Global Market Quick Take: Europe – July 24, 2023

What is our trading focus?

US equities (US500.I and USNAS100.I): Friday finishes flat.

The S&P500 made a few failed attempts to rally before finishing at 4,536, near the low of the day and unchanged from the previous close. The Nasdaq 100 slid 0.3% to 15,425. Performance diverged among sectors, with utilities, healthcare, and energy gaining while communication services, industrials, and financials lagging.  Animal medicines and vaccine maker Zoetis, rising 6.9%, was the top winner within the S&P500 Index.

Regional banks pulled back on Friday. Comerica (CMA:xnys) plunged 4.1% after the regional lender guided a decline in net interest income in Q3, while Regions Financials (RF:xnys) dropped by 3.1% after it reported large credit losses and a fall in deposits. The SPDR S&P Regional Bank ETF (KRE:arcx) slid 1.3% on Friday but managed to sustain a weekly gain of 7.5%. American Express (AXP:xnys) fell by 3.9% after the payment card and travel company’s Q2 revenue missed analyst estimates.

FX: Dollar finished last week on a strong note ahead of FOMC.

The US dollar broke above 101 on Friday, closing the week with o gain of over 1% after a 2.3% decline in the preceding week. The Japanese yen remains a key focus this week as USDJPY surged again to 142 on Friday on reports that BOJ sees little need to tweak yield curve control now. Bank of Japan meeting decision is scheduled for this Friday and will likely continue to trigger volatility in almost any scenario. NZDUSD was the underperformer last week as it dipped below 0.6170 from highs of 0.6300+ earlier in the week amid a softer NZ Q2 CPI. AUDUSD was somewhat supported by efforts from Chinese authorities to support the yuan but retained its downtrend to close below 0.6730 for the week from 0.6850 at open last week and is testing its 200-day moving average to start this week. GBPUSD broke below 1.29 on the back of a cooler than anticipated UK June CPI reportr.

Gold sent lower by rising yields and stronger US dollar

Gold consolidated late last week on the combination of a surge in US treasury yields and the stronger US dollar, posting a low of 1,956 on Friday. The first Fibonacci retracement of note on the rally from the sub-1,900 lows comes in around just above 1,950, while bears will need a reversal back through 1,930 to gain traction. To the upside, the pivot high has been 1,987.50, with the psychological 2,000 level looming above and then the triple top from 2,063-2,075.

Crude Oil: Brent above $80 to start week.

Crude oil closed last week on a strong footing, with Brent closing clear of 80 dollars per barrel, within reach of the pivot high near 81.75.  Supply concerns linked to Russia and Saudi production cuts, as well as hopes for policy stimulus from China have supported the demand side. The week ahead brings several key tests for markets as key central bank decisions will be due from Fed, ECB and BOJ and earnings season rumbling on. USD direction and global growth sentiment will be other factors.

US Treasuries (2YYU3, 10YU3, 30YU3): FOMC meeting and PCE deflator in focus.

At this week’s FOMC meeting, the bond market expects the Fed to deliver the last rate hike of the cycle. Therefore, if Powell cannot convince markets that at least one more rate hike is still in the cards, the yield curve could steepen sharply as bond investors position for future rate cuts. The bull steepening can accelerate further on Friday if PCE data, specifically the monthly rate, shows an increase of prices between 0.1%-0.2%. Two-year yields are likely to find strong resistance at 4.50%. Ten-year yields are unlikely to break below 3.70% as they will remain underpinned by a lack of signs of an upcoming recession. We, therefore, might see the 2s10s spread steepening to -80bps.

EU sovereigns (D5BC:xetr, IS0L:xetr): ECB and German inflation in focus

This week's ECB rate hike is taken for granted. The market is pricing the central bank to hike once more in the fall. However, amid a potential U.S. treasury rally on Wednesday, and keeping in mind that the euro currency strength is becoming an issue for the bloc’s growth, EU rates also have the potential to drop despite the ECB hiking rates. Yet, a bull flattening of the German yield curve is more likely as Schatz yields will remain supported amid the expectation of another hike. In contrast, Bunds yields have the potential to drop amid recession fears. If bunds break support at 2.40%, they will find support next at 2.30%.

What is going on?

Massive downgrades of US junk loans

Q2 saw the most downgrades in the riskiest corporate loan category –leverage loans – since the worst days of the Covid outbreak crisis in 2020. The FT reports that a JP Morgan analysis of the leverage loan market saw downgrades on $136 billion in leveraged loans, which typically have floating coupons. There are few signs of strain in the traditional High-yield category of debt, as a Bloomberg measure of the High-yield spread to US treasuries closed last week at its tightest level since May of last year at 375 basis points.

