Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Summary: Equity markets are in a nervous mood after the recent sharp comeback, perhaps in part on signs of a sustained energy crunch nearly everywhere, as natural gas prices spiked to a new record in Europe and to multi-year highs in the US and Brent crude traded north of 80 dollars per barrel for the first time in nearly three years.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - key focus today is Nasdaq 100 as the US 5-year yield has broken above 1% for the first time since the pandemic started. We saw tentative signs yesterday that higher energy prices and higher interest rates were having an impact on sentiment. Energy, power, and natural gas prices are higher again today in Europe and our view is that it will drive interest rates higher, and equities lower with Nasdaq 100 futures testing 15,000.
Hang Seng (HSI.I) - Hang Seng futures are firmly higher taking out yesterday’s intraday high trying to muster enough energy to move towards the 25,000 level. The move is happening while the global economy is experiencing an energy crunch that has the potential to severely cut into growth and lower companies’ profit margins. Evergrande shares are also higher today as the real estate developer is still trying to find a way to stay afloat.
EURUSD – the price action remains sticky around 1.1700 despite the strong repricing higher of US yields which have supported the US dollar against the yen but otherwise haven’t driven broader strength. The sell-off needs to take out those 1.1664 lows soon or fresh shorts could risk getting squeezed. Potential sources of additional USD strength here include a fresh weakening of risk sentiment (the energy issue reaching critical attention threshold could be one source of uncertainty there) and a further rise in US long treasury yields.
USDJPY and JPY crosses – the yen is tumbling across the board on the sudden jolt higher in global yields and as the energy story is negative for Japan due to the nation’s near total reliance on imported oil and gas. USDJPY is within striking distance of the 111.66 high for the cycle from July and other JPY crosses have shifted direction violently over the last week, including EURJPY, which has rallied back above 130.00 and above the 200-day moving average. The key coincident indicator for JPY direction likely remains the direction of yields.
Gold (XAUUSD) treads water around $1750 for a second day with a firmer dollar and rising US Treasury yields being offset by surging energy prices reigniting the focus on inflation and its potential negative impact on company earnings. Gold is often used by fund managers as a hedge or diversifier against risks across financial assets, and in recent months record high valuation and low volatility has driven an exodus. A development that, despite rising yields, may start to reverse. Gold, however, remains almost 90 dollars below levels that could trigger fresh speculative momentum buying, hence the lack of urgency in the market currently. Focus this week on EU CPI and US PCE date as well as US stimulus package and debt ceiling.
Surging energy prices remain the key focus in commodities with all sources of fuel from crude oil to natural gas and coal continuing to surge higher amid worries about a global supply crunch during the coming winter. Low stockpiles of most fuels and limited time left to replenish before the peak demand season has left consumers around the world increasingly exposed to a colder than normal winter. Brent crude oil trades above $80 for the first time in three years on a rising prospect for fuel substitution from gas and coal. Natural gas prices around the world continues to spike with record prices in Europe and surging LNG prices in Asia helping to drive US futures up 27% in just four days to a 7-year high above $6. The next focus is at what level demand will continue to suffer thereby helping to balance the market.
A disastrous 2-year US treasury auction shows that the bond market may begin to fear the Federal Reserve’s tightening and debt ceiling’s risk (IEF, TLT). The bid-to-cover of yesterday’s 2-year US notes auction fell to 2.28x the lowest since December 2008. Indirect bidders also fell to 45.32%, from 60.52% in the previous auction. The notes prices at 0.31% the highest yield since March 2020 and tailed by 0.08 bps. Surprisingly, weakness didn’t leak to the following 5-year notes auction, which saw solid demand despite indirect bidders decreased compared to the previous 5-year auction. It may be a sign that the market is beginning to price Fed’s tightening monetary policies and the risk coming from the debt ceiling saga. Today the US Treasury is going to sell 7-year notes one of the least liked maturity, which provoked a widespread selloff in February. If demand lacks as we have seen during yesterday’s 2-year auction a selloff might ensue in longer maturities.
Until a governing coalition is formed, German Bunds are more vulnerable to rising yields in the US than the German election (IS0L). Ten-year Bund yields are trading in a fast area, which may take them quickly to -0.15%. Despite the German election may represent a big change for the European sovereign space, it will not set direction until a governing coalition is formed. Rising yields in the US are more likely to impact Bunds’ direction in the mid-term. We expect Bund yields to turn positive by the end of the year, however, there is potential for them to drop once again below -0.25% before they resume their rise.
What is going on?
US fails to deal with debt ceiling issue in first attempt this week, as Republicans in the Senate voted down the progress of a bill aimed at suspending the debt ceiling. If no measures are taken before Friday, the US government may be forced to shutdown and theoretically could default somewhere between mid-October and early November once the US Treasury runs out of emergency maneuvers.
Two regional Fed presidents now resigning, both accused of inappropriate trading activity while at the Fed. The first was Dallas Fed head Kaplan (the Dallas Fed president not scheduled to become voter until 2023), with Boston Fed Head Rosengren now also set to resign. He was a hawkish voice on the Fed and the Boston Fed president will be a voter next year. This leaves six seats open on the 19-seat FOMC that will need filling in coming months.
Spain August PPI rose 18% yoy. This is the largest increase since May 1980. The jump partially reflects supply bottlenecks and higher energy prices. The situation might further deteriorate due to the risk of energy crunch in Europe this winter. The ECB expects inflation to peak in November. We believe inflationary pressure will last longer.
U.S. August durable goods rose more than expected. It was out at 1.8% versus expected 0.7% and previous -0.5% after revision. Excluding transports, the rise was at 0.2%. The biggest driver of the gains was aircraft orders (+77.9% mom). With the revision to July, durable goods orders have risen in 15 of the past 16 months. This is a remarkable run. It confirms that demand remains very high despite bottlenecks.
Polestar to IPO in biggest SPAC deal ever. The EV-maker that is controlled by Geely and Volvo (also controlled by Geely) is set to IPO through a $20bn SPAC deal which just further increase the competition in electric vehicles. It will also provide investors with the first pure exposure EV alternative to Tesla from a non-China EV maker.
What are we watching next?
When do energy prices seize more of broader market attention? Around the global, coal prices and natural gas prices are driving all manner of new input cost pressures and outright disruptions, particularly with natural gas prices in Europe. At some level, there could be an inflection point where the issue reaches critical mass and crimps sentiment, at least until prices ease more significantly. Oil pressing close to multi-year highs and above the 80 dollar/barrel level could also start to serve as a tipping point.
US stimulus packages/debt ceiling in focus this week - the Republican approach seems to be hoping that the Democrats will fail to pass their larger stimulus bill due to intra-party agenda differences and the Republicans seem dead set on avoiding any contribution to the resolution of the debt ceiling issue. Meanwhile, the next step on the stimulus front is a Thursday vote on the smaller infrastructure bill passed with bipartisan vote in the Senate, but with progressive Democrats threatening a veto unless the larger social- and climate spending bill is attached to the smaller bill. But the debt ceiling issue will dominate market attention into Thursday, the last day of the US government’s fiscal year as some form of government shutdown will ensue after that date.
Economic calendar highlights for today (times GMT)
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