Summary: After celebrating the injection of liquidity from the Bank of England on Wednesday, global markets swooned again yesterday, taking the major US indices. Elsewhere, sterling has recovered most of the lost ground since the announcement of last week’s tax cuts on the stabilization of the gilt market, with other major sovereign yields also easing lower. The drop in yields and a consolidation in the US dollar have supported gold, which is poking higher toward important resistance.
US equities traded lower yesterday after hawkish remarks from Mester and Bullard that policy rates will stay higher for longer than what the market is expecting (pricing in). In addition, the market is increasingly at edge with the expectation that Russia will annex four regions of Ukrainian territory because the fear is that it could escalate the war to new levels. Nasdaq 100 futures are most sensitive to the hawkish Fed messages and tumbling growth outlook, so watch this index going into the weekend. Nasdaq 100 futures are trading around the 11,265 level this morning and 11,000 is naturally the big next level on the downside in case selling resumes into the weekend.
Hong Kong and mainland China markets were treading water ahead of the week-long National Day golden week holiday. Chinese developers rallied to recoup some of the recent losses following PBoC’s supportive statement coming out of its quarterly monetary meeting saying that the central bank will expand its special lending program to ensure the delivery of delayed housing projects. Country Garden (02007:xhkg) rebounded 10% after plunging 11% yesterday. Chinese EV maker, Zhejian Leapmotor (09863:xhkg), tumbled another 11% after having tumbled 33.5% yesterday on its first day of trading. Other Chinese EV names traded in the Hong Kong bourses plunged from 2% to 9%.
The weak US dollar suggests that the market was more focused on rising US treasury yields during the recent upswing than the accompanying risk sentiment deterioration: yesterday, the USD weakened sharply as yields were flat to lower while risk sentiment was in the dumps. Hard to tell if some end-of-month/quarter rebalancing through today might be in play as well. A proper reversal of the recent USD bull move would require far more weakness, for example: EURUSD back above the 0.9900-0.9950 area and AUDUSD above perhaps 0.6700 (more on GBPUSD below). Next week features a full line-up of key US macro data and should bring a test of the USD’s status.
Too early to draw conclusions here, as sterling has not yet recovered sufficient ground in the most important EURGBP and GBPUSD pairs to suggest that we have seen a climax reversal, although overnight, GBPUSD did reverse the entire plunge sparked by the announcement of the special budget last Friday by Chancellor Kwarteng, which started around 1.1200. Arguably, a close above 1.1200-1.1250 suggests a chance over reversal, though really 1.1500 was a more significant starting point for the recent slide. For EURGBP, the key support/pivot zone is 0.8750-0.8700. While there was nothing specifically supportive about the Bank of England’s emergency QE, if the logic is that the BoE saved the system from a financial crisis and that the exercise demonstrated that quantitative tightening will prove impossible elsewhere eventually (and therefore the BoE is only the first of many), sterling’s situation looks less bad if other central banks eventually follow suit.
Gold continues to rebound from key support at $1615 with the focus now being the critical resistance zone into 1,680-1,700 that is the departure point for this latest bear market move. While global bond yields and the USD will continue to lead the way as coincident indicators, the market has held up relatively well with geopolitical concerns (Putin’s N threat) and investors increasingly worried the FOMC with its hawkish actions may break the currency and bond market. Some signs of that were seen this week with some extreme moves in local bond and currency markets. Speculators hold a rare net short in COMEX gold futures and any further strength will trigger short covering, while total holdings in ETFs backed by bullion have declined to a 30-month low.
Crude oil is heading for its first albeit small weekly gain in five and the first quarterly drop since 2020. The market remains troubled by forces pulling prices in opposite direction, and while the strong dollar, surging yields, and continued lockdowns in China have raised demand worries, the risk to supply continues to be a supporting theme. That focus returned on Thursday when OPEC+ said a production cut would be discussed at next week's meeting with Russia proposing a 1 mln barrels per day cut, a reduction towards which they are unlikely to contribute much as they are already producing below their quota. In addition, the combination of Russian sanctions and embargo and the US pausing its sales from strategic reserves will continue to dampen the downside risks.
US treasury yields remained calm yesterday as we can infer that the recent wild ride in UK gilts had triggered contagion into US treasury yields, likely aggravating the recent rise toward 4.00% for the 10-year treasury benchmark before the BoE’s emergency efforts took major sovereign yields back lower. US macro data next week, including the ISM surveys and the September jobs report next Friday, will be key for the direction in US yields, with the major 3.50% level, the June high, the key downside pivot point.
Apple shares ended the day nearly 5% lower, helping to drag the broader market lower as it is world’s largest company by market capitalization. A Bank of America analyst cut the rating on the company to “neutral” from “buy”. Apple’s demand is hurt by the cost-of-living crisis and the earnings outlook last night from the chip manufacturer Micron Technology is indicating that demand is coming down fast.