China eyes selective property market stimulus.

China’s State Council released a directive on Friday evening to improve the living conditions in some shanty areas of the 21 largest cities in the country. The directive was to follow through on the policy direction laid out in the Politburo meeting in April this year. However, the scale seems to be much smaller than the last round of shantytown redevelopment which was nationwide and aimed at redevelopment not just improvement. Also notably, the last round of shantytown redevelopment was financed by money printing by the People’s Bank of China through policy banks, such as China Development Bank, in the form of pledged supplementary lending. This time, the directive last Friday called for financing from multiple sources including local governments and the private sector.

Potential disappointment from China’s Politburo meeting may present buying opportunities

The much-awaited Politburo meeting that has a focused economic agenda to review the performance of the economy in the first half and adjust, if necessary, the strategies for the second half of the year is expected to take place towards the end of this week. Last year, the meeting was held on July 28. After several months of eager anticipations to bazooka stimulus policies and disappointments by a long series of piece-meal measures, investors have adjusted down but not written off their expectations for a forceful and comprehensive stimulus package.

At Saxo, we believe that it is unlikely for China to launch an aggressive package as China’s long-term trend growth declined to around 6% before the pandemic. With 5.5% real GDP growth in the first half of the year, the Chinese leadership is unlikely to put long-term financial stability at risk to expand fiscal spending massively and print money. It is important to note that China has been in two important campaigns. First, to deleverage the economy. Second, to transform into a new development paradigm that aims at bringing about higher-quality growth through an increase in productivity and advances in technological innovation. However, the Chinese economy is in a cyclical growth upturn, though it is slow. Positions are light and sentiments are poor so the bar is low for a strong rally through Q3 after some initial disappointments from the Politburo meeting.

What are we watching next?

Big week ahead for markets – key central bank meetings and big tech earnings

The recent rally in equities faces several tests this week as key central bank decisions are due from Fed, ECB and Bank of Japan. While a data-dependent approach is likely to be the key messages coming out of Fed and ECB meetings, any clear indication of another rate hike from the Fed could spoil the party. Big tech earnings will be key as well with top 7 stocks mostly driving the gains in equities, and expectations are likely running high to justify these strong gains. We discuss the big tech earnings expectations in detail here, and keep an eye out on rotation into cyclicals and other quality stocks.

Technical Analysis

• S&P 500. Correction on going. Support at 4,455
• Nasdaq 100. Correction down to 15K-14,687 likely
• DAX Range bound. Rejected at 16,210. Need to close above for uptrend
• AEX25 Range bound between 781 and 748
• CAC40 closed above key resist at 7,403. But uptrend fragile 
• EURUSD uptrend. Short-term correction to 1.11 before uptrend resumes. Medium-term room to 1.1485
• GBPUSD correction could be over and uptrend likely to resume
• USDJPY Rebound facing resistance at 142. Expect setback to 140 before moving higher
• EURJPY testing 158. Expect minor setback before break of 158
• EURGBP Struggling for upside momentum. Double bottom pattern could be cancelled
• Gold uptrend but short-term correction to 1,940-1,930 likely
• Copper rang bound 370-396 
• Brent and WTI have resumed uptrend resistance at 83.00 and 79.20 respectively
• Wheat Dec 2023. Uptrend. Strong resist at 200 MA and 784
• US 10-year Treasury yields resuming uptrend towards 4%

Earnings to watch

Earnings season peakas this week and next Tesla and Netflix results spoiled a strong start to earnings sentiment after US financials began reporting their results. The highlights of the very busy week ahead include the first mega-caps reporting tomorrow, topped by luxury goods giant LVMH (after European close and followed by Microsoft and Alphabet after the close of trading in the US.

Earnings this week:

• Tuesday: Snap, Microsoft, Alphabet, LVMH, Visa, Texas Instruments, Danaher, NextEra Energy, Verizon
• Wednesday: Meta, Coca-Cola, Thermo Fisher Scientific, Christian Dior, Union Pacific, Rio Tinto, Boeing, ServiceNow
• Thursday: Samsung, Amazon, MasterCard, Nestle, Roche, L’Oreal, AbbVie, McDonalds
• Friday: ExxonMobil, Procter & Gamble, Chevron, Hermes, AstraZeneca, Sanofi, Keyence, ITC

Economic calendar highlights for today (times GMT)

• 0715-0800 – Eurozone Jul. Preliminary Manufacturing and Services PMI
• 0830 – UK Jul. Preliminary Manufacturing and Services PMI
• 1230 – US Jun. Chicago Fed National Activity Index
• 1345 – US Jul. S&P Global Preliminary Manufacturing and Services PMI
• 1700 – US 2-year Treasury Auction