Summary: Unexpectedly strong US GDP, durable goods, and jobless claims data saw bond yields higher, weighing on stocks. EUR and GBP fell around 1% after a much anticipated 25bp rate hike from the ECB that turned to data-dependent and open to skipping a hike in September. The Bank of Japan tweaks its yield curve control policy and effectively allows long-term yield to move above the upper bound of the YCC range. Today’s data focus will be the core PCE deflator and employment cost index in the US.
Equities ended its rising steak with the S&P500 declining 0.6% to 4,537 while the Nasdaq 100 sliding 0.2% to 15,464. A series of unexpectedly strong economic data saw the 10-year Treasury yield jump to 4%, weighing on stocks. The weakness was broad-based except in the communication services sector which was supported by a 4.4% in Meta Platforms (META:xnas) after reporting strong Q2 results.
Lam Research jumped 9.3% after the semiconductor equipment maker guided strong sales growth. Textron (TXT:xnys) soared 11.9% following the aerospace company beat earnings and gave an upbeat outlook citing higher pricing for business jets. Royal Caribbean (RCL:xnys) surged 8.7% on a higher profit forecast for 2023. McDonald’s (MCD:xnys) added 1.2% after an earnings beat despite noting growth slowing.
Banking shares declined, seeing the KBW Bank Index falling 1.2% as the Federal Reserve and the Federal Deposit Insurance Corp (FDIC) held meeting to consider a plan to require additional capital at large banks.
After a dovish and well-anticipated rate hike by the ECB which turned data-dependent for its next move, EURUSD plunged nearly 1% to 1.0980. The rise in US Treasury yields on strong economic data also weighed on EUR. Likewise, GBPUSD declined by 1.1% to 1.2790.
On the other hand, the Japanese Yen strengthened by 0.7% against the US dollar from Wednesday New York to 139.20 after the Bank of Japan (BOJ) made a tweak to its yield curve control policy and potentially allow the 10-year Japanese Government Bond yield to rise above the official upper-bound of 0.5% to as high as 1%.
Treasuries sold off on Thursday first stemmed from unexpected increases in the Q2 GDP and durable goods orders and a decline in the initial jobless claims, all suggesting a more resilient US economy than expected. Later on an increase in pending home sales, contrary to the consensus forecast of decline, and a Nikkei story saying the BoJ will discuss broadening the cap on the 10-year JGB yield (adjusting the YCC policy) further weighed on Treasuries prices. Finally, a poorly received 7-year auction that was awarded at 1.2bps cheaper than the level at the auction deadline and a 2.48 bid-to-cover (vs previous 2.65) added fuel to the selling. The 2-year yield finished the day 8bps higher at 4.93% while the 10-year yield jumped 13bps to 4.0%.
The German yield curve bull steepened yesterday as the ECB hinted to a September pause. Yet, another rate hike in the fall remains at play, as bond futures are pricing the possibility for a ECB peak rate at 4%. That means that although German yields might adjust lower in the short term, a further bear flattening is likely as 2-year Schatz move towards 3.5%. Today’s German CPI figures remain in focus as a surprise on the upside might show that the ECB is not done with hiking. Long-term EU sovereign bond yields are moving higher as the BOJ surprised with changes to the rate ceiling.
The ECB raised policy rates by 25bps, as widely anticipated. The statement changed to saying rates will be “set at” sufficiently restrictive levels rather than previously saying “brought to” sufficiently restrictive levels. At the press conference, ECP President Lagarde’s message was that the ECB’s next move would be data-dependent, especially on the incoming data about domestically generated inflation and services inflation while some other measures of inflation showed signs of easing. She said the incoming data will determine “whether and how much more ground” for future rate hikes to cover. Lagarde opened the door to skip a rate hike at the upcoming meeting in September as the Fed did in June.
While the BOJ maintains its +/- 50bps allowable range of deviation from zero for the 10-year Japanese Government Bond (JGB) yield, the central bank says that it will be flexible and the 0.50% previous yield cap will from now only be a reference, not a cap on yield. Further, the BOJ said it will offer to buy 10-year JGBs at 1% every business day. After the change, the BOJ has discretion to allow the 10-year JGB yield to go above 0.5% but not higher than 1%. In effect, the cap has been raised from 0.5% to 1.0% despite the official allowable range stays. The nine-member board voted 8-1 in favour of the change.
The US Q2 GDP unexpectedly grew 2.4%, rising from 2.0% in Q1 and contrary to the forecast of a decline to 1.8%. Durable goods orders increased 4.7% (vs 1.8% in May; consensus: 1.3%) in June on strong aircraft orders. The weekly initial jobless claims fell to 221k from 228k, contrary to an expected increase.
The focus of today’s data from the US will be on the Personal Consumption Expenditure (PCE) deflator and the core PCE deflator, both are expected to slow in June. According to the Bloomberg survey, the median forecast of the growth in the headline PCE deflator is at +0.2% M/M (vs +0.1% in May) or +3.0% Y/Y (vs +3.8% in May) and that of the core PCE deflator is at +0.2% M/M (vs +3% in May) or +4.2% Y/Y (vs +4.6% in May). One important to note is that some of the drivers for a soft core CPI we saw earlier this month were not present in the core PCE. For example, the core CPI captured a sharp decline in airline fares while the core PCE used a different measure of passenger transportation costs in its calculation. Core PCE deflator is the Fed’s preferred measure of inflation.
The growth in the employment cost index (ECI) is expected to slow to +1.1% Q/Q in Q2 from +1.2% in Q1. The ECI includes stickier components such as non-wage benefits and government wages so it may lag some other measures but it is the preferred measure of wage inflation of the Fed.
Also scheduled to release today is the University of Michigan consumer sentiment survey. The median forecasts for the sentiment reading to remain at 72.6 while the 5-10 year inflation expectation softens to 3.0% in July from 3.1% in June.
Earnings this week:
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
