Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Summary: We are seeing daily direction changes in US equities, as local cycle support held yesterday and the market rallied smartly, only to fade again in late trading and overnight. Rising crude oil prices are a new source of concern to add to the worst single-day spike yet in natural gas and some European power prices yesterday. As well, rising yields could quickly steal considerable focus after yesterday saw US treasuries selling off yesterday and, somewhat oddly, in Asian hours as well overnight.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - the global energy crunch is also coming to the US with US natural gas prices rising fast. The US 10-year yield has touched levels just above 1.57% this morning reaching highest levels since May. The combined effect is a more negative sentiment in equity futures sliding lower. Yesterday’s session failed to take out the previous day’s high, so if the energy crunch narrative builds today with yields extending their rise, then we could see a renewed sell-off. The VIX futures curve is still in contango and thus the pressure remains low in equities suggesting there is plenty of downside risks in equities. The 200-day moving average in S&P 500 futures are fast approaching the 4,200 level which we see as the next big level to be fought over.
EURUSD – remains relatively heavy as the euro is one of the weakest G10 currencies at the moment, at a loss for a positive catalyst, likely, at least until the political situation in Germany begins to clear up and/or possibly more dynamism in the Euro around the time of the ECB meeting in December. Otherwise, USD direction is likely in the driver’s seat with yields the focus on their latest rise and with a key jobs (and earning) report is up on Friday. Until then, the 1.1700 area is the key resistance for bears looking to take the pair to the next objective toward 1.1500, while the big-picture level is perhaps 1.1290, the 61.8% retracement of the 2020 low to early 2021 high.
USDJPY – extended its comeback yesterday and overnight on the latest move higher in US treasury yields, as the 10-year benchmark notched a new high for the recent cycle. The high water mark for USDJPY is a bit higher, just above 112.00 and the pair is likely to react to any further rise in US yields, particularly with the Friday jobs report and if the USD can get to the other side of the debt ceiling issue without major drama. The next zone above 112.00 extends to the big 114.50-115.00 area that was the range resistance for much of 2017 and 2018.
Crude oil (OILUKDEC21 & OILUSNOV21) trades higher for a sixth day with rising stockpiles being more than offset by the prospect of surging natural gas and coal prices (see below) driving an estimated 0.5 million barrels/day increase in demand for crude oil products. A development that on Monday left traders rattled by the OPEC+ decision to continue its gradual increase in supply. However, Saudi Aramco’s decision to cut its premium to the lowest since March on its November sales to Asia could indicate the market not being as tight as prices are signaling, potentially raising the risk of a correction.
Gold’s (XAUUSD) link to other market developments looks increasingly broken with the metal struggling to find a bid despite the continued surge in costs seen through higher prices from crude oil and gas to cotton. Yesterday, breakeven yields on US treasuries finally jumped in response to the recent surge in energy prices, but gold nevertheless ended lower on the day despite support from falling real yields as inflation expectations rose. Support today at $1748 with resistance being the 21-day moving average at $1765.
Non-farm payrolls and inflation expectations might add to a bearish bond market, but the debt ceiling crisis will keep 10-year US Treasury yields rangebound (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, the debt ceiling crisis is causing significant volatility in money markets, underpinning the long part of the curve as investors fly to safety. Therefore, we expect 10-year yields to trade rangebound between 1.4% and 1.6% until a resolution of the debt ceiling crisis is reached.
The fast rise in Gilt yields proves that inflation will drive monetary policies going forward (IGLT). Ten-year Gilt yields broke above their 1.07% resistance, entering in a fast area which could take them to 1.2%. The fast move higher in yields has been caused by spiraling energy prices and supply-chain bottlenecks showing that inflation will ultimately force the central bank’s hand into interest rate hikes and tighter monetary policies. In the meantime, Gilts continue to look extremely expensive compared to the UK breakeven rate which is nearly touching 4% for the first time since 2008.
What is going on?
Gas, coal and with that power prices surged higher yesterday on mounting fears that tight supplies in Europe and Asia may struggle to meet rising demand into the winter months. Since China issued its order last week to buy fuels at all costs, the price of European TTF benchmark gas has surged by 30% and at €118/MWh it now trades more than 7 times higher than the long-term average. Coal, the world’s most polluting fuel hit €190 per ton in Amsterdam, a 56% jump during the past month. The unfolding energy crisis in Europe and Asia has lifted crude oil prices on the prospect for substitution, while US natural gas yesterday settled at the highest price in more than a decade.
Five EU nations, including France and Spain, ask EU to take action on natural gas price surge, urging the EU in a joint statement to react immediately to the price spike and to coordinate activity to improve bargaining power. Reuters reported yesterday that the EU is looking into whether Russia is aggravating the natural gas price rise.
UK new car registrations are in free fall. In September, it was down 34.3% YoY versus prior minus 22.0%. This is usually considered as a leading indicator of the UK economy. There is certainly data noise related to the impact of the pandemic. But with inflation skyrocketing and increasing supply chain disruptions in the United Kingdom, we cannot exclude that UK GDP growth will be hit in the coming months.
RBNZ hikes as expected and guides for more hikes to come, although the decision to hike 25 basis points to 0.50% and guidance appeared priced into the forward yield curve, as 2-year NZ rates were little changed after erasing a slight surge in the wake of the announcement. The bank does not believe that the current covid restrictions will “materially change” the medium-term outlook for inflation and employment. The NZD traded slightly weaker versus the Aussie overnight in the wake of the announcement.
US Sep. ISM Services survey beat expectations with a reading of 61.9 vs. 59.9 expected and vs. 61.7, suggesting that the dominant US services sector continues to see powerful expansion. The prices paid index rose 2.1 points to 77.5 and New Orders were up 0.2 points to 63.5, while employment was 53.0 vs. 53.7 in Aug.
PepsiCo Q3 earnings were good. Fiscal year organic growth is expected at 8% vs previous estimate of 6% as the company says global business momentum remains strong. The CFO said yesterday that the company’s first tool to address higher input costs is to raise prices across the board which indicates that companies are now moving into a position of just passing on higher commodity prices.
What are we watching next?
The U.S. ADP private payrolls report for September is out today. The economist consensus expects job creation will reach 430,000 last month. But beware that the two previous readings for July and August were disappointing. Payrolls produced about half of the expected hires. Investors tend to closely look at the ADP report. But this is usually not a good guide for the Labor Department’s nonfarm payrolls due on Friday.
The UK Prime Minister Boris Johnson will take the Conservative conference stage to speak to the nation. The UK is facing a complicated situation: energy crunch and supply chain disruptions due to Brexit. On the same day, about 4.4 million households will see their incomes fall as the government implements a big cut to Universal credit – a welfare scheme for individuals out of work or on low income. Johnson will also speak on the need for a “high wage, high skill, high productivity” economy, blaming low pay and excess prior reliance on cheap imported labor for lorry drivers, for example. It is an interesting populist twist on the converging issues impacting the UK economy.
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 bar 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 and pace of the tapering, in our view.
US debt ceiling showdown – a third vote – likely today – in the Senate on a bill to suspend the debt ceiling through December of next year looks set to fail, and keeps the suspense high on how the US can raise the debt ceiling, with Democrats said to be considering an “exception” to the 60-vote filibuster rule in the Senate that prevents measures from passing that don’t have at least 60 votes in favour of the bill. The US Treasury has said it will run out of emergency measure room on October 18.
Earnings Watch – Tesco has already reported 1H results before the market open with results in line with estimates but is cutting its semi-annual dividend by 21% a sign of a weaker outlook and requirement for more investments.
Economic calendar highlights for today (times GMT)
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