Summary: The FOMC June meeting minutes failed to provide any impetus to the markets despite reaffirming a steady fight against the threat of inflation. U.S. equities were in modest gains although the futures have erased some gains in the overnight session, while 10-year yields remain capped below the 3% mark. A slight pullback in the dollar overnight helped commodities to take a broad-based breather in Asia with Copper leading the gains after touching 20-month lows. ECB minutes today will be the next catalyst for EURUSD but key focus still on the U.S. jobs data due on Friday.
US equities were stronger yesterday, rallying with higher interest rates as June ISM Services figures beat expectations and May JOLTS Job Openings were also stronger than estimated suggesting the US economy can absorb the tighter financial conditions. S&P 500 futures are trading around the 3,860 level this morning with the 3,900 level being the natural gravitational pull in the market to the upside
The USD remains in the driving seat as equities and bonds struggle for a direction, and the DXY index climbed above 107 in the U.S. session but eased slightly in Asia. EURUSD now trades at 1.0200-levels and getting closer to parity with more room on the downside as the gas debacle has raised the possibility of a deeper recession. Eurozone construction PMI also fell yesterday, with both output and new orders falling at the fastest pace in 16 months, further adding to recession fears and making the task of ECB tougher. ECB minutes are due today and may be the next catalyst for the EUR.
USDJPY traded around 136-levels, as the yen weakness returned in the U.S. session. Reports suggested that the Bank of Japan may consider moving its inflation forecast higher at the next meeting, while revising down the growth forecast. This will further emphasize their accommodative monetary policy settings, which are a contrast to the global tightening wave.
Pressure on crude oil accelerated in the U.S. session with Brent futures also slipping below the $100/barrel mark and WTI futures down to $97/barrel. Although some recovery was seen in Asia, speculators and technical traders seem to have the upper hand right now, and the market stays away from reflecting its true fundamentals. We did have some supply concerns alleviated as U.S. API inventories surprisingly came in higher as against expectations of a drawdown. Demand destruction may be starting to make an impact, and the EIA report due today may have more light to shed. But we do not think the market will be in balance even with some level of demand destruction as supply concerns linger.
The iron ore price rallied ~2% today in the APAC session to US$113.40, a five day high. Iron ore sentiment got a boost because firstly; a US top official in Hong Kong urged China urged to stop eroding “Hong Kong’s position as a business hub”. US Consul General Hanscom Smith implied that China should ease restrictions and that China should not further endanger the laws, and values which helped Hong Kong develop. Secondly, iron ore sentiment was boosted after the oil price continued to sharply fall for the second day. Energy costs are one of the biggest costs for iron ore producers. If sentiment remains upbeat, iron ore may continue to see a short term rally. Resistance is around $127.55. It sentiment weakens, $103 is the level of support to watch. If iron ore falls further, support is ~ $94-$96. BHP (BHP) rose 2.8%. Rio Tinto (RIO) rose 4.2%.
The US 10-year yield rallied yesterday closing at 2.93% as ISM Services figures and JOLTS Job Openings showed that the tighter financial conditions over the past six months had made little overall impact on the service sector and labour market. This coupled with FOMC Minutes underscoring the FOMC’s commitment to get inflation down suggest that policy rates and longer-term bond yields will likely continue to go higher.
What is going on?
The South Korean chipmaker reported today preliminary Q2 figures showing that revenue grew 22% y/y surprising the market to the upside and lifted semiconductor stocks in the Asian session. While revenue growth was better than expected operating income was a tad worse than estimated and the outlook was cloudy.
French government to nationalize EDF
The energy crisis in Europe which has forced the utility company Uniper in Germany to ask for a government bailout has now come to France where the government is going to nationalize the utility company EDF. In a statement the government says that “The climate emergency requires strong, radical decisions. We need to have full control of the production and our energy future. We must ensure our sovereignty faced with the consequences of the war and the colossal challenges ahead...”.
FOMC minutes provide little new input
The FOMC minutes from the June meeting continued to reaffirm the Fed’s hawkish stance as the focus remains on fighting inflationary pressures even if that means an economic slowdown. Overall, there was little new to learn, but the market pricing for a 75bps rate hike for the July meeting picked up. It is important to keep in mind that the minutes were from the June meeting and the recession concerns have picked up materially since then. This means that the 50 vs. 75bps debate for July is still alive, but the bigger focus is on the path of rate hikes beyond that as economic slowdown will likely pick up pace by then. Key to watch is the payrolls data due this week and CPI due next week for further sense.
