Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Summary: Sentiment is off to a cautious start this week after US treasury yields rebounded on Friday, pressuring equity market sentiment and supporting the US dollar. This week should prove a volatile one, with the November US CPI data point up tomorrow, one that has triggered huge swings in markets nearly every month for the last several months, this time with an FOMC meeting to follow on Wednesday and ECB and other central bank meetings up on Thursday.
US equity markets rolled over again on Friday after US treasury yields jumped on a hotter-than-expected PPI release on Friday, taking the S&P 500 Index back toward the key support here, which comes in between 3900 and 3900 for the cash index, with the equivalent area around 11,430 in the Nasdaq 100 Index. Markets may be in for a fresh down-draft if US yields rise farther this week, whether due to the CPI release tomorrow, the FOMC meeting on Wednesday, or for any other reason.
Ahead of two key events, the FOMC meeting in the U.S. and the Central Economic Work Conference (CEWC) in China, investors in Hong Kong and mainland Chinese stocks took profits and saw the Hang Seng Index nearly 2% lower and the CSI300 sliding 0.8%. Meituan (03690:xhkg) declined nearly 7% and Country Garden Services (06098:xhk) plunged almost 17%. The CEWC will set out the blueprint for the macroeconomic policies in China for 2023 but will likely not release specific growth targets which be for the National People’s Conference in March.
The US dollar rebounded on Friday and overnight as US treasury yields bounced back after the release of hotter than expected November PPI data on Friday. USDJPY was one of the bigger movers intraday, rebounding from sub-136.00 levels and trading above 137.00 this morning. EURUSD eased away from the recent cycle high of 1.0595 and was trading near 1.0515 this morning. Markets should be prepared for the risk of significant volatility on the CPI release tomorrow, with the market likely lease prepared for surprisingly firm core CPI readings – the surprisingly soft October CPI data released November 10, for example, triggered some 600 pips of USDJPY downside intraday.
Crude oil has started the week trading higher after plunging sharply last week on demand concerns from a weakening macro backdrop as well as thin liquidity leaving short sellers in control. No signs yet of calmer conditions ahead of year-end with multiple uncertainties still unresolved: The Keystone pipeline supplying Canadian oil to refiners on the US Gulf Coast remains shut with no date set for a restart. The market awaits news from Russia on whether it will make good on its threat to cut supply to price cap supporters. Meanwhile in China, surging virus case counts are raising concerns about a slowdown in demand. Focus on US CPI, FOMC and oil market reports from OPEC and IEA.
... ahead of US CPI data on Tuesday and the FOMC rate decision on Wednesday. This after Friday’s stronger than expected US PPI, suggesting inflation is not cooling enough, helped trigger profit taking and another rejection at $1808, a key level of resistance. Ahead of the key data print, the current strength of the market would be tested on a break below $1765, a level where support was found on several occasions last week.
After teasing below the key 3.50% level for a couple of days last week, the 10-year treasury yield benchmark surged back higher to 3.59% Friday after higher-than-expected November PPI data (see more below) before easing a few basis points overnight. The US November CPI print tomorrow data will likely spark considerable volatility all across the curve, especially given the market’s strong expectation that inflation will fall back sharply already by late next year.
Headline PPI rose 7.4% in November Y/Y, above the expected 7.2% albeit down from the upwardly revised 8.1% for October. The core (ex-food and energy) Y/Y was also above expectations at 6.2% (exp. 5.9%), but cooler than the prior upwardly revised 6.8%. on a M/M basis, headline rose 0.3% while core was stronger at 0.4%, beating expectations. While the PPI data continued to show a peak in inflation in the Y/Y terms, but the downward surprise remains limited and may not be enough to support the Fed pivot expectations. Attention now turns to the US CPI data on Tuesday to see if a similar inflation story is seen for December ahead of the FOMC rate decision on Wednesday. Preliminary University of Michigan survey for December was also strong across the board, as the headline rose to 59.1 from 56.8, and above the expected 56.9. The headline was supported by current conditions and the forward-looking expectations both lifting to 60.2 (prev. 58.8, exp. 58.0) and 58.4 (prev. 55.6, exp. 56.0), respectively.
