Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Summary: The Bank of Japan maintained its ultra-loose monetary policies, seeing USDJPY surging over 1% to 141.95. The S&P 500 secured its fifth consecutive weekly gain but dipped modestly on Friday ahead of the long weekend. Treasury yields rose amid hawkish Fed comments. US markets are closed for a holiday on Monday. Hang Seng and CSI300 continued upward momentum on China's rate cuts and additional stimulus optimism. Grain prices soared on concerns of draughts caused by El Nino.
The S&P 500 index exhibited an impressive feat by securing its fifth consecutive weekly gain, marking its longest such streak since the autumn of 2021. However, on Friday, the S&P 500 encountered a slight setback, shedding 0.4% to 4,409 amidst an enormous $4.2tn options expiry and ahead of a long weekend with the market closes on Monday for a public holiday. The VIX, which measures the implied volatility of the S&P500, dipped to 13.5, reaching a new 3-year low. Within the S&P 500, the majority of sectors declined, with the exceptions of utilities, materials, and consumer staples, which managed to register modest gains. Nasdaq 100 declined 0.7%, settling at 15,083.
U.S. Treasuries extended the month-long bear-flattening trend on Friday as the shorter-term maturities faced selling pressure due to hawkish comments made by Fed officials Waller and Barkin. However, there was a brief period of buying activity in the 2-year segment following a significant drop in inflation expectations for the 12 months ahead, down to 3.3%. Despite this, the buying momentum faded, resulting in a 7bp increase in the 2-year yield, which ended at 4.71%. The 10-year yield, on the other hand, saw a more modest increase of 4bps. Consequently, the yield curve between the 2-year and 10-year maturities flattened, reaching an inverted level as low as -98 before recovering to -95, marking the most inverted level observed since the collapse of the Silicon Valley Bank in March. Currently, the market is indicating a 71% probability of a 25 basis points increase in the Fed Fund target rate taking place in July. The Treasury market closes today for the Juneteenth holiday.
Following the rate cuts by China's central bank last week which reinforced investor confidence and expectations of further stimulus measures, the Hang Seng Index and CSI300 continued to advance, The Hang Seng Index saw a 1.1% increase on Friday, contributing to a month-to-date rally of 9.9%, which fully recovered the losses experienced in May. However, there were net sales of HKD9.6 billion in southbound flows from mainland China to Hong Kong, marking the largest southbound net selling of shares in Hong Kong by mainland investors in over two years.
Several sectors performed well during this period, including property, pharmaceuticals, mining, China Internet, and EV. Country Garden Services (06098:xhkg) and Wharf (01997:xhkg) were the top gainers within the Hang Seng Index, rising by 4.2% and 3.9% respectively. Notable outperformers in the pharmaceutical sector were CSPC Pharmaceutical (01093:xhkg) and Hansoh Pharmaceutical (03692:xhkg). In addition, CStone Pharmaceuticals (02616:xhkg) surged 9.1% after the results of the company's lung cancer treatment were published in an international scholarly journal. Among China's Internet companies, Alibaba (09988:xhkg) and Tencent (00700:xhkg) led the way with gains of 2.9% and 2.3% respectively. Nio (09866:xhkg) stood out in the EV sector, surging by 8.6%.
In mainland China's stock exchanges, the rise in value was driven by central state-owned enterprises following a meeting held by the State-owned Assets Supervision and Administration Commission. The focus of the meeting was to enhance the quality of SOEs and promote mergers and acquisitions among them. The telecommunication, computing, construction, and defense industries outperformed others, leading to a 1% increase in the CSI300. Northbound flows into mainland China's stock market saw RMB10.6 billion net purchase, the largest since February, reflecting renewed buying interest in A shares from overseas investors.
USDJPY printed a fresh YTD high of 141.95 in early Asian hours as the new week opened, extending the weakness from Friday when Bank of Japan doubled down on its dovishness, awaiting wage growth to believe that price pressures are sustainable or else standing ready to add more easing. This brings USDJPY close to the ~145 levels where authorities intervened previously, and verbal hints may be seen. GBPJPY rose to its highest levels since 2015 as sterling gains continued. GBPUSD surged above 1.28 as BOE rate hike pricing has surged since the hot UK labor data last week and focus this week turns to CPI and BOE meeting. USDCAD down to 1.32 amid the surprise BOC rate hike and crude oil gains.
Demand concerns eased in both the US and China, sparking further gains of ~1.5% in crude oil on Friday and about ~2.5% for the week. The US Fed paused its rate hike cycle, and market is still not pricing in additional two rate hikes that the Fed guided for. There were also signals that the US driving season would bring strong demand. US gasoline demand climbed to 9.24mb/d last week, its highest level since December 2021 amid significantly lower pump prices. Meanwhile, stimulus measures in China also underpinned hopes of a demand recovery. WTI prices rose above $71.50 before easing a notch, while Brent was above $76.
