Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Chief Investment Strategist
Summary: US equities remained range-bound as banking sector was once again given a lifeline with JP Morgan bailing out First Republic. Fed meeting a key focus ahead with a 25bps rate hike nearly fully priced in after the surprise upside in ISM prices paid, but markets looking for clear indication of a pause. USD strength prevailed on higher Treasury yields, and JPY weakness continuing to extend. RBA meeting on watch today before focus turns to JOLTs data in the US and another slew of earnings from AMD, Starbucks, Uber and Ford.
The US benchmark indices were little changed on Monday, closing in a minor red, despite the S&P 500 initially rising to a new high. Liquidity was thin with many Asian markets including China and HK closed for Labor Day and London also away, while others stayed on the sidelines ahead of the key Fed meeting this week as well another set of quarterly earnings – all of which will be discussed in detail in our weekly Saxo Spotlight article. Regional banks continued to be under pressure with banking turmoil risks remaining despite the First Republic takeover. The SPDR S&P Regional Banking ETF (KRE:arcx) slid 2.8%.
The bond market was dominated by selling, sending Treasury yields higher. The US ISM manufacturing PMI release sent a hawkish message to the markets, bringing the probability of a rate hike from the Fed on Wednesday to over 90%. Treasuries bear-steepened with the long-end weighed on from heavy corporate issuance, including USD 8.5bln from Meta, and the bounce in ISM priced paid.
Higher treasury yields brought the USD higher overnight but yen weakness is a purely isolated story. USDJPY has zoomed past 137, breaking above the 200DMA, and target now at March high just shy of 138. The weakness in yen seems aggressive despite Bank of Japan’s dovish surprise on Friday suggesting a 1-1.5 year timeline for policy review. GBPUSD also reversed back below 1.25 and EURUSD slid below 1.10. AUDUSD attempted a surge overnight, clearing 0.6650 before prices paid component of ISM manufacturing index sparked fresh inflation concerns just ahead of Fed meeting and brought gains in the dollar. AUDUSD treading cautiously around 0.6630 ahead of the key RBA meeting (preview below) today.
Crude oil prices fell again on Monday after the weekend data from China showed a slump in manufacturing activity, even as travel demand showed signs of a recovery at the start of the Golden Week holiday (read below). Sentiment was also dampened by fresh banking concerns in the US as First Republic bank became the latest casualty of the increases in interest rates. WTI traded near $75.50/barrel after a decline of 1.5% while Brent was below $80. Fed meeting a key focus ahead but the market will also be watching the impact of the new production cuts from OPEC announced at the start of April. The agreement to cut output by 1.6mb/d officially begins this week.
Gold prices surged higher on Monday to take another look above the $2000-mark as renewal of the banking sector concerns and a possible pullback in lending brought a safe haven bid. However the surge in yields following the higher-than-expected ISM prices paid component resulted in a sharp reversal and gold prices were back at $1980-levels. What happens next could set the short-term direction for gold as the market seeks confirmation that rates indeed will start to come down from June and onwards. A 60bps reduction is priced in before yearend, down from 75bps last week and any further lowering of expectations may trigger a move towards the key $1955-60 support area.Silver meanwhile holds above the key support at $24.50 area.
FDIC and California regulators announced that they were to close First Republic Bank and sell-off its USD 93.5bln of deposits and most assets to JPMorgan. The move makes First Republic the second-largest bank failure in US history, after Washington Mutual in 2008. Depositors retain access to their cash, but JP Morgan is not assuming First Republic’s corporate debt or preferred stock. Jamie Dimon said that US banking turmoil is near its end and that the country's financial system "extraordinarily sound." Still, lending will suffer for a time, he warned.
Regional banks ended the day lower as there are understandably pockets of risk in the system. The solution remains a one-off, and even as it gives the market some hope to move on, funding concerns will remain.
China’s PMIs for April were reported over the weekend, and official manufacturing PMI print surprised to the downside, slipping into contraction at 49.2 from 51.9 in March. Services strength was sustained with PMI at 56.4 from 58.2 previously, but was still below expectations. Data brought back risks that China’s recovery is losing steam, and built the case for further policy support.
However, travel demand during the Golden Week has started on a positive note. According to the China Railway Group, the country tourism and consumer activities rose sharply on the first day of the five-day Labor Day holiday, as residents rushed to travel and spend after three years of Covid-19 restrictions finally ended. As Bloomberg reports, some 19.7 million railway trips were made across the country on Saturday, the highest on record for a single day. The railway operator expects traffic to jump to a record 120 million passengers for the extended holiday period, up 20% from the same period in 2019, before the pandemic struck. To get exposure to the recovery in Chinese travel demand, we have several themes from APAC Tourism to luxury & gaming stocks.
ISM Manufacturing PMI rose to 47.1 in April, above the expected 46.8 and prior 46.3, but remained in contractionary territory, while concerningly the prices paid component jumped to 53.2 (exp. 49.0, prev. 49.2). New orders and employment lifted to 45.7 (prev. 44.3) and 50.2 (prev. 46.9), respectively. While the data showed that US manufacturing sector is still seeing slowing activity, there are some hints of a stabilization. Still, inflation concerns remain apparent. Meanwhile, US S&P Global PMI rose to 50.2 in April from 49.2 previously, jumping into expansion territory.
The Reserve Bank of Australia (RBA) has no reason to go back on its pause decision from last month as it announces its next policy decision on May 2. Q1 CPI released last week signalled sustained price pressures with headline inflation still at 7%, although cooling from last quarter’s 7.8%. More importantly, the trimmed mean measure, which is the preferred central bank measure, came in below the RBA’s forecast. So, even as real rates remain negative, the RBA has to focus on the impact of its tightening measures so far given the higher proportion of floating-rate mortgages in the economy. The big question is whether the central bank still keeps the door open for more rate hikes, as it has done previously, or marks a peak in the tightening cycle. And if that was to happen, there is a high risk to credibility with the employment side remaining strong.
Coming into this week the ECB is priced to hike 25bps on Thursday and the forward curve almost fully pricing two additional rate hikes through the September meeting this year. A couple of important data points are up today, that could help shape the size of the ECB hike as well as how much further tightening is flagged in the ECB’s guidance at its meeting on Thursday. The ECB will release its quarterly survey of bank lending and we will also get the Eurozone April flash inflation figure after the German flash April CPI report on Friday came in slightly softer than expected. The market is looking for Eurozone to report core inflation of 5.6% YoY after 5.7% in March, which was also the cycle high. Upside surprises could still tilt the needle towards a 50bps move from the ECB this week, pushing EUR to fresh highs.
DBS Group (D05) reported 1Q net income of record S$2.57b, +43% YoY beating estimate S$2.26b, underpinned by a surge in lending income due to higher interest rates while fee income declined. Net interest margin was 2.12% vs. est. 1.94%. CEO Gupta sees wealth management and investment banking recovering in 2023 bringing fee income rebound, and sees loan growth of 3-5%. Interim dividend of S$0.42 was declared.
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