Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Summary: A choppy session on Friday for equities as the market looks forward to the central bank bonanza this week, including the FOMC meeting this Wednesday, ECB meeting on Thursday and Bank of Japan meeting on Friday. After a weak weekly jobless claims number, most believe the Fed will hold off on tightening again this week, with tomorrow’s May US CPI data the last important data point ahead of the decision.
US equities extended momentum on Friday as strong sentiment around EVs and AI technologies continued to push the equity market higher with S&P 500 futures closing at their highest level for the cycle. This morning S&P 500 futures continue to push higher trading around the 4,355 level defying economists’ scepticism around the economy. On Friday, the VIX Index pushed lower again to a new low signalling strong sentiment and indications of a potential melt-up scenario unfolding.
The US dollar was modestly higher on Friday after steep fall on Thursday following a spike in jobless claims which eased fears that the Fed could tighten again this week. The Canadian dollar was volatile on weak Canadian May jobs data as the unemployment rate rose and average hourly earnings for permanent workers ticked down. But focus remains on US CPI tomorrow and Fed meeting on Wednesday this week. Hotter-than-expected Norwegian inflation saw NOK sharply higher on Friday. NZDUSD also rose above 0.6120 with AUDUSD well above 0.6700 amid expectations of China stimulus, although copper prices dropped back lower late Friday after an attempt through key resistance. USDJPY remains stuck between 138.50-140 despite Friday’s surge in short-end yields, with the market complacent that the Bank of Japan leaves policy unchanged at its meeting this Friday.
Crude oil prices extended their late Friday afternoon slide into today’s Asian session amid ongoing concerns about the demand outlook amid China’s slow recovery and recession risks elsewhere. Also, the market is facing week that delivers rate decisions from major central banks, including the PBoC. Saudi’s Energy Minister, meanwhile, reiterated his view a discrepancy exits between the futures market and the physical market. A gap that in our opinion will persist until the macroeconomic outlook stabilises. Goldman Sachs made its third price downgrade in six months after lowering its end of year Brent forecast to $86 from $95 previously, siting additional supply from sanctioned countries from Russia to Venezuela and Iran. OPEC to publish its monthly oil market report on Tuesday followed by the IEA on Wednesday. Brent remains rangebound between $72 and $78.50.
Gold remains rangebound after as it continues to struggle for momentum, currently exemplified by its struggle to break above the 21-day moving average, today at $1965. An eventful week awaits with rate decision from several major central banks, the most important being Wednesday’s FOMC meeting where a hawkish pause is expected. Support remains firm below $1940 resulting in the first week of buying from funds in four in the week to June 6.
The market will need to digest $296bn between today and tomorrow in what is the beginning of an intense issuance spree. Last week's T-Bill demand was strong except for Thursday’s 4-week T-Bill sale, as the yield tailed by 4.5bps. We will continue to monitor this week’s debt issuance to see if we find cracks in liquidity. Today the Treasury will sell 3- and 10-year coupon issuances and 4- and 6-month bills. The CPI data on Tuesday and the FOMC meeting on Wednesday might further pressure US Treasuries. Yields can rise across the yield curve, particularly in the front part. Two-year yields are testing resistance at 4.60%. Once broken they will find resistance at 4.75% next. Ten-year yields found teste 3.8% to find new resistance to 3.9%.
The two-year German swap spread fell to the lowest since mid-April last week as the front part of the yield curve moved higher, pricing an interest rate hike at this week’s ECB meeting. We believe two-year Schatz remains rich, and yields look likely to rise above 3% this week. Besides the ECB meeting on Thursday, our attention is also on the Bank of Japan on Friday. A hawkish tilt from the BOJ will accelerate the selloff in European sovereign as support from Japanese investors wanes.
Japan’s May PPI entered deflationary territory to come in at -0.7% MoM from +0.3% last month, missing expectations of -0.2% MoM. On a YoY basis also, PPI came in softer-than-expected at 5.1% from 5.9% previously, relieving pressure on Bank of Japan to recalibrate its easy monetary policy. Bank of Japan (BOJ) Deputy Governor Masazumi Wakatabe was on the wires this morning saying don’t expect a change from BOJ at the June meeting.
Days after Ukraine's counteroffensive was widely reported to have begun in international press reports, currently concentrated in four areas of the east and south, President Volodymyr Zelensky appeared to confirm that it is indeed in progress for the first time in weekend statements by saying that "counteroffensive and defensive actions are being taken in Ukraine." Ukrainian sources claimed the retaking of three villages in Russian-occupied Donetsk.
Gas prices in Europe surged 35% last week with the Dutch TTF benchmark contract closing at €32/MWh, a one-month high, as hotter weather forecasts signalled stronger demand than previously expected amid signs of budding competition from Asia as it faces an ongoing heatwave. In addition, a reduction in pipeline gas from Norway look set to extend after several outages, while the recent sharp drop in EU prices have made it more profitable to ship LNG to Asia. However, recently Eurozone has confirmed a technical recession and if fears of a global slowdown accelerate, industrial demand could weaken and any price spikes in gas prices could remain temporary.
Recent data from China indicates an increased risk of a stalled economic recovery. The CPI and PPI data released last Friday showed deflationary pressure, further adding to concerns. Additionally, upcoming activity data scheduled for release this week could reinforce the case for the People's Bank of China (PBOC) to implement a rate cut. While the Bloomberg consensus forecast suggests that the 1-year Medium-term Lending Facility Rate (MLF rate) will remain unchanged, there is a growing probability of a reduction in the MLF rate this Thursday. This likelihood has been strengthened by recent comments from PBOC Governor Yi Gang, who stated that the central bank would lower funding costs and support the real economy. The PBOC already reduced the Reserve Requirement Ratio in March and has recently urged large state-owned banks to cut deposit rates.
The market is pricing that the Fed will likely hike once more for the cycle, whether at this Wednesday’s FOMC meeting or at the meeting in July. The odds for a hike dropped sharply last Thursday on the release of a worse than expected US weekly initial jobless claims number. Tomorrow’s May US CPI print is an important last data input ahead of the Fed’s decision after several months of stick core YoY inflation in that data series around 5.5-5.6%. The May figure is expected to drop to a 17-month low of 5.3% and the headline figure to drop all the way to 4.1% from 4.9% in April as the most dramatic year-on-year base effects kick in for the May-July period on the enormous spike in gasoline prices to record highs in June of last year.
The market will also pore over the update of the Fed’s economic and policy path projections for guidance on the Fed’s thinking. It is worth pointing out that the March projections suggest that the median Fed view is that its policy would be at just above 5% through the end of this year even as it anticipated that the Unemployment Rate would rise to 4.5% and core PCE inflation would moderate to 3.6% by year-end. For perspective, the latest unemployment rate (for May) was 3.7%, while core PCE inflation has been sticky for five months running in the 4.6-4.7% area.
The more concentrated energy becomes in a system the more fragile it becomes to adverse changes so the fact that the 10 largest stocks in the S&P 500 now have a combined index weight of 30.4% is a very bad sign. It tells us several things. First, it shows that competition is going down in the US economy. Second, it shows that the US equity market offers less and less diversification thus inherent risks to a smaller set of risk factors. With technology stocks being so dominant in US equities sentiment changes and thus the underlying risks are much higher than what is signaled in the VIX Index.
Today’s earnings focus is Oracle which reports FY23 Q4 (ending 31 May) earnings tonight after the US market close with analysts expecting 16% revenue growth as the Cerner acquisition continues to impact y/y figures. EPS is expected to at $1.58 up 32% y/y. Read our Friday’s earnings preview for our take on Adobe earnings scheduled for Thursday this week.
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