As we noted in our Saxo Spotlight last week, agriculture crops have been on a tear with gains of ~10% across wheat, corn and soybean over the last week. Concerns of El Nino have been rising underpinning supply worries while a US government report hinted that global appetite for vegetable oil and biofuel feedstocks remains high while stockpiles are running low. This is fuelling fresh concerns of food inflation. Wheat futures in Chicago gained 11% last week while corn futures rose 13%.
While the Fed paused last week, officials continued to ramp up the hawkish rhetoric and continued to guide for more rate hikes to come. Fed Governor Christopher Waller downplayed the banking sector concerns, and said that the US economy is still "ripping along", adding anticipated global spillovers from coordinated central bank tightening have not really materialised. His concerns on inflation was noteworthy, as he said that core inflation is not coming down "like I thought it would'', and will probably require some more tightening. Thomas Barkin (non-voter) was somewhat more data-dependent saying that he is comfortable doing more on rates if incoming data does not confirm a story that slowing demand is returning inflation to 2%. This week’s focus will be on Chair Powell who testifies in the House on Wednesday and Senate on Thursday.
The Bank of Japan maintained yield curve control and asset purchases on Friday, with the central bank remaining willing to even add further easing without hesitation if needed. Interest rates remain negative with the short-term rate at -0.1% with price goals and wage gains remaining a key focus. Governor Ueda said core CPI is expected to slow towards the middle of FY2023. May’s wage data will become the next key focus point to see of this year’s wage negotiations had any real impact on wage growth, before the outlook report from July 28 meeting takes the limelight on what’s to come next in BOJ’s policy. For now, pressure on JPY could continue as US yields continue to surge, widening the difference to Japanese yields, while Japanese equities remain a bright spot.
The recent Federal Reserve H.4.1 report reveals that the Treasury General Account (TGA) saw a substantial $86 billion increase, rising from $48.5 billion on May 31, 2023, to $136 billion on June 14, 2023. However, this rise was more than offset by a $145.75 billion decrease in the overnight Reverse Repo balance at the Fed during the same period, dropping from $2,255 billion to $2,109 billion. Contrary to fears of a liquidity drain, US banks' reserves in the Federal Reserve system grew by $101 billion to $3,306 billion between May 31 and June 14.
Money market funds, driven by the Fed's decision to skip a rate hike in June and expectations of only one more hike before the cycle concludes in July, appear inclined to shift funds from overnight Reverse Repos to capitalize on higher yields offered by Treasury bills. With the Fed currently paying an overnight interest rate of 5.05% to money market funds, the investment rates (higher than quoted discount rates) on Treasury bills, ranging from 5.113% to 5.511% in recent auctions, make them an attractive alternative. This shift in investment preferences reduces exposure to reverse repos and mitigates potential liquidity concerns.
The preliminary University of Michigan survey for June reported strong gains with headline up to 63.9 (exp. 60.0, prev. 59.2) and a sizeable jump in both conditions, 68 from 64.9 (exp. 65.5) and expectations, 61.3 from 55.4 (exp. 56.5). The optimism may have been driven by the easing of banking sector concerns and resolution of the banking crisis even as the sentiment still remains low by historical standards as income expectations have softened. The inflation expectations saw the more volatile, energy-exposed 1yr-ahead gauge slashed lower to 3.3% from 4.2%, the lowest since March 2021, following the recent drop in gasoline prices. Meanwhile, the long run 5-10yr expectations, which the Fed pay more attention to (in order to gauge how anchored inflation expectations are), saw a slight move lower in June to 3.0% from 3.1%, however, the report notes that is still elevated to the 2.2-2.6% range seen in the two years before COVID.
On Friday, Micron warned of a bigger hit to revenue from a Chinese ban on sale of its chips to key domestic industries, saying it expects an impact on about half of its revenue from China-headquartered firms, which equates to a low-double-digit percentage of its total revenue compared to an earlier estimate of low-to-high single digits percentage impact. Still, the company announced that it would invest 4.3 billion yuan ($603.8 million) over the next few years in its chip packaging facility in the Chinese city of Xian, a move that CEO Sanjay Mehrotra said demonstrated the company's "unwavering commitment to its China business and team." Meanwhile, diversification in supply chains also remains a key focus, with Micron investing $1bn in a semiconductor packaging factory in India.
After meeting with Qi Gang, China’s Foreign Minister and concluding that both sides would meet again in Washington, US Secretary of State Antony Blinken will meet with Wang Yi, Director of the Office of the Foreign Affairs Commission of the Communist Party of China Central Committee and the top diplomacy advisor to President Xi Jinping on Monday. The news of the Blinken and Qi meeting is posted in an article the third in length on the third page of the People’s Daily and it is still not sure if Blinken and Xi will meet.
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