Market Cross-Currents

There are many cross currents afflicting markets at present.  Equity valuations look high but US earnings have been strong so far, with close to 90% of S&P 500 earnings coming in above expectations. This has helped to buoy equity markets despite concerns over the spreading of the Delta COVID variant and its negative impact on recovery.  Yet the market doesn’t appear entirely convinced on the recovery trade, with small caps continuing to lag mega caps. 

The USD index (DXY) remained supported at the end of last week even as US yields remain capped, but the USD does appear to be losing momentum. Positioning has now turned long according to the CFTC IMM data indicating that the short covering rally is largely exhausted; aggregate net USD positioning vs. major currencies (EUR, JPY, GBP, AUD, NZD, CAD & CHF as a percent of open interest) turned positive for the first time in over a year. 

Inflation fears have not dissipated especially after recent above consensus consumer price index (CPI) readings, for example in the US and UK.  Reflecting such uncertainty, interest rate market volatility remains high as seen in the ICE BofA MOVE index while inflation gauges such as 5y5y swaps have pushed higher in July.  There was some better news on the inflationary front at the end of last week, with the Markit US July purchasing managers indices (PMIs) revealing an easing in both input and selling prices for a second straight month, albeit remaining at an elevated level. 

This week we will get more information on inflation trends, with the June Personal Consumption Expenditures (PCE) report in the US (Fri), Eurozone July CPI (Fri), Australia Q2 CPI (Wed) and Canada June CPI (Wed), on tap this week.  We will also get to see whether the Fed is more concerned about inflation risks at the Federal Open Markets Committee (FOMC) meeting (Wed).  The Fed is likely to continue to downplay the surge in inflation, arguing that it is transitory, while the standard of “substantial further progress” remains a “ways off”.   Nonetheless, it may not be long before the Fed is more explicit in announcing that is formally moving towards tapering. 

An emerging markets central bank policy decision in focus this week is the National Bank of Hungary (NBH) where a 15bp hike in the base rate is expected.  Central banks in emerging markets are taking differing stances, with for example Russia hiking interest rates by 100 basis points at the end of the week while China left its Loan Prime Rate unchanged.  The July German IFO business climate survey later today will be in focus too (consensus 102.5).  Overall, amid thinner summer trading conditions market activity is likely to be light this week.

US Jobs Report Provides Comfort For Markets

The US June jobs report released on Friday provided plenty of comfort for US equity markets. Non-farm payrolls rose by an above consensus 850,000 while the unemployment rate ticked higher to 5.9% from 5.8%.  The strong increase in payrolls helped US equities close out another week in positive mood; S&P 500 rose 0.75% and the Nasdaq gained 0.81% as investors continued to pile back into growth stocks. US Treasury bonds were supported, helped by an increase in the unemployment rate, while the US dollar fell.

Despite the jobs gain, payrolls are still around 6.8 million lower than pre-Covid levels, suggesting a long way to go for a full recovery. Federal Reserve officials will likely need to see several more months of jobs market improvement to achieve their “substantial further progress” tapering criterion.  Overall, the data played into the Fed’s narrative that tapering is still some way off and higher US interest rates even further away, leaving little for markets to fret about.

OPEC+ tensions between Saudi Arabia and UAE have increased, delaying OPEC+ talks to today against the background of oil prices pushing higher above $75 per barrel.  Riyadh along with other OPEC+ members appear keen to increase production over coming months while the UAE supports a short term increase, rather than the end of 2022 which other OPEC members are looking for.

Markets activity is likely to be subdued at the start of the due to the US holiday and there seems to be little to break out of the low volatility environment that we are currently in the midst off, though the US dollar will look to extend recent gains against the background of persistent short market positioning as reflected in the CFTC IMM data.  

This week attention will turn to the Federal Reserve FOMC Minutes of its last meeting (Wed), ISM non-manufacturing survey (Tue), and central bank policy meetings in Australia (Tue) and Poland (Thu) alongside Chinese June inflation (Fri) and credit aggregates data (from Fri). 

Given the sharp market reaction following the less dovish Fed FOMC meeting, markets will look for any further elaboration on the potential timeline for tapering in the Fed Minutes.  While both the RBA in Australia and NBP in Poland are likely to stay on hold, the RBA is likely to strike a dovish tone in its statement and Q&A while the NBP is likely to announce a new set of economic projections.  No shocks are expected from China’s June CPI inflation reading, though producer price inflation, PPI is likely to remain elevated.

When Bad Means Good

Bad meant good on Friday as weaker than expected US April jobs data helped to dampen concerns over inflation risks and higher rates. At a time when markets were becoming increasingly fearful of rising inflation risks the softer US jobs data will act as a balm on such fears. It also complicates matters ahead of bipartisan talks between President Biden and congressional leaders this week. Democrats will likely use the data to outline their case for more stimulus to boost growth, while Republicans will highlight that excessive unemployment benefits are holding back hiring.  

US Payrolls increased by 266,000 in April, well below the 1 million consensus and the unemployment rate rose to 6.1% from 6.0%, above the 5.8% consensus.  The data supports the view of most Fed officials that progress has not been “substantial” enough for them to start signaling tapering.  Unsurprisingly Markets pushed back the pricing of the first rate hike from early-2023 to May 2023 in the wake of the weaker US jobs data. The US dollar (USD) took a hit and looks likely to kick off the week on the back foot.  High yielding currencies will likely benefit the most.  

