Summary: US equities rolled over after challenging to new local highs after yields dropped further yesterday on a considerable drop in the Prices Paid component of the July ISM Manufacturing survey. The headline for that survey was more resilient than expected, but New Orders fell deeper into contraction for the month. Elsewhere, the RBA surprised overnight with dovish guidance and the world waits with bated breath for US-China tension risks as US House Speaker Nancy Pelosi is set to visit Taiwan tomorrow.
Oil prices tumbled on Monday and extended their decline overnight in Asia as demand concerns were aggravated by a slide in China and European PMIs while the US ISM manufacturing PMI also weakened. Meanwhile, improved supply from Libya weighed, as the country is seen rebounding to producing 1.2mb/d after a series of disruptions that halved supply. WTI futures slid below $94/barrel and Brent was also seen below the $100 mark.
Gold prices yesterday touched the key chart resistance at 1,780 – a key support on the way down to the lows below 1,700 recently as US yields have now dropped nearly 100 basis points from the highs in mid-June. The 1,780-1,800 is a critical zone for whether gold can achieve relevance again after easing yields have taken real interest rates sharply lower since the June peak.
The RBA surprised overnight with guidance that was interpreted as dovish after hiking rates by 50 basis points as most observers expected. The new statement removed wording from the prior statement that the rate hike represented a “further step in the withdrawal of the extraordinary monetary support”, replacing it with the increase representing simply a “further step in the normalisation of monetary conditions”. Guidance near the end of the statement that the RBA “is no on a pre-set path” and said that the size and timing of interest rate increases will be data dependent, suggesting the RBA is taking a leaf from the most recent FOMC meeting, in which the Powell Fed generally avoided guiding for future moves outside of pointing to data dependence. The RBA did raise its inflation forecast to 7.75% this year. However, surprisingly the RBA thinks inflation will fall to 4% in 2023 (then 3% across 2024). More broadly, the RBA dropped its growth and employment outlook, which proves we could see a stagflation environment. It expects GDP to slow to 3.25% in 2022, then 1.75% next and the following year. It sees unemployment creeping up from 3.5% (50-year lows) to 4% later this year; probably as businesses need to trim their balance sheets to account for wage growth and interest rate hikes. Australian rates at the front end of the curve dropped sharply and the Australian dollar was sharply weaker.
With much of US earnings season behind us for Q2, with almost 300 of the S&P 500 companies reporting results, we have again continued to see the most earnings growth come from energy companies. For the second straight quarter energy companies have beat the most as gas, coal and oil prices continued to move higher. Average energy company earnings growth of 288% was reported by 13 energy companies in Q2. Stand out companies include Valero Energy, Hess Corp, Devon Energy, Diamondback, and Chevron, all reporting earnings growth of over 200% each.
The visit was not in Pelosi’s official itinerary but has been anticipated and has created much tension between China and the U.S. in recent days. There is speculation that China might take drastic measures to prevent Pelosi from landing in Taiwan. China announced holding a military exercise in Bohai. The House Speaker is well-known for being critical about China and in support of closer ties between Washington and Taipei. The visit will at its minimum set the stage of further escalation of tension in the Sino-American relationship for months to come.
While the PCE or ISM data remains back-dated, the Fed speakers can provide us some insights into what the central bank is thinking in terms of policy options going forward and whether there is any pushback against the market’s interpretation of the FOMC meeting last week. Having kept the forward guidance vague at the FOMC last week, Powell has increased the volatility around data and Fed speakers in the weeks ahead. Chicago Fed president Charles Evans (non-voter this year), Cleveland Fed president Loretta Mester (voter) St. Louis Fed president James Bullard (voter) are scheduled to speak later today. Investors are likely to pay close attention to their remarks for insights into the Fed’s thinking, and to build further views on the inflation vs. recession argument.
The Q2 earnings season has been good for equities as we wrote in our equity update yesterday with earnings up 13% q/q on much stronger revenue growth and a jump in operating margins driven by the energy sector. Today’s key focus is Caterpillar with its big exposure and importance in the global construction industry. Analysts expect revenue growth of 9% y/y and operating margin of 17.8% up from 15.7% in Q1.
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