All eyes are turning to who could be the possible replacement of Bank of Japan Governor Kuroda in April 2023. One of the contenders, Takehiko Nakao, said that subtle changes in policy framework should be considered as the leadership is changed next year. This comes after board member Naoki Tamura called for a policy review last week and hinted that it may come as early as next year (before Kuroda retires. However, another board member Toyoaki Nakamura said it’s too early to conduct a review now. Likewise, board member Hajime Takata also said it is too soon to start a policy review. While the timing may be uncertain, the open discussions about a possible BOJ policy review at some point is keeping expectations of an eventual BOJ pivot alive.
The Monday price for UK power surged to a record on Sunday with the Met Office having issued snow and ice warnings throughout the country through to Thursday. The combination of low wind generation and surging demand for heating saw the day-ahead price for power double and reach a record £675/MWh (€785/MWh). The UK power grid operator has ordered two out of three coal-fired plants kept in reserve for emergencies to fire up in case they are needed on Monday. German day-ahead power prices jumped 33% to €434/MWh, the highest since September 13 while the French contract rose 40% to €465/MWh on Epex Spot. In the US meanwhile, natural gas prices jumped 12% on the opening today, thereby extending a four-day surge to $7/MMBtu, after a powerful Pacific storm knocked out power to thousands across California and is forecast to deliver heavy snow and blizzard conditions from Montana to Minnesota in coming days.
The market is aggressively pricing for inflation to drop back sharply this year, with inflation swaps suggesting inflation will be below 2.5% by year-end, even more aggressive than the Fed’s inflation forecast of 2.8% headline and 3.1% core PCE inflation by year-end. This leaves the “surprise side”, as we saw with the Friday US November PPI release, any data that suggests hotter than anticipated inflation, particularly for the core month-on-month ex Food and Energy reading (expected at +0.3%). Meanwhile, due to the market’s anticipation of quickly retreating inflationary pressures and a softening economy, it is pricing the Fed to begin cutting rates as soon as Q4 of this year, something the FOMC forecasts will likely push back against, although the market will likely lean on incoming data more than Fed guidance, which now that the Fed is seen decelerating the pace of hikes to 50 basis points on Wednesday, is only given credence for the next few meetings. Some argue that this could be the Fed’s last rate hike of the cycle, with the “dot-plot” of Fed policy forecasts on Wednesday also likely to push back strongly against that notion with an end-2023 forecast rate of above 5.0% (which would require another 75 basis points of hiking beyond this week’s 50 basis point move, which will take the rate to 4.25-4.50%.
Vladimir Putin said Russia may lower crude output in response to the G-7 price-cap and added the country won't sell to price-cap participants. The price of Russian crude in Asia appears to be holding well above the $60 cap as it finds enough shipping and insurance capacity. While the crude oil prices last week have remained in the grip of technical traders and seen little impact from the price cap decision, there could be more volatility in store this week as Russia’s response is awaited which could range from production cuts to retaliatory measures.
There are a couple of economic read outs that could move the ASX200 (ASXSP200.1) needle this week. Weakening confidence is expected; starting with Consumer Confidence for December (released on Tuesday), followed by Business Confidence for November. Employment reports are due on Thursday for November, with payrolls growth of +17k jobs, down from the rise of 32.2k in October. So focus will be on the AUD and a potential pull back if the data is weaker than expected.
The U.S. Federal Reserve (Wednesday), the Bank of England (Thursday) and the European Central Bank (Thursday) are expected to hike interest rates by 50 basis points each this week. Less than two weeks ago, Fed Chairman Jerome Powell said a December rate-hike slowdown is likely. But the hawkish tone should remain based on the latest Non Farm Payroll and Producer Prices reports which indicated that inflation remains high and broad-based. In the eurozone, this is a done-deal that the central bank will hike rates by 50 basis points. Pay attention to the updated economic forecasts (Is a recession the new baseline for 2023?) and to any indication regarding the expected quantitative tightening process. In the United Kingdom, the money market overwhelmingly believes (78%) that the Bank of England will hike its rate by 50 basis points to 3.5% this week. Only a minority (22%) foresees a larger increase, to 3.75%.
This is a quiet period in the earnings season, though a couple of interesting names are reporting this week, with former high-flyer Adobe up on Thursday. Adobe has something to prove as the US software company has seen a negative share price reaction on its past five earnings releases. Trip.com, China's leading online travel agency, reports on Wednesday and investors will judge the result on the company's outlook for Q4 and ideally 2023 as China's reopening is raising the expected travel demand in China for 2023. Read more here.
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