US Earnings, Virus Cases, Dollar & Data

Last week US equities registered gains, led by value rather than momentum stocks, with US equities closing higher for a third straight week amid low volumes and declining volatility.  However, the S&P 500 is still marginally lower year to date, compared to a 17% gain in the tech heavy Nasdaq index.  In theory this implies more room to catch up for value stocks vs. momentum but I wouldn’t bank on it. If the surge in virus cases equates to renewed lockdowns, the value stock story will likely fail to gain traction until either the virus curve flattens again or a vaccine is found.

Unfortunately Covid-19 infections continue to accelerate, with more than 14 million cases confirmed globally, but mortality rates are likely to be key to the extent that lockdowns intensify. US, Latin America and India are at the forefront, risking another downturn in global activity if lockdowns intensify at a time that concerns about a fiscal cliff in the US have grown.  All of this has to put against vaccine hopes, with some success in various trials, but nothing imminent on the horizon.

Meanwhile the US dollar (USD) remains under pressure, continuing its grind lower since the start of this month, with the euro (EUR) capitalizing on USD weakness to extend gains as it targets EURUSD 1.15.  The USD has maintained its negative relationship with risk, and sentiment for the currency has continued to sour as risk appetite has strengthened.  It’s hard to see the USD turning around soon, especially given uncertainty about renewed US lockdowns, fiscal cliff and US elections.

Over the weekend European Union leaders’ discussions over the “recovery fund” failed to reach a deal though there has been some softening from the “frugal four” on the issue of grants vs. loans.  However, after a third day of meetings there was still no agreement on how much of the recovery fund should be distributed via grants versus loans.  Despite the lack of agreement EUR continues to remain firm against USD and approaching key resistance around 1.1495.

US Q2 earnings remain in focus and this week is particularly busy, with tech earnings under scrutiny (including IBM today).  Last week banks were the main highlight of the earnings calendar, with US banks reporting a very strong quarter in trading revenues amid heightened market uncertainty and volatility, but large loan loss provisions. Aside from earnings expect more jawboning from US officials over China. While there is some focus on whether the US will target Chinese banks with sanctions, it is still likely that the US administration will avoid measures that will roil markets ahead of US elections.  

On the data and event front, highlights over this week include Australia RBA minutes (Tue), Eurozone PMIs (Fri) and policy rate decisions in Hungary (Tue), Turkey (Thu), South Africa (Thu), and Russia (Fri).

Market Volatility Continues To Compress

The US Independence Day holiday kept trading, market activity and volatility subdued for much of last week.  In any case equity markets and risk assets have been struggling on the topside and appear to be losing momentum.  Markets are being buffeted by conflicting forces; economic news has beaten expectations. For example, the US June jobs report was better than expected though total job gains of 7.5 million in recent months are still only around a third of total jobs lost.  In contrast, worsening news on Covid 19 infections, with the WHO reporting a one day record high in global infections, threatens to put a dampener on sentiment.  Consolidation is likely, with Summer trading conditions increasingly creeping in over the weeks ahead. As such volatility is likely to continue to be suppressed, aided by central banks’ liquidity injections.

Over recent weeks geopolitical risks have admittedly not had a major impact on markets but this doesn’t mean that this will remain the case given the plethora of growing risks.  China’s installation of new security legislation into Hong Kong’s basic law and the first arrests utilizing this law were in focus last week.  A US administration official has reportedly said that the president is considering two or three actions against China, and markets will be on the lookout for any such actions this week, which could include further sanctions against individuals are more details of what the removal of HK’s special trading status will entail.  Meanwhile the US has sent two aircraft carriers to the South China Sea reportedly to send a message against China’s military build up in the area, with China’s PLA conducting a five-day drill around the disputed Paracel Islands archipelago.

Data releases and events this week are unlikely to lead to a change in this dynamic.  At the beginning of the week attention will focus on further discussions between the UK and EU over the post Brexit landscape while in the US the June non-manufacturing ISM survey will garner attention.  So far talks on a trade deal between the UK and EU have stalled though there were hints of progress last week, even as officials admitted that “serious divergencies remain”.  The US ISM non-manufacturing survey is likely to move back to expansion (above 50) but is increasingly being threatened by the increase in Covid infections, which could yet again dampen service sector activity. On the policy front there will be fiscal updates from the UK and Canada on Wednesday against the backdrop of ramped up spending, and monetary policy decisions by the Reserve Bank of Australia (RBA) and BNM in Malaysia on Tuesday.  The RBA is widely expected to keep policy unchanged while BNM may cut rates by 25 basis points.

 

Bumpy Ride Ahead

Just as it looked as though there was some hope of stabilisation in global economic conditions, the September US ISM (Institute of Supply Management) Index released on Monday was not only weak but it was a lot worse than expected at 47.8 (below 50 means contraction).  Markets clearly took fright, with the sell off in stocks intensifying yesterday in the wake of the US ADP jobs report for September, which recorded an increase of 135k jobs by private sector employers, its weakest reading in three months.

This all sets up for a nervous wait ahead of tomorrow’s September jobs report in which markets will be on the look out for any slowing in nonfarm payrolls and/or increase in the unemployment rate.  The consensus expectation is for a 148k increase in payrolls in September and for the unemployment rate to remain at 3.7%, but risks of a weaker outcome have grown.  The US dollar has also come under pressure as US economic risks increase.

