Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Summary: Markets poked around with little conviction yesterday as US markets were closed for Labor Day. Overnight, the JPY dropped to new lows versus the US dollar and weakened broadly even as global bond yields bounced around in a range, a sign of mounting pressure on the Bank of Japan to abandon its policy of capping bond yields. In Europe, the focus this week is on plans to cap gas and power prices and new UK Prime Minister Liz Truss has announced a 130 GBP billion plan to deal with soaring energy costs - more than 5% of UK GDP.
US equities are trying to find some stabilisation in the short-term trading higher this morning at around the 3,935 level with the 3,903 being the key level to watch on the downside. The US 10-year yield is still seeing upward momentum sitting at 3.24% this morning and consensus is slowly moving on ECB in favour of significant tightening to reign in inflationary pressures in the economy. Today’s ISM Services print for August is the key macro figure to watch today. A negative surprise in the US services sector could be a positive for equities as it could cool inflation expectations and longer-term US yields.
With the US out on holiday yesterday, the US dollar backed off a bit, not including the move in the Japanese yen to new cycle lows, which is more about the BoJ’s reluctance to change policy (more below). The greenback is at a technically pivotal spot here in EURUSD (trying but so far failing to separate from parity after posting a marginal new low in the wake of the as Europe attempts its move against soaring energy prices, which will require some energy rationing and therewith a reduction in real GDP even if successful and as the ECB scrambles to gain credibility in its fight against inflation, with expectations for the policy rate through the December ECB meeting rising nearly 70 basis points since mid-August.
USDJPY has rallied to new 24-year highs overnight, trading nearly 141.00 this morning, even as US long treasury yields remain a few basis points below their recent peak, suggesting that the market is set to challenge the Bank of Japan policy of capping yields. A Bank of Japan that continues to hold the line on capping yields could create a pressure cooker of a situation on the yen and tremendous volatility, particularly if US 10-year treasury yields continue back higher toward the 3.50% peak from June. The next important economic data points for the US are today’s ISM Services survey for August and Monday’s August CPI.
EU gas and power market rallied on Monday following Putin's decision to further weaponize its energy supplies to Europe by closing Nord Stream 1. However, the sense it can hardly get much worse saw the market turn its attention to the EU and Friday’s energy summit where proposals to mitigate Russia’s hostile actions will be discussed. After surging to €290/MWh on the opening, the Dutch TTF benchmark gas contract ended the day at €245/MWh, up 14% and well below the €350 peak seen when the Nord Stream 1 maintenance was announced. German year ahead power closed at €570 after failing to get anywhere near the panic peak above €1000 seen last Monday, an indication the market is looking for a new pricing structure and speculators worrying about the derivative market being shut down for a period.
Crude oil rallied on Monday after the OPEC+ group of producers in a surprise move took away the token 100k b/d production increase that was added last month in response to lobbying from the US President. Additional action to keep prices stable (read supported above $90) could be enacted at short notice, the group said. Other developments traders must deal with is the prospect of an unlikely revival of the Iran nuclear deal until after the November US Midterm elections, further lockdowns in China hurting demand, and a deepening energy crisis in Europe where punitively high gas prices will likely support demand for refined products such as diesel and heating oil. The EIA will publish its monthly Short-Term Energy Outlook on Wednesday. Brent is currently stuck between support at $91.50 and the 21-day moving average, last at $97.15.
Gold and silver trades higher supported by selling fatigue and short covering following last week’s rout, especially silver that was dragged down by copper’s slump on China growth concerns. All three metals have, however, managed to find a bid but the question remains how much further they can recover without the support from a weaker dollar and yields pausing following their recent ascent. Copper needs to hold support at $3.38/lb, the 61.8% retracement of the July to August bounce while silver needs a solid break above $18.40 and gold above $1728/oz.
The dip in US treasury yields from Friday has so far proven a one-day affairs as yields have rebounded slightly ahead of the next important couple of important US macro data points, the August. SM Services survey today and the August CPI data on Monday. Technically, the remainder of the range from 3.25% to 3.50% in the US 10-year treasury benchmark is critical for whether rising global yields once again become the market’s primary focus.
