Summary: Asian stocks and US equity futures pared earlier gains following a post July 4 holiday jump on news the US may announce the rollback of some Chinese tariffs this week to counter high inflation. Souring the sentiment somewhat was a renewed jump in US treasury yields, following last week’s recession-led slump, weighing on the Japanese yen which is getting back to test the critical 137 levels. AUDUSD trades calmly after RBA, as expected, raised rates by 50bps rate. US data watch resumes with focus on factory orders and durable goods orders for May.
S&P 500 futures continued their gains throughout yesterday’s session during a closed cash session due to the US Independence Day closing at 3,827. Momentum is continuing this morning in early European trading hours with S&P 500 futures trading around the 3,845 level which is the mid-point between the recent high and low. The levels to watch on the upside are 3,870 and 3,900 with the US 10-year yield being the important driver to watch as a push higher again towards 3% could stop the momentum in US equities.
Stocks traded in the Hong Kong and mainland China bourses initially got a lift form the WSJ report on President Biden’s inclination to reach a decision to relax some tariff on goods form China as early as this week. It was also reported that China’s Vice Premier Liu He had a video call conversation with U.S. Treasury Secretary Janet Yellen on the global economy, global supply chains and U.S. tariff on Chinese goods. Caixin Services PMI, came at a much better than expected reading of 54.5 for June (vs Bloomberg consensus: 49.6; May: 41.4), returning to expansionary territory. The risk of resurgence of Covid-19 cases however continued to hang over sentiment. For July 4, 335 cases of locally transmitted cases were reported in mainland China.
President Biden’s announcement on possible relaxation of China tariffs helped take the focus off recession concerns and risk sentiment improved. US Treasury yields pushed higher with 10-year back to 2.95% and 2-yaer up at 2.92%. This weighed on the yen as well, and USDJPY surged back higher above 136, getting back in close sight of 137 which has been tough to penetrate so far. US Treasury Secretary Janet Yellen will be in Japan next week, there remains a possibility for discussion on currency intervention. Still, looking at the path of US inflation ahead of the midterm elections, it is hard to believe that option being taken up in a coordinated manner.
EURUSD has been stable around the 1.0440 area. However, Germany’s first trade deficit since 1991 highlights the scale of the headwinds faced by the Eurozone in general. Given the nature of Germany’s exports which are commodity-price sensitive, it remains hard to imagine that the trade balance could improve significantly from here in the next few months given the expected slowdown in the Eurozone economy. Meanwhile, high energy prices will continue to take a toll on the trade balance as well, and possibly dampen the sentiment on EUR. EURUSD is likely to find it tough to go above 1.0500 in a sustained manner, and focus is therefore on the 1.0350 support.
The commodity currency fluctuated overnight with the expected 0.5% rate hike from the RBA having a limited impact. The softer tone into the European session being driven by general dollar strength and the current downward price pressure on and demand for Australia’s biggest export, iron ore. If the USD continues higher, the AUD may meet its next level of support, 0.6816, and if that level breaks, the next level of support for the AUDUSD is at 0.6500. Currently, the big picture of the AUD is bearish, given demand for Australia’s biggest export, iron ore, is not likely to pick up any time soon.
Crude oil trades steady as the battle between recession fears and tight supply from sanctions and lack of investments keep the market stuck in a relative tight range compared with the weakness seen across the industrial metal and agriculture sectors. A recent softening in refinery margins, the so-called crack spreads, do however point to some easing in the otherwise bullish outlook for the sector. However, crude oil time spreads remain deeply backwardated, supporting the tight supply outlook narrative. At this point, Brent crude oil remains stuck in a wide but slowly narrowing range, and has spent the past few days pivoting around the 50-day moving average, currently at $113.9/bbl
Dutch TTF gas (TTFMQ2), the European benchmark surged above €160/MWh on Monday, thereby extending a rally which resumed last month following an explosion at Freeport LNG in Texas, a major US export hub and after Russia’s Gazprom cut supplies to Germany through its Nord Steam 1 pipeline. Developments that have left many utilities scrambling for supplies that needs to be bought at punitively high prices in the spot market, thereby raising the risk of bankruptcies and recession. Strike action at several fields in Norway starting today and the risk of Russia keeping Nord Stream 1 closed following upcoming seasonal maintenance all adding the risk of storage levels not being filled to the level required to avoid a winter of blackouts and restrictions on consumption.
