Global Market Quick Take: Europe – July 28, 2023

What is our trading focus?

US equities (US500.I and USNAS100.I): stocks decline on higher bond yields

Equities ended its rising steak with the S&P500 declining 0.6% to 4,537 while the Nasdaq 100 sliding 0.2% to 15,464. A series of unexpectedly strong economic data saw the 10-year Treasury yield jump to 4%, weighing on stocks. The weakness was broad-based except in the communication services sector which was supported by a 4.4% in Meta Platforms (META:xnas) after reporting strong Q2 results.

Lam Research jumped 9.3% after the semiconductor equipment maker guided strong sales growth. Textron (TXT:xnys) soared 11.9% following the aerospace company beat earnings and gave an upbeat outlook citing higher pricing for business jets. Royal Caribbean (RCL:xnys) surged 8.7% on a higher profit forecast for 2023. McDonald’s (MCD:xnys) added 1.2% after an earnings beat despite noting growth slowing.

Banking shares declined, seeing the KBW Bank Index falling 1.2% as the Federal Reserve and the Federal Deposit Insurance Corp (FDIC) held meeting to consider a plan to require additional capital at large banks.

FX: EUR and GBP plunge 1% on dovish ECB hike, JYP strengthens on BOJ YCC Tweak

After a dovish and well-anticipated rate hike by the ECB which turned data-dependent for its next move, EURUSD plunged nearly 1% to 1.0980. The rise in US Treasury yields on strong economic data also weighed on EUR. Likewise, GBPUSD declined by 1.1% to 1.2790.

On the other hand, the Japanese Yen strengthened by 0.7% against the US dollar from Wednesday New York to 139.20 after the Bank of Japan (BOJ) made a tweak to its yield curve control policy and potentially allow the 10-year Japanese Government Bond yield to rise above the official upper-bound of 0.5% to as high as 1%.

US Treasuries (2YYU3, 10YU3, 30YU3): Yields jump on strong economic data

Treasuries sold off on Thursday first stemmed from unexpected increases in the Q2 GDP and durable goods orders and a decline in the initial jobless claims, all suggesting a more resilient US economy than expected. Later on an increase in pending home sales, contrary to the consensus forecast of decline, and a Nikkei story saying the BoJ will discuss broadening the cap on the 10-year JGB yield (adjusting the YCC policy) further weighed on Treasuries prices. Finally, a poorly received 7-year auction that was awarded at 1.2bps cheaper than the level at the auction deadline and a 2.48 bid-to-cover (vs previous 2.65) added fuel to the selling. The 2-year yield finished the day 8bps higher at 4.93% while the 10-year yield jumped 13bps to 4.0%.

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

The German yield curve bull steepened yesterday as the ECB hinted to a September pause. Yet, another rate hike in the fall remains at play, as bond futures are pricing the possibility for a ECB peak rate at 4%. That means that although German yields might adjust lower in the short term, a further bear flattening is likely as 2-year Schatz move towards 3.5%. Today’s German CPI figures remain in focus as a surprise on the upside might show that the ECB is not done with hiking. Long-term EU sovereign bond yields are moving higher as the BOJ surprised with changes to the rate ceiling.

What is going on?

ECB hikes 25bps and the next move turns data dependent

The ECB raised policy rates by 25bps, as widely anticipated. The statement changed to saying rates will be “set at” sufficiently restrictive levels rather than previously saying “brought to” sufficiently restrictive levels. At the press conference, ECP President Lagarde’s message was that the ECB’s next move would be data-dependent, especially on the incoming data about domestically generated inflation and services inflation while some other measures of inflation showed signs of easing. She said the incoming data will determine “whether and how much more ground” for future rate hikes to cover. Lagarde opened the door to skip a rate hike at the upcoming meeting in September as the Fed did in June.

Bank of Japan tweaks its YCC policy potentially allowing higher long-term yields

While the BOJ maintains its +/- 50bps allowable range of deviation from zero for the 10-year Japanese Government Bond (JGB) yield, the central bank says that it will be flexible and the 0.50% previous yield cap will from now only be a reference, not a cap on yield. Further, the BOJ said it will offer to buy 10-year JGBs at 1% every business day. After the change, the BOJ has discretion to allow the 10-year JGB yield to go above 0.5% but not higher than 1%. In effect, the cap has been raised from 0.5% to 1.0% despite the official allowable range stays.  The nine-member board voted 8-1 in favour of the change.