Her promises range from quick action on energy security to alleviating the cost-of-living crisis for the hardest hit by price rises, all while cutting corporate and other taxes. She has announced a GBP 130 billion plan to freeze energy bills, which is around 5% of currently rapidly rising nominal UK GDP and a recipe for ballooning fiscal deficits, an issue that is already an ingredient in sterling’s steep fall this year, so an even steeper recession is in the wings. This could come either from a drop in real GDP due to soaring inflation aggravated by further sterling declines or as demand is crushed by a steep recession due to the need for the Bank of England to accelerate its pace of rate hikes or more likely a combination of the two. Longer term, investments in fracking shale gas and new North Sea exploration could pay dividends. For the moment, sterling is enjoying a modest relief rally.
While the Kremlin had earlier said that they were halting gas supplies on Nord Stream 1 for a technical fault, it has now clearly stated that gas supplies to Europe via the Nord Stream 1 pipeline will not resume in full until the “collective west” lifts sanctions against Moscow over its invasion of Ukraine. Russia is still supplying gas to Europe via Soviet-era pipelines through Ukraine that have remained open despite the invasion, as well as the South Stream pipeline via Turkey. But supplies along the northern pipeline routes, including Nord Stream 1 and the pipelines through Ukraine, have fallen by more than 90% since September last year. Higher supplies from Norway, the UK, north Africa and increased imports of LNG have helped to an extent offset the loss of Russian supplies.
The PBoC announced that the central bank is cutting the reserve requirement ratio for foreign exchange deposits (the “FX RRR”) to 6% from 8%, effective September 15. The cut is expected to release about USD 19bn (2% of the USD 954bn FX deposits outstanding) in FX liquidity for banks to make loans in foreign currencies. The PBoC last cut the FX RRR to 8% from 9% on 15 May, to send a signal to the market to put a pause to the depreciation of the USDCNY which had weakened from 6.40 to 6.80 in one month (15 April to 13 May). After the surge of the USDCNY from 6.75 to above 6.90 in about half a month since 15 Aug, the PBoC apparently wants to send a signal again to the market to slow the speed of the renminbi depreciation against the USD.
A token cut by OPEC+ last night of 100k barrels per day just reverses the output increase agreed to last month. The decision was ‘symbolic’, with the new quotas taking effect in October. The amount is significantly small compared to a 100 million bpd market but it shows that OPEC+ wants to set a floor near $100/barrel in Brent. Saudi Arabian oil minister Prince Abdulaziz bin Salman had warned last week that a cut was a possibility given what he said was a disconnect between financial and physical oil markets.
As Europe is facing an energy crisis this winter, it will need to increase energy imports. The UK is already importing Australian LNG. In anticipation of such a scenario, this might explain why the Australia coal price trades at a record, along with the futures price. The Australian energy supply is already likely to run low in 2023, meaning inflation will continue to worsen and for coal companies, their earnings and free cash flow will likely increase.
The property sector is already struggling to absorb the hikes already in the bag from this cycle, so we will be watching signs of further strain in the banking sector, along with property stocks and property ETFs, given Australia’s private debt to GDP is one of the highest in the world.
It appears that the market is ready to challenge the Bank of Japan more directly again on its yield-curve-control policy as the entire developed market complex ex-Japan has been marked to continue tightening policy, while the Bank of Japan tries to remain an unmovable object, and this is without a notable further jump in the important longer yields . Even GBPJPY is tearing higher this morning as sterling catchs a bit of a relief rally in the wake of PM LIz Truss’ arrival on the scene.
Already in July, there was a significant contrast between the two surveys, with the S&P Global survey suggesting that the US services sector is in contraction, with a reading of 47.3, a number that dropped to 44.1 for the preliminary August release of the survey. Meanwhile, The July ISM Services survey surprised to the upside with a strong 56.7 reading in July and the August release later today is expected in at 55.4. Which is correct?
Australian economic growth is expected to show 1.2% growth q/q in the second quarter and 3.8% y/y. Second quarter GDP will likely get a boost from record retail sales, and a pickup in overseas travel. However, construction costs and hampered residential construction activity could weigh on the headline GDP figure.
While the earnings release date for NIO has been moved around multiple times it should be final now so tomorrow one of China’s largest EV-makers will report Q2 earnings. Investors will focus on the Q3 outlook for revenue growth and margins in order to gauge when NIO can break even on its operations.
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