The US 10-year yield is opening up higher this morning at 2.93% as better than expected PMI figures from China and higher than expected inflation figures in South Korea are bolstering the inflation trade this morning sending US bond yields higher. The 50-day average is sitting just below the 3% level and a push above this level is important for the inflation trade.
What is going on?
The bank will continue to hike rates over the coming months and even stands ready to act between meetings after saying; ‘the size and timing of future interest rates increases will be guided by...incoming data…and the outlook for inflation and the labour market’. The RBA expects unemployment will fall to new record lows, while wage growth is expected to rise over the coming months. As it stand the RBA expects YOY inflation to hit 7%. Updated forecasts will be released after June quarter CPI data is published next month. Intertest rate futures price in official interest rates could sit at 3.2% at 2022 end. But we lean towards official rates being closer to 4%
Japan’s labor cash earnings were up only 1% y/y against expectations of 1.5% y/y, with real cash earnings down 1.8% y/y. That means the inflation pressures we have been seeing lately are not creating a feedback cycle to wages, and consumption will likely remain subdued. This gives more reasons to Mr. Kuroda to justify the accommodative policy for the Bank of Japan which is a complete divergence to the global tightening regime we are in currently.
Headline CPI for June came out at 6% y/y from 5.4% y/y in May. This was the fastest pace since November 1998, despite subsidies and price caps, suggesting that more outsized rate hikes are possibly coming to Asia as well. Bank of Korea’s rate decision is due July 14, and the bank may need to consider a 50bps rate hike to 2.25% to fight inflation pressures after five hikes of 25bps each have been announced so far. While growth remains strong in the region, aggressive tightening would mean some slowdown is likely in the months ahead.
According to Spiegel information, the federal government is now creating the legal basis for taking over energy companies. The draf is said to have already been agreed with the factions of the traffic light coalition. This officially aims to regulate financial aid up to and including a state entry in order to be able to avert the bankruptcy of a gas supplier. Germany is facing a tough time. The country’s natural gas storage occupancy is rather low compared to other European countries, at 62 % against 97 % for Portugal, for instance. If the next winter is very cold, expect supply issues in Germany and certainly in many other European countries.
In May, it reached €1bn. This is not surprising. Export-oriented economies suffer from the rise in the price of imported goods. On top of that, the economic outlook weighs on the demand for exported goods thus generating a negative effect on growth. This is not worrying at this stage.
The Scandinavian airliner is filing for chapter 11 bankruptcy for the second time in two years as the failed negotiations yesterday with a labour union representing 1,000 pilots failed. The airliner must raise more capital, convert existing debt into equity, and lower costs with its employees to become financially sustainable again as the airliner is currently operating with revenue about SEK 10bn below its level befor the pandemic.
The US services sector PMI figure has declined from 62.3 in December to 55.9 in May suggesting the US economy is cooling but still running strong. Figures for June are released tomorrow, and economists are looking for a further slowdown to 54 and a downside surprise would bolster the current safe haven flows and recession fears.
It happens rarely but this week has no important earnings but the Q2 earnings season start next week with companies such as PepsiCo, Fastenal, Delta Air Lines, JPMorgan Chase, Morgan Stanley, Conagra Brands, PNC Financial Services, UnitedHealth, Well Fargo, Charles Schwab, US Bancorp, BlackRock, State Street, and Citigroup.
Titled "The Runaway Train” and can be accessed here
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