US Q2 GDP grows 2.4%, above expectations

The US Q2 GDP unexpectedly grew 2.4%, rising from 2.0% in Q1 and contrary to the forecast of a decline to 1.8%.  Durable goods orders increased 4.7% (vs 1.8% in May; consensus: 1.3%) in June on strong aircraft orders. The weekly initial jobless claims fell to 221k from 228k, contrary to an expected increase.

What are we watching next?

US Data focus on core PCE deflator, the employment cost index, and the U of Michigan survey

The focus of today’s data from the US will be on the Personal Consumption Expenditure (PCE) deflator and the core PCE deflator, both are expected to slow in June. According to the Bloomberg survey, the median forecast of the growth in the headline PCE deflator is at +0.2% M/M (vs +0.1% in May) or +3.0% Y/Y (vs +3.8% in May) and that of the core PCE deflator is at +0.2% M/M (vs +3% in May) or +4.2% Y/Y (vs +4.6%  in May). One important to note is that some of the drivers for a soft core CPI we saw earlier this month were not present in the core PCE. For example, the core CPI captured a sharp decline in airline fares while the core PCE used a different measure of passenger transportation costs in its calculation. Core PCE deflator is the Fed’s preferred measure of inflation.

The growth in the employment cost index (ECI) is expected to slow to +1.1% Q/Q in Q2 from +1.2% in Q1. The ECI includes stickier components such as non-wage benefits and government wages so it may lag some other measures but it is the preferred measure of wage inflation of the Fed.

Also scheduled to release today is the University of Michigan consumer sentiment survey. The median forecasts for the sentiment reading to remain at 72.6 while the 5-10 year inflation expectation softens to 3.0% in July from 3.1% in June.

Technical Analysis

• S&P 500. Top & reversal pattern intact. Plus new created Bear Engulfing. A correction almost certain. Support at 4,455
• Nasdaq 100. Correction down to 15K-14687 likely
• DAX closed above 16,210 i.e., uptrend confirmed
• AEX25 Uptrend to 802. Possibly 830
• CAC40 Broken above resist at 7,403 but indicators not supporting bullish break. However, no resist until 7,581  
• Hang Seng broken bullish. Likely move to 20,155 and 20,865.
• EURUSD failed to rebound. Now testing rising trend line and likely the  0.786 retracement at 1.0927. Medium-term uptrend intact
• Dollar Index testing 0.618 retracement at 101.73
• GBPUSD correction could be over at 1.28 support and uptrend likely to resume
• USDJPY Rejected at resistance at 142. Likely to test support 137.20
• EURJPY broken rising trendline. Trying to find support at 0.618 retracement at 152.20 but could drop to 150.30
• EURGBP Double bottom pattern cancelled. Downtrend resumed. Could test 0.85
• Gold uptrend but short-term correction to 1,940-1,930 could be seen
• Copper could be building uptrend.  Minor resistance at around 395   
• Brent above resistance at 83. Next resistance at 87.25
• WTI above resistance at 79.20. Next resistance at 83.35
• Wheat testing June peak at 784. Likely higher prices next few weeks
• US 10-year Treasury yield back at 4%. Resistance at 4.1% 

Earnings to watch – heavy day of earnings ahead

Earnings this week:

• Friday: ExxonMobil, Procter & Gamble, Chevron, Hermes, AstraZeneca, Sanofi, Keyence, ITC

Economic calendar highlights for today (times GMT)

• 0328– BOJ Monetary Policy Decisions
• 0645 – France Jul. HICP
• 0900 – Eurozone Jul. Economic Confidence
• 1200 – Germany Jul. HICP
• 1230 – US Jun. Personal Income and Spending
• 1230 – US Jun. PCE Deflator
• 1230 – US Q2 Employment Cost Index
• 1400 – US Jul. U. of Michigan Consumer Sentiment (Final)