Summary: As Q2 ends, recession fears have been overpriced by the markets while Fed’s inflation focus has taken a step-up. This will likely mean a very different H2, with bonds likely gaining relevance again. China’s relaxations and support measures, while unlikely to be consistent, will send a positive impulse to economy and markets. USDJPY is back at record highs despite a retreat in US Treasury yields, setting a stage for markets to test Bank of Japan’s resolve yet again in Q3. OPEC+ meeting in focus, although a positive surprise remains unlikely.
APAC equities were in the red for the day, even as China’s PMI rebound added a flare or optimism in the region. Lower treasury yields meant some gains in tech stocks like Apple and Microsoft but semiconductors stocks were lower as Bank of America warned that chip demand will be weaker which led to declines in NVIDIA and AMD.
China’s CSI300 (000300.I) led the region with gains of 1.3% even as President Xi’s reiteration of sticking to zero Covid policy dented some optimism on the relaxation of quarantine requirements. There is however little doubt that China will focus more on reviving economic growth as a key political event is ahead, and that will mean a positive impulse to the markets. Hang Seng Index (HSI.I) also followed higher with 0.2% gains.
Japan’s Nikkei (NI225.I) fell close to 1% as semiconductor stocks led the index lower. Singapore’s STI (ES3) was down 0.3%; NIO recovered slightly in Singapore after a plunge yesterday on accusation by Grizzly Research for inflating revenues. Australia’s ASX 200 was in losses of 0.85% as banking and mining stocks dipped.
The DXY index rose above 105 again overnight despite the 10-year Treasury yields dipping below 3.1%. EURUSD plunged below 1.0500 to lows of 1.0433 as German inflation cooled but Spanish HICP touched 10% levels coming in above expectations. The lack of a fragmentation tool may limit the ECB to a 25bps rate hike in July, meaning more pressure on EUR. USDJPY touched the key 137 level overnight, printing a new 24-year high. Thursday brings announcement of BOJ's quarterly bond purchase plan for July-September, which may likely be revised higher as BOJ’s resolve on yield curve control continues to be tested. Tokyo inflation for June is also due on Friday.
Crude oil came under pressure again overnight and may be looking at its first monthly decline since November, although both WTI and Brent are on track to close the week in gains. We believe demand destruction fears have been over-priced by the markets and the focus will shift back to supply constraints. OPEC+ meeting today will confirm the supply plans until September, but major oil producers led by Saudi Arabia and Russia are expected to stick to a previously decided output boost. It will be hard to get a positive surprise from the meeting given that the current production targets have also not been met.
Fed Chair Powell said the job for policymakers is to find price stability even during the new forces of inflation and that a reversal of globalisation could mean lower growth in place, while he added the US economy is in strong shape and can withstand monetary policy moves. Powell added the aim is to have growth moderate and there is a risk that the Fed could go too far but it is not the largest risk as the biggest risk would be a failure to restore price stability. Meanwhile in a separate speech in another event, Cleveland Fed President Mester (FOMC voting member) said she supports a 75bps hike in July if econ conditions stay unchanged.
June Manufacturing PMI came at 50.2, marginally back to the expansionary territory and below expectations (Bloomberg consensus: 50.50, May: 49.6). At 54.7, non-manufacturing PMI however beat expectations nicely (Bloomberg consensus: 50.5, May: 47.8), with the service sector sub-index at 54.3 and the construction sector sub-index at 56.6, both showing notable improvements from last month. Reopening of Shanghai and release of pent-up demand contributed significantly to the recovery in the service sector.
Japan’s bond traders are still testing the BOJ’s resolve on the yield curve control, even as US Treasury yields turned lower. Super long yields (30year) are still running higher and the yield curve is the steepest since 2016. The BOJ’s bond buying schedule for Q3 will be closely watched today, but greater risks are seen from US data coming out on the stronger side and ruling out the scenario of a deep recession, which would mean US Treasury yields will go higher again and make things ugly for the BOJ yet again. But more than the bond markets, focus of Gov Kuroda will be on the stickiness of Japan’s inflation and that could be a trigger point for BOJ to capitulate. Certainly one of the things I am watching going into Q3.
The battle between recession fears and inflation concerns continued to escalate. U.S. Q1 GDP was revised further lower to -1.6% from -1.5% but Chair Powell is now getting more aggressive to fight inflation, and it and appears they will do that even if the economic slowdown worsens. It may start to make more sense to consider bonds in this situation as H2 will likely bring more Fed tightening but also more slowdown fears. iShares 20+ Year Treasury Bond ETF (TLT) is on track for its third weekly gain and up over 5% since June 16 low.
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2024: The wasted year
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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.