Rising geopolitical risks are adding to the market malaise, with the impeachment enquiry into President Trump intensifying and risks of a hard Brexit in the UK remaining elevated.  On the latte front UK Prime Minister Johnson published his plans for a Brexit strategy yesterday replacing Theresa May’s “backstop” plan with two new borders for Northern Ireland.

If the proposal isn’t agreed with the EU, there is a strong chance that Johnson will be forced to seek another extension to Article 50 from the end of October, prolonging the three and a half years of uncertainty that the UK has gone through.  GBP didn’t react much to the new plan, and surprisingly did not fall despite the sharp sell off in UK equities yesterday, with the FTSE falling by over 3%.

The fact that the US has now been given the green light to impose tariffs on EU goods after the EU lost a World Trade Organisation (WTO) ruling adds a further dimension to the trade war engulfing economies globally.  The US administration will now move ahead to impose 25% tariffs on a range of imports from the EU, with the tariffs implementation likely to compound global growth fears.  If the EU wins a similar case early next year, expect to see an onslaught of EU tariffs on EU imports of US goods.

This is taking place just as hopes of progress in trade talks between the US and China in talks scheduled for next week have grown.  But even these talks are unlikely to be smooth given the array of structural issues that remain unresolved including technology transfers, Chinese state subsidies, accusations of IP theft, etc.  Additionally, the fact that the US administration has reportedly discussed adding financial restrictions on Chinese access to US capital suggests another front in the trade way may be about to open up.

The bottom line is that there is a host of factors weighing on markets at present and adding to global uncertainty, none of which are likely to go away soon.  Now that fears about the US economy are also intensifying suggests that there is nowhere to hide in the current malaise, implying that risk assets are in for a bumpy ride in the weeks ahead while market volatility is likely to increase.

 

 

 

 

The Devil is in the details

The “partial solution” delivered by European Union (EU) leaders last week has failed to match the high hopes ahead of the EU Summit. Nonetheless, the deliverance of a “fiscal compact”, acceleration of the European Stability Mechanism (ESM) to July 2012 , no forced private sector participation in debt restructuring (outside Greece), and possible boost to the International Monetary Fund (IMF) of up to EUR 200 billion, are steps in the right direction. The fact that UK Prime Minister Cameron threw a spanner in the works to veto a joint proposal to revise the EU Treaty should not detract from the progress made.

Nonetheless, the measures may not be sufficient to allay market concerns, with disappointment at the lack of European Central Bank (ECB) action in terms of stepping up to the plate as lender of the last resort still weighing on sentiment. Data will add to the disappointment this week as “flash” Eurozone purchasing managers indices (PMI) drop further in December.

This week events in the US will garner more attention, including the Federal Reserve FOMC meeting, November inflation and retail sales data plus manufacturing confidence gauges as well as November industrial production on tap. The Fed will not shift its policy stance at this meeting but may sound a little more upbeat on the economy following recent firmer data. Inflation will likely remain subdued while the other data will continue to show gradual recovery.

Overall, the market is likely to thin further as the week progresses and holidays approach, with ranges likely to dominate against the background of little directional impetus. Our call to sell risk assets on rallies remains in place, however. The EUR will likely struggle to make much headway in the current environment, especially given that many details of the EU agreement still need to be ironed out and once again the risk to market confidence lies in implementation or lack of it. A range of EUR/USD 1.3260-1.3550 is likely to hold over the short term.

All Eyes On Europe

EUR looks range bound ahead of key events including the European Central Bank (ECB) meeting, European Union Summit and release of bank stress test results. A senior German official poured cold water over expectations of a concrete outcome from the EU Summit, dampening EUR sentiment as a result.

There will be plenty of attention on the ECB to determine whether they will give a little more ground and provide further assistance to the Eurozone periphery. While a refi policy rate cut is highly likely as well as additional liquidity measures I do not expect any move in the direction of more aggressive action to support peripheral bonds in terms of becoming “lender of the last resort’.

If however, the ECB hints at intensifying its securities market purchases of Eurozone bonds this will likely bode well for the EUR. Indeed, reports overnight suggest that the ECB will announce a set of measures to stimulate bank lending including easing collateral requirements for banks.

More weak UK data in the form a bigger than consensus drop in manufacturing and industrial production in October add to the soft BRC retail sales and house price data, in putting pressure on the Bank of England (BoE) to increase its quantitative easing at today’s policy meeting. While the BoE is set to keep policy unchanged it is only a matter of time before additional asset purchases are announced.

Despite the weaker IP data GBP has held up relatively well against the USD although downside risks appear to be intensifying. If I am correct in the view of no change by the BoE today we expect little change in GBP although there could be a risk of a push higher in EUR/GBP if the ECB delivers some positive news, with resistance seen around 0.8665.

The RBNZ unsurprisingly left policy rates unchanged at 2.5%, sounded less hawkish than the previous meeting and also lowered growth forecasts. The NZD was left unmoved by the rate decision and looks well supported at current levels perhaps due to relief that the statement was not more dovish. The kiwi has been an underperformer over the year but unlike the AUD it has not been particularly influenced by gyrations in risk aversion.

Interest rate futures differentials have seen a renewed widening versus the US over recent weeks. This is significant given that the NZ-US interest rate differentials have a very strong correlation with the performance of NZD/USD. If this widening is sustained it will point to upside potential for the Kiwi.

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