U.S. ISM services PMI still holding up well
The U.S. ISM no-manufacturing PMI for June edged lower to 55.3 from 55.9 in May, but came in above consensus of 54.3. The services side is still keeping the economy afloat, and that continues to provide room to Fed to continue to be aggressive in order to fight the inflation pressures. Still, the strength of the services sector is depleting fast, as the PMI was the third consecutive month of growth slowdown in US services industry and a 20-month low, so that again puts the focus back on Fed’s expected path beyond the July rate hike.
U.S.-China relations aren’t getting any better
After some reports earlier this week around the Biden administration considering a potential rollback of some China tariffs, we cautioned against excessive euphoria as Biden’s only agenda is to bring down inflation ahead of the midterm elections. Now according to Politico, the cut is only for $10 billion worth of goods, a small fraction of the total of $370 billion worth of imports from China. We believe strategic goods like steel will not be considered, and this is unlikely to have any material impact on macro dynamics. Meanwhile, U.S.-China tensions on the tech side are picking up again with China's foreign ministry accusing U.S. of "technology terrorism" in forcing ASML & Nikon from selling semiconductor chip making technology to China. China reports Q2 GDP data next week, but the true extend of economic headwinds will hardly be visible in the headline figure.
Ocean shipping rates are falling again.
This indicates the economic slowdown is deeper than expected. This is quite unusual to have falling rates in this period of the year, which usually corresponds to the peak season. Blank sailings are increasing to adjust to lower demand and preserve profitability. This basically means that shipping companies cancel calls or skip a particular port, region or possibly an entire leg on a scheduled route. For instance, the 2M Alliance (Maersk and MSC) have reduced their services by up to 71 % around mid-May according to the latest data available. Several companies are now focusing mostly on East-West routes which are more profitable and exit secondary routes. On a bright note, shipping line reliability has substantially improved in recent weeks, especially for trade coming from Asia.
The cryptocurrency hedge fund Three Arrows Capital and the crypto broker Voyager Digital have filed for Chapter 15 and Chapter 11 bankruptcy respectively this week. More companies will likely follow the same pace in the short term.
Apple (AAPL) is said to be launching a new extreme sports model that could potentially rival a Garmin. It could be announced later this year with a 7% bigger screen than the largest Apple Watch. Separately, Apple is offering a new optional feature for ‘extreme’ security protection. “Lockdown Mode” will be available for iPhone, iPad and Mac devices to prevent targeted cyberattacks on high-profile users like activists, journalists and government officials. Meanwhile after the US Federal Communications Commission (FCC) wrote to Apple and Google (GOOGL) to remove TikTok from their app store as “TikTok poses an unacceptable national security risk", now US senators are seeking a federal investigation into TikTok. Apple (AAPL) shares moved ~1% higher, extending their three day uptrend.
Australia’s trade surplus hits new record $16 billion; as the nation ramps up fossil fuel exports
Despite Australia’s biggest export iron ore’s price being down 50%, the nation grew its trade surplus (exports minus imports) to an unprecedent all-time record high of $16 billion (in May). The surplus was $2.7 billion higher than April and also beat the $10.5 billion surplus expected. Exports swelled 10% to $58.4 billion, driven by Australia increasing its shipments in fossil fuels; thermal coal, coke (a mineral that is used in steelmaking), and briquettes (compressed blocks of coal dust, which are used for fuel) as well as other mineral fuels. Meanwhile, costs to Australia, its imports rose 6% to $42.4 billion, with lubricants, and non-industrial transport equipment leading the rise.
What are we watching next?
Today we get initial jobless claims which have weakened lately indicating early signs of a potential rollover in the US labour market. Challenger job cuts figures for June are also out today which is an interesting time series to watch in this current phase because it can reveal the intensity of layoffs in the US economy.
With most of Europe away on holiday, market liquidity is usually thinner in July and moves can be amplified. It is prudent to give less weight to volatile market moves and focus on the long-term fundamentals, this is especially the case for investors. Holding the US Dollar and cash may be the kings for now, along with selective quality stocks, perhaps in coal given coal prices seen to be supported. However, when it comes to cash positions, remember that with inflation remaining higher for longer, cash value will erode. Also bear in mind that the supply side of the economy is still not fixed, and the focus will move back to bringing that in balance, once the market moves away from speculative trading.
It happens rarely but this week has no important earnings but the Q2 earnings season start next week with companies such as PepsiCo, Fastenal, Delta Air Lines, JPMorgan Chase, Morgan Stanley, Conagra Brands, PNC Financial Services, UnitedHealth, Well Fargo, Charles Schwab, US Bancorp, BlackRock, State Street, and Citigroup.
Titled "The Runaway Train” and can be accessed here.
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Head of Fixed Income Strategy
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