Summary: The US and Asian equity markets were largely sideways after US equities attempted new highs for the cycle yesterday. The announcement of OPEC production cuts at the weekend meeting saw oil prices closing only slightly higher after an initial surge. Overnight, the Reserve Bank of Australia shocked expectations by raising the policy rate another 25 basis points, the second consecutive hawkish surprise and a move that drove a further boost to the resurgent Australian dollar.
US equities did not manage to extend the momentum yesterday after the strong jobs report on Friday taking the S&P 500 futures to their highest close since August 2022 signalling that the equity market is still maintaining a balanced outlook. While the US equity market is technically strong the narrow rally this year and in particularly recently with AI-related stocks pushing the indices higher there are considerable downside risks to US equities should sentiment shift on AI stocks.
The soft May ISM Services Index out yesterday at 50.3 suggests the US services economy is essentially at a standstill and the US dollar and US treasury yields traded lower after the release. The greenback got a further blow overnight on the Reserve Bank of Australia surprising for the second time in a row with another 25 basis point hike, taking the policy rate to 4.1% (more below). The surge in the AUD takes the AUDUSD fully back into the former range, suggesting a bullish reversal, while AUDNZD extended well above 1.0900, with support for the AUD not only from the RBA move, but also solid strength in copper prices. Elsewhere, the USD is in a bit of limbo sa the market mulls whether the Fed is finished hiking and whether the US treasury rebuilding its account in coming weeks/months will lead to a USD-supportive pinch in liquidity.
The 1 million barrels per day unilateral crude oil production cut in July announced over the weekend by Saudi Arabia failed to lift on oil prices. After gapping higher to touch resistance around the March highs, both WTI and Brent ended the day slightly lower than were they left on Friday. The market remains focused on the risk to demand with recession concerns mounted on a broad-based miss in US services PMI giving room for a Fed pause on rates. Cutting production as the Saudi’s did is likely to be easier than adding them back in, and they and other producers will probably look to China where additional stimulus measures may be needed to turn the sentiment on the energy markets. For now, the crude oil market is likely to remain rangebound, but in our view, with the risk skewed to the upside, given OPEC’s willingness to sacrifice production to support prices.
Following on from Friday’s strong US job report which helped send gold prices down to a March 17 low, the bullion market turned higher on Monday after data showed the US service sector nearly stalled in May as business activity and orders dried up. The ISM Services Index raised the prospect of a Fed pause while reducing bets on a July rate hike. Given the current close correlation between gold and the direction of Fed funds we continue to monitor closely the December SOFR futures (SR3Z3). the short-end contract that recently replaced the Eurodollar futures contracts. Gold remains in a short-term downtrend, and for that to change it needs a break above $1977, the 21-day moving average.
Yesterday, the 3- and 6-month T-Bill auctions received strong demand with their bid-to-cover ratio at 3.1x and 3.14x respectively, the highest in one year. It is not surprising that demand remains elevated as the yield offered on T-Bills remains one of the highest on record. However, the US Treasury needs to issue large volumes of debt to rebuild the TGA. The question is whether demand will stay strong throughout the month. Since the end of April, 2-year US Treasury yields soared by approximately 50bps, signaling that the Fed might not be done hiking and that it might keep rates higher for long. To confirm this thesis might be the dot plot next week. A key resistance level remains at 4.49% for 2-year yields while they will find support at 4.29%.
We still see scope for 2-year yields to soar test resistance at 4.68%, we believe it’s unlikely rates will soar to break 5%. As yields rise towards the 5% level, the financial sector will begin to suffer as it happened last September during Truss’ mini-budget crisis. Therefore, the BOE will need to step into rescue, limiting rates’ upside to avoid a financial crisis.
The Direction 20+ Year Treasury Bull 3X (TMF:arcx) more than doubled its assets as investors bought it amid speculations that the Fed is done with its rate hiking cycle. Yet, it returned only 2% YTD, while it plunged 73% in 2022, showing that the strategy didn't take off yet. On the contrary, the Ultra Short 20+ Year Treasury ERF (TBT:arcx) suffered from the worst outflows showing that there might be little downside in US Treasury still.