This week inflation releases will come under scrutiny, with CPI data in the US (Wed), China (Tue) and India (Wed) in focus, albeit for different reasons.  In the US, base effects will likely push inflation higher, with a sharp pick up in core CPI in particular likely.  A similar story is expected in China, but base effects will likely act in the opposite direction in India.  Other highlights this week include a likely modest decline in US retail sales (Fri), further easing in China’s credit aggregates (9-15 May) and a material improvement expected to be revealed in Australia’s Federal Budget (Tue).  Last but not least, central banks in Mexico and Philippines (both Thu) are expected to leave policy unchanged.

Separately, markets will digest the outcome of UK local elections, especially those in Scotland, which revealed that pro-independence parties (SNP and Scottish Greens) gained a majority in the Scottish parliament. A constitutional battle with the Conservative UK government looms though UK Prime Minister Boris Johnson is showing no signs of acceding to demands for a new Scottish referendum.  There will also be focus on the aftermath of the ransomware attack on the Colonial Pipeline in the US, which has already pushed energy prices higher.  And finally, the much anticipated (among Krypto traders) appearance of Elon Musk on SNL hit Dodgecoin, after he called it “a hustle”. 

India Risks, Highlights For The Week Ahead

It was a strong end to last week for US markets, with S&P 500 up over 1%, helped by stronger than expected new home sales and April US Markit purchasing managers indices (PMI) data. As risk assets rallied the US dollar and US Treasuries sold off.  There are plenty of event risks this week. Also, there will be deluge of US earnings releases this week including most tech heavyweights while markets will likely remain nervous over President Biden’s tax plans.  Geopolitical risks will also remain on the forefront. 

Even as the progress on the vaccination front continues the renewed increases in virus cases in many countries, particularly in India, where the situation has deteriorated markedly, threatens to delay recovery. The acceleration in virus cases has been dramatic, with Prime Minister Modi noting how it has “shaken the nation”. Virus cases hit 349,000 on Saturday and show no sign of receding. The toll on the health system in India has been massive, but the variants also holds risks to the rest of the world while it will also lead to a major disruption in India’s vaccine exports, threatening vaccination programs in several countries.  

Friday’s economic data round was broadly firm. Alongside the US releases noted above, Euro area April PMIs were generally better than expected, with G10 manufacturing PMIs pointing to strengthening momentum overall.  Separately, Russia’s central bank, the CBR surprised with a bigger than expected 50bp rate hike.  Today’s data releases include the April German IFO business confidence survey; consensus expectations forecast an increase to 97.8 from 96.6 previously. In the US, durable goods orders are forecast to rise in March by 2.5% m/m following a weather-related 1.2% m/m drop in February.

The focus over the rest of the week will turn to central bank decisions in Japan, Sweden and Hungary (all on Tue) and the Federal Reserve FOMC (Wed).  Although the Bank of Canada’s shift last week will prompt a little more nervousness about G10 central bank tapering the policy meetings are likely to be largely uneventful, this week. Nonetheless, the Fed tone is likely to be more positive than in March, while in contrast the Bank of Japan may sound more cautious amid a third state of emergency in Tokyo. 

A key event this week will be President Biden’s address to a joint session of Congress.  After the hit to markets in the wake of the news of a proposal to hike taxes, markets will look for any further details.  Key data releases this week include Australia Q1 CPI inflation (Wed), US Q1 advance GDP (Thu), China’s April purchasing managers indices data (Fri) and Euro area Q1 GDP (Fri).  

Inflation Debate Rages On

Good morning, last week ended on a solid note for global equity markets, capped by strong gains in US stocks and in particular a surge towards the end of the session on Friday.  The S&P 500 is on track for its best month since November though in the next few days, month and quarter end rebalancing will continue to hold risks, which could result in increased volatility.  Another imponderable is potential follow through from huge equity sale block trades at the end of last week reportedly from Archegos Capital, which hit US media companies and Chinese tech stocks. All of this suggests risks of higher volatility in the days ahead.  

US interest rate markets came under renewed pressure, with yields backing up over the week, while the US dollar (USD) had a firmer week, with the USD index (DXY) ending above its 200-day moving average and technical indicators pointing to further gains this week.  CFTC IMM speculative positioning data (in the week to 23 March) shows that net aggregate USD short positions have been pared back further as USD sentiment continues to improve.  Positioning in most currencies vs. USD fell while Japanese yen (JPY) short positions increased further.  The oil market and container costs could be pressured higher by the continued delay in dislodging the stricken Ever from the Suez Canal, which seems to have made little progress over the weekend.

Attention this week will turn to a few key data and events.  Important among these will be President Biden’s speech in Pittsburgh (Wed) where he will likely give further details on his infrastructure plan and how it will be funded.  Key US data include the March ISM manufacturing survey (Thu) and March non-farm payrolls (Fri).  Solid outcomes for both are expected.  In Asia, focus will be on March purchasing managers indices (PMIs) across the region (Thu) including in China (Wed) where broadly positive readings are likely.  There will also be attention on the going malaise in Turkey’s markets since the sacking of the central bank (CBRT) governor while Europe continues to struggle with fresh virus waves, lockdowns, and vaccine reluctance as well as tensions over vaccine exports to the UK.

As President Biden gives his speech this week the debate about a potentially sharp rise in inflation rages on.  The Fed has tried to calm fears by highlighting that any rise in inflation over the coming months will likely be transitory.  However, with massive stimulus in the pipeline, economic recovery taking shape and the Fed set to keep policy very accommodative for years to come, market fears have risen as well as warnings from the likes of former Treasury Secretary Larry Summers.  Consumer inflation expectations remain largely subdued but the debate will not end quickly, and bond markets will be on tender hooks.  In the next few months inflation will turn up but this will largely be due to base effects as the collapse in activity in prices in Q1 last year falls out of the equation.  However, the jury is out on whether this will turn to more persistent inflation, something that could have a much more severe impact on markets and force central banks to belatedly tighten policy. 

%d bloggers like this: