Summary: The market churned wildly in the wake of perfectly in-line US CPI data yesterday after perhaps hoping for even stronger signs of decelerating inflationary pressures than the data delivered. Alas, in the end the market celebrated the data, sending US treasury yields and the USD lower and risk sentiment higher, with the S&P 500 testing its 200-day moving average. Gold touched $1,900 per ounce.
US equities chopped around after the in-line December CPI data release, with the S&P 500 index taking a stab at trading above the 4,000 level and the 200-day moving average just above that level for the March future (and at 3,984 for the cash index – the cash index never traded north of 4,000 yesterday, peaking at 3997). For its part, the Nasdaq 100 has been interacting with the prior support areas now resistance around 11,550. Interesting days and weeks ahead as we trade up into pivotal technical levels just ahead of earnings season.
Hang Seng Index had a lackluster session on Friday trading sideways around yesterday’s close. Mainland’s CSI300 advanced 0.8% led by a bounce in domestic consumption, brokerage, and insurance names. China’s exports in December fell 9.9% in U.S. dollar terms from a year ago and imports declined 7.5%. The Chinese authorities have reportedly drafted an action plan to help “quality” property developers to strengthen their balance sheets. Shares of Chinese developers however have generally retraced and registered modest losses. The three Chinese state-own oil companies traded in Hong Kong advanced between 1% and 3% on higher oil prices. NetEase, rising 3%, stood out among China internet names.
The US dollar fell after a chaotic knee-jerk reaction to in-line CPI data, as the market may have been leaning for a softer-than-expected surprise. In the end, US yields dropped and risk sentiment rallied anew, the ideal combination for USD bears. The selling was most intense for the balance of the day in USDJPY, which probed new cycle lows below 129.00 and much of the move coming ahead of the US data as the market was busy absorbing the news flow from earlier in the day on the potential for a shift in BoJ policy at next Wednesday’s BoJ meeting. Japanese 10-year bonds continued to test the 0.50% upper limit of the permitted trading band, rising to above 0.57% by late Asian hours hours and testing the central bank’s resolve. EURUSD broke above 1.08 to fresh highs of 1.0867 with expectations of Fed-ECB divergence setting a bullish tone. EURUSD also cleared the prior highs and traded as high as 1.0868, while AUDUSD touched a new high of 0.6983, just ahead of the key 0.7000 level.
Crude oil has rallied strongly this past week on China’s improving outlook and after US inflation continued to cool, thereby supporting the general level of risk appetite, not least through a weaker dollar. China, the world's biggest importer is expected to hit record consumption this year, a development already gathering pace with Chinese buyers becoming more active in the physical market as import quotas are increased. Gains in the energy sector being led by gasoline after its premium over WTI rose to the highest since August. In the short-term WTI may now find some resistance at $80, where the 50-day moving average is lurking while in Brent that level can be found at $84.75.
Gold is heading for a fourth weekly gain as US inflation continues to ease thereby supporting a further downshift in the Fed’s rate hike trajectory. A broadly dovish tone from Fed members also supported gold as the dollar and bond yields softened. Trading just below $1900 and within an area of resistance, today’s price action ahead of the weekend will be important in order to gauge the underlying strength. Physical demand may struggle in the short term as traders warm to higher prices, not least in India where demand according to Reuters plunged by 79% in December from a year earlier. In addition, we have yet to see demand for ETF’s, often used by long-term focused investors, spring back to life with total holdings still hovering near a two-year low at 2923 tons.
The in-line US CPI data release yesterday saw a choppy market but eventually saw treasuries strongly bid later in the session, sending the 2-year to a test just below the prior 4.13% low at one point and the US 10-year yield toward the 3.40% pivot low from back in early December. A 30-year T-bond auction saw the strongest bidding metrices since last March.
A further slowdown in US CPI as expected yesterday, as the headline slid to 6.5% YoY as expected from 7.1% YoY in November, stepping into the disinflationary territory on a m/m basis with a negative 0.1% print from +0.1% previously. Core inflation also eased in-line with expectations to 5.7% YoY in December from 6.0% YoY previously but still higher on m/m basis at 0.3% from 0.2% in November. Services inflation was still higher, being the stickier component of inflation, but with six consecutive months of softening in inflation, the Fed could take some comfort that its tightening moves are working. The market is pricing in another step down at the Fed’s next decision on Feb 1 to 25bps rate hike, but the terminal rate pricing still stands at sub-5% levels compared to a unanimous voice from the FOMC members calling for rates over 5%. Meanwhile, US jobless claims point to a tight labour market, unexpectedly falling to 205,000 from a revised 206,000 the previous week. Continuing claims also surprisingly improved, dropping to 1.63 million from 1.7 million.
Commodities companies are likely to start to upgrade their outlooks for 2023, ahead of reporting full year results in February. Iron ore, copper and aluminium companies in particularly are likely to upgrade their 2023 earnings as these respective commodity prices quickly entered bull markets +64%, +30%, and +20% respectively from their lows as China eased restrictions sooner than expected. The Iron ore (SCOA) price as an example, rose 2% alone in Asia today, hitting a new 6-month high. BHP shares in Australia hit a new record high of A$49.64 while Rio Tinto trades about 3% shy of its record, with both iron ore, and copper giants trading higher in anticipation of higher free cashflow in 2023.
The USDA on Thursday unexpectedly cut its outlook for US domestic production and available stocks of both corn and soybeans, a sign that an ongoing drought from last year may continue to underpin prices. The worst Argentinian drought in 60 years also led to a downgrade in the outlook for soybeans and corn production, some of that being partly offset by an expected bumper harvest in Brazil. One bright spot was wheat where the USDA raised its outlook for global production. Following the WASDE report corn (ZCH3) rose 2.5%, soybeans (ZSH3) 1.8% while wheat (ZWH3) was up by less than 1%.
The December headline number came in at +2.1% MoM and +12.3% YoY vs. 1.8%/12.0% expected, respectively and vs. 11.5% YoY in Nov. The core data was +1.9% MoM and +10.2% YoY vs. +1.6%/+9.8% expected, respectively and vs. +9.5% YoY in Nov.
The recent news flow and rumor mill sees the Bank of Japan announcing further tweaks to its policy next Wednesday at its meeting. Ironically, the anticipated further widening of its yield curve control “band” (de facto more of a “cap”) on 10-year JGB’s comes as long yields are dropping sharply elsewhere, accentuating the tightening of spreads between Japanese yields and those in, for example, Europe and the US.
The Q4 earnings season kicks off today with banking earnings from Bank of America, JPMorgan Chase, and Citigroup with consensus expecting earnings to continue contracting among US banks before coming back to growth in 2023. The key uncertainty is credit quality in 2023 as it is linked to the degree of a recession or maybe no recession at all in the US economy. With higher interest rates level expectations are that banking revenue will slowly begin to accelerate and if high interest rates persist for an extended period, the longer-term growth for banks could be quite attractive. In addition, US banks have extended credit at the fastest pace in 2022 since the year leading up to the Great Financial Crisis. Overall, the Q4 earnings season is likely going to see an extension of value and tangible companies performing better than intangible-driven companies.
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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.
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