Cleveland Fed president Loretta Mester (voter this year) remains more hawkish than the Fed’s median dot plot and said that rates are not in restrictive territory yet and more rate hikes will be needed. No signs of concern on economy or dollar strength were noted, while inflation remained the key point of concern for her. St. Louis Fed president James Bullard, likewise a voter this year, said it was a ‘bad idea to mess’ with the inflation target while labor market conditions remain tight and recession is only a risk. San Francisco Fed president Mary Daly (voter in 2024) was more cautious, saying officials should work to avoid "inducing a deep recession." However, she still raised the bar on expectations on the Fed funds rate saying that she is comfortable with median Fed rate path projection of 4%-4.5% by year end, 4.5%-5% in 2023 (pointing to upside risks as the dot plot suggested 4.6%, or 4.5-4.75% if we talk in ranges).
The September eurozone inflation will be released today. Expect a new record which will increase the pressure on the European Central Bank to hike interest rates by at least 75 basis points in October. The economist consensus expects that the headline harmonized index of consumer prices (HICP) will reach 9.7 % year-over-year against 9.1 % in August. The core rate is expected to climb to 5.6 % year-over-year against 5.5 % previously. The spread between the headline and the core inflation figures is mostly explained by a decrease in oil and natural gas prices in recent months. However, this is clear that inflation is becoming broad-based, including in the services sector. This means that inflation is here to stay for long. The HICP is likely to continue increasing in the coming months. A peak in inflation in the eurozone is possible in the first quarter of 2023, in our view. This is much later than in the United States.
H&M delivered a big miss yesterday on operating profit as input costs surprised to the upside. H&M is starting charging for online returns to save costs and the demand in China is still weak due to H&M’s challenging position in the country. Nike surprised positively on revenue but missed on earnings against estimates as margin compression has begun, and the company’s inventory is building up fast creating a potential headache going forward as consumer demand is expected to decline in the coming quarters. Micron delivered a shocking outlook for the current quarter with revenue expected at €4-4.5bn vs est. €6bn.
CEE currencies are under significant pressure since the news of the pipeline explosions this week – this was likely triggered by the sabotage of the Nord Stream pipelines to Germany, which could be a prelude to the cutting off of other pipelines from Russia. EURHUF has pulled above 420 for the first time ever, EURPLN yesterday spiked to the highest level since the timeframe just after the breakout of war in Ukraine. Hungary continues to not support new sanction efforts against Russian energy imports. In Prague, protests have broken out against the country’s energy policy, while EURCZK remains sedated by heavy Czech central bank intervention.
Initial claims came in lower than expected at 193k with last week’s also revised lower to 209k from 213k. Continued claims cooled to 1.347mln from 1.376mln despite the expected rise to 1.388mln. The data shows how tight the labour market is in the US and Fed's Bullard labelled today's claims metric as "super low". Meanwhile, the third estimate of Q2 GDP was confirmed to decline 0.6%, notably with consumer spending revised higher to 2% from 1.5% previously.
Aluminum prices on the London Metal Exchange briefly jumped by a record 8.5% on Thursday before retracing lower. The sudden burst which to a minor extent was replicated in zinc and nickel was driven by a Bloomberg report saying that the LME as an option is looking into whether and under what circumstances they might place a ban on Russian metal being cleared via the exchange. Any such move by the LME to block Russian supplies could have significant ramifications for the global metal markets given their importance as a supplier of the mentioned metals, which to a smaller extend also includes copper.
What are we watching next?
UK Prime Minister Liz Truss and Chancellor Kwarteng will meet with the Office of Budget Responsibility today for emergency talks before they receive the first draft of fiscal forecasts from the OBR next week. The recent crisis in the UK gilt market and downward spiral in sterling could elicit a response and possible backtracking on some portion of the recent policy announcement, although Truss said as recently as yesterday that she will stay the course. The most recent YouGov political poll release yesterday shows the Conservatives trailing Labour by a whopping 33 points, the largest gap since the 1990’s.
Election in Brazil at the weekend
Brazilian voters go to the polls on Sunday, with left-leaning former president Lula leading strongly in the polls over the incumbent right-populist Bolsonaro, but with many fearing the risk of disorder and violence as Bolsonaro has already made claims of election fraud and has hinted at not wanting to leave office. A run-off election between the two candidates will be held on October 30 if neither gets more than half the popular vote this weekend. The Brazilian real is at the weak end of the recent range versus the US dollar.
The data point is for August and comes nearly three weeks after the BLS CPI data for the month. It will likely echo the same message as given by the last strong CPI number which has made the Fed even more hawkish in the last few weeks since the Jackson Hole. Headline numbers may be lower due to the decline in gasoline prices, but the price pressure on services side will likely broaden further. At last week’s FOMC meeting, the Fed also raised its forecasts for inflation, with the central bank now seeing core PCE at 4.5% by the end of this year (it previously projected 4.3%), moderating to 3.1% next year and at 2.1% at the end of its forecast horizon in 2025, but thinks that headline PCE prices will be at its 2% target by then.
Today’s earnings release to watch is from Carnival which is expected to deliver strong results but there are significant downside risks to the outlook from fuel costs, staffing costs and the cost-of-living crisis hurting disposable income.
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2024: The wasted year
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.
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.
