rate hikes through the end of next year. Prior forecasts have generally come in lower than market expectations, but to maintain credibility in light of their recent shift, the Fed will have to at least match market expectations. The baseline expectation for the pace of QE “tapering”, or slowing of purchases, is that the Fed will double the pace of tapering, which would mean the Fed’s balance sheet is set to stop growing by mid-March. Anything that suggests a faster pace of tapering than this doubling (for example, a promise to wind down before March) and that leaves room for the belief that a hike at the March FOMC meeting is possible would be a hawkish surprise.
ECB and Bank of England Meetings tomorrow – more is at stake for the ECB meeting, although the BoE has plenty of room to surprise. For the ECB, the focus is on the latest series of economic forecasts, which will strain credibility if the ECB does not raise inflation forecasts for next year at minimum. In the meantime, the EU is beset by the latest wave of covid and an energy crisis that could trigger a recession, which makes it difficult to manage the signaling around the reduction of asset purchases after the emergency QE purchases are set to end in March. For the Bank of England, the market is not expecting a hike at the meeting, but certainty is low after prior missteps in communicating their guidance. The UK CPI this morning was out higher than expected and could be a factor as the core reading rose to 4.0%, a modern era high.
The European Council meets on Thursday, and apart from having to deal with Covid-19 and the Russian threat on its eastern borders, the council is also set to decide whether investments in gas and nuclear energy should be labelled climate friendly. The design of the EU green investment classification system is closely watched by investors worldwide and could potentially attract billions of euros in private finance to help the green transition, especially given the need to reduce the usage of coal, the biggest polluter.
Earnings Watch – today’s earnings focus is Inditex and Lennar with investors worrying about Inditex continuing to lose market share to Chinese-based Shein. Lennar is still seeing strong demand for housing in the US but is constrained on some building materials.
Today: Inditex, Toro, Lennar, Heico, Trip.com, Nordson
Thursday: FedEx, Adobe, Accenture
Economic calendar highlights for today (times GMT)
1315 – Canada Nov. Housing Starts
1330 – US Dec. Empire Manufacturing
1330 – Canada Nov. CPI
1330 – US Nov. Retail Sales
1500 – US Dec. NAHB Housing Market Index
1530 – US Weekly DoE Crude Oil and Product Inventories
1700 – Canada Bank of Canada Governor Tiff Macklem to speak
1900 – US FOMC Meeting
1930 – US Fed Chair Powell Press Conference
2145 – New Zealand Q3 GDP
2330 – Australia RBA Governor Lowe to speak
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