For the second consecutive meeting, the RBA surprised expectations with another 25 basis point rate hike, taking the cash rate target to 4.1%. The RBA’s statement indicated that while it felt inflation was past its peak, that it would require some time for it to return to the target range and that the move was aimed at increasing confidence that inflation would fall. The statement also noted wage pressures rising (as it began increasing rates last year, much of its focus was on weak wage growth as a reason to take a slow approach to hiking rates), particularly in the public sector. House price rises were also noted and the Bank guided for possible further policy tightening going forward: “some further tightening of monetary policy may be required”.
ISM Services PMI saw a surprise fall to 50.3 in May from 51.9 in April, against the consensus view for a rise to 52.2, indicating a slower pace of growth for the services sector as well. The index saw declines in both the forward-looking New Orders (52.9 vs prior 56.1) and Employment (which slipped into contractionary territory at 49.2 from the prior 50.8). Prices paid component, which raised some alarm bells last month, also eased to a 3-year low of 56.2 from 59.6. The index sends another signal that demand is cooling and that the cumulative tightening is working through the economy, giving room to the Fed to pause in June to assess conditions further.
Apple yesterday announced that it would bring a Vision Pro mixed reality headset to the market early next year. The gadget will sell for a price of $3,499, which is more than 10 times Meta’s headset, the current volume leader in the space. Apple CEO Tim Cook said the headset would allow “seamlessly blending the real world with the digital world”. He also said that the product would mark “the beginning of a journey” to “spatial computing”, suggesting that the volume of sales will likely be modest in the beginning. Apple shares had a wild ride yesterday on the announcement, trading briefly to a new all-time high past the early 2022 peak before closing more than five dollars a share off the highs and below 180. Disney was part of the event highlighted as a key partner in the early phase of the Vision Pro allowing users to see Disney+ content on the device. Disney shares were unchanged suggesting the market has difficulties pricing the success of the Vision Pro headset and how big the market is.
April cash earnings was reported this morning from Japan. Nominal wages rose 1.0% YoY from 1.3% YoY in March, coming in below expectations of +1.8% YoY. Real wages were down for a 13th straight month by 3.0% YoY after a decline of 2.3% YoY in March and expectations of -2.4% YoY. This continues to give Bank of Japan the leeway to avoid any drastic changes to its policy stance for now even as minor tweaks may still be considered to respond to market pressures.
The US securities market watchdog has sued Binance, the world’s largest crypto exchange, accusing it of sending billions of dollars to a separate trading firm owned by its chief executive. The Securities and Exchange Commission’s 13 civil charges against the company are latest blow to Binance after another US financial agency sued it in March.
Wheat futures in Chicago and Paris has risen strongly this week with the Chicago contract seeing the longest stretch of increases since March last year as the market worry about tighter supplies this year. Apart from already very dry and challenging conditions in parts of Europe and the US, the latest rally came after Australia, the world’s second biggest exporter this season, said its next harvest could slump one-third from a year earlier following the second driest May on record. Drry weather in the US is taking its toll on other crops like corn after conditions deteriorated by the most in three years. These challenges emerging even before El Ninõ later this year will start to impact food producers around the world.
The dam at the Kakhovska hydroelectric power plant has been destroyed this morning which will lead to flooded banks on the west side of the Dnipro River in the Kherson regions. In addition, the destruction will lower the water level in Kakhovska reservoir which is used for cooling of the Zaporizhzhia nuclear power plant. The full potential fallout from this destruction is unknown at this point with the Ukrainian government holding an emergency meeting over the incident. The destruction of the dam is also an indication that the Ukrainian offensive is accelerating.
The earnings season continues to run light and among this week’s earnings releases our focus is on Inditex. The Spanish fast-fashion retailer reports FY24 Q1 (ending 30 April) on Wednesday with analysts expecting revenue growth of 12% y/y and EBITDA of $2.13bn up from $1.92bn as the retailer has got a good start to the year. However, uncertainty around the outlook is elevated with growth expected to decline in the coming quarters.
0800 – ECB Consumer Expectations Survey
0830 – UK May Construction PMI
0900 – Eurozone Apr. Retail Sales
1400 – Canada May Ivey PMI
2320 – Australia RBA’s Lowe to speak
0130 – Australia Q1 GDP Quarterly Outlook
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