Summary: US equities rebounded from new lows on Friday in an attempt at a reversal ahead of an important week for US data, including the Friday jobs report for September. Today, the US Trade Representative Katherine Tai is set to speak on the status of the US-China trade relationship and whether the latter is living up to the terms of the deal struck under the Trump Administration as well as providing possible hints on the approach that the Biden Administration will take on the issue.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - S&P 500 futures are weaker this morning in European trading despite a strong rally on Friday. Sentiment is weak in Hong Kong trading despite clear signs of a restructuring is taking place in Evergrande. With power prices in Europe pushing higher and natural gas in the US being bid the equity market will likely continue to be in risk-off mode. The key support level in S&P 500 futures on the downside is 4,300 and the 4,365 level is the key resistance level on the upside.
EURUSD – EURUSD broke down through key levels last week, including the prior lows for the year at 1.1664 and has even tested below the 1.1600 area lows from around the US election time frame in November of last year. Plaguing Europe are the energy crunch and uncertainty on the political front as the difficult task of building a governing coalition in Germany is underway after the election. In the euro’s defense, ECB rate expectations out the curve into 2024-25 have actually shifted more consistently higher since late August than they have for the US. The next focus area to the downside in EURUSD is likely 1.1500, while 1.1650-1.1700 is now resistance.
EURGBP and GBPUSD – the US dollar ended last week on a weak note on the comeback in risk sentiment, but sterling seemed to be doing its own thing as it rallied hard on Thursday and Friday without notable correlation with swings in sentiment. The move reversed nearly all of the rally in EURGBP earlier last week, while GBPUSD rallied back toward the key break level around 1.3600 - the real test for whether sterling can dig itself out of a newfound funk on concerns that it is isolated in vulnerable due to the energy crunch and capacity constraints in its economy, including labor shortages and supply chain issues.
Crude oil (OILUKDEC21 & OILUSNOV21) trades near the recent high ahead of today’s OPEC+ meeting where output levels for November will be discussed. The current energy crunch in global coal and gas prices may boost oil demand by 500,000 barrels a day this winter due to substitution demand for diesel, propane and gas oil. With oil already trading at $80 it has raised speculation of a bigger than the planned 400,000 barrels a day increase, not least considering that OPEC’s own model is showing a supply deficit over the next few months.
Copper (COPPERDEC21) once again managed to bounce from key support in the $4 per pound area on Friday after stronger than expected US Factory data helped reduce worries about weakness in Chinese demand as it battles power cuts and property sector problems. Precious metals also managed to bounce since Friday, as the dollar and yields steadied. In the US, the personal consumption expenditures price gauge showed the strongest yearly rise in 30 years while the current energy crunch has raised global inflationary pressures. In gold (XAUUSD) we focus on the 21-day moving average, today at $1770, for any signs of renewed upside momentum.
Non-farm payrolls are a focus this week for the bond market as they could foster bearish sentiment (IEF:xnas, TLT:xnas). 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. However, a weak job report is unlikely to cause a massive drop in yields for the simple reason that inflation is now driving the Fed’s agenda. Yet, if the Fed remains dovish, a bear-flattening of the yield curve will indicate that the market is pricing a policy mistake. Another reason for the yield curve to bear flatten is the debt ceiling issue, which is driving money market yields well above the RRP facility rate.
What is going on?
Worrying European data. September EZ inflation hit 3.4% yoy. This is a 13-year high. Prices of food, alcohol and tobacco were up 2.1% (fresh food were up 2.6%) and energy jumped to 17.4%. Core inflation (excluding volatile components such as fuel and food) accelerated to 1.9%. All of this does not look « transitory » in our view. But you can always argue the duration of the « transitory » period. This is something that central banks will do, perhaps. Expect EZ inflation to climb higher by year-end given risks related to energy crunch in Europe and persistent supply chain disruptions. In Germany, August retail sales disappointed at 1.1% mom, following a revised 4.5% decline in July. Retail sales are still 5% below the pre-pandemic level of February 2020.
Challenging US-China relations. The US State Department criticized Chinese military flybys that over the weekend entered Taiwan’s air defense identification zone as Beijing sent almost 100 military flights as it celebrated the anniversary of the founding of the PRC, according to Taiwan. Washington called the moves destabilizing and “provocative”.
Evergrande shares suspended. The suspension of shares is due to an ongoing restructuring with the news today that one of China’s real estate developers Hopson Development plans to acquire a 51% stake in Evergrande Property Services which is a profitable unit in the Evergrande group and can thus potentially raise capital for Evergrande. The interpretation among investors is for now negative with Hang Seng futures trading lower in today’s session.
US Progressive Democrats offer to negotiate smaller social- stimulus bill - after the failure to bring the smaller $550 billion infrastructure bill to a vote in the House last week as the votes were not there (progressive Democrats had demanded linking the bill to a larger $3.5 trillion social- and climate spending bill that moderate Democrats want to shrink). A new deadline for passing the infrastructure bill has been set for October 31 by House Speaker Pelosi, while some suggest that the progressives are willing to discuss a reduction of the larger stimulus.
What are we watching next?
The U.S. nonfarm payrolls September report is out on Friday – In recent weeks, high-profile FOMC members (Chair Jerome Powell and Vice-Chair Lael Brainard, for instance) have lowered the bars for the September job report regarding a QE tapering announcement. They consider the September job report may be weaker and less informative of underlying economic momentum than they had hoped. Therefore, the report should not have many consequences for a QE tapering announcement. We still expect the Fed’s tapering to be announced in November, with an effective start in December. What will really matter is the composition of the tapering, in our view.
US Trade Representative Katherine Tai to deliver speech on US-China trade relationship. This is seen as the Biden administrations first major assessment of the status of the trade deal signed under the Trump administration and whether the US will seek new policy initiatives as sources, according to at least one article from CNBC, suggest that Tai will announce that China is not living up to the terms of the agreement.
New Zealand and Australian central banks meet this week - an interesting test for the AUDNZD cross this week on the differing approaches to the virus (NZ extending lockdowns, although it appears both are admitting that Zero Tolerance doesn’t work) and as the RBA meets tonight and the RBNZ on Wednesday. The RBA has continued to insist on its dovish guidance, with the anticipation that conditions for a rate hike will not be present until 2024, but a macroprudential focus on financial stability risks linked to housing could be a new policy focus. The RBNZ clear intent to hike rates will once again be put to the test due to new virus lockdown efforts after a virus outbreak derailed the intent to hike for the first time for the cycle back in August.
Chinese mainland markets are closed through Thursday this week for Golden week which comes at an interesting time with the huge policy shifts there and ongoing energy crunch, the Evergrande story and today the speech from USTR Katherine Tai noted above, which could take the US-China trade relationship higher on the agenda. China returning from the holiday on Friday could prove pivotal. It should be noted that the Hong Kong exchange on which many mainland companies trade is open all of this week.
Earnings Watch – last week before the Q3 earnings season starts in the US with US financials providing the first glimpse of the economy and earnings power. But even more importantly the outlook of consumer and manufacturing companies will be the key focus given the ongoing pressures in commodity prices.
Economic calendar highlights for today (times GMT)
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
