Global Market Quick Take: Europe – July 7, 2023

What is our trading focus?

US equities (US500.I and USNAS100.I): A new dynamic has entered the market

The US economic figures yesterday suggest that the economy remains robust with strong employment gains seen in ADP driven by big gains in the services sector. JOLTS job openings in May suggest the US labour market remains very tight supporting the FOMC position that underlying inflationary pressures will remain stronger for longer and thus higher policy rates may be needed. S&P 500 futures declined 0.8% after being down as much as 1.3% around the lows with technology stocks and real estate sector being the strongest on relative basis while energy and consumer discretionary were two weakest sectors. Today’s focus is on whether S&P 500 futures extend lower to the 4,400 level, another US 10-year yield close above 4%, and whether the SOFR futures Dec23 (contract approximately pricing the Fed Funds Rate in December 2023) breaks below 94.50 and take out the lows from early March before the US regional banking crisis began.

European equities (EU50.I): Biggest decline since March turmoil

STOXX 50 futures fell 3% yesterday as higher bond yields across the board is feared to put Europe into a recession. Recent data points from the EuroCoin Growth indicator suggest that the European economy is slowing down rapidly, The 4,200 level is critical support level for STOXX 50 futures in today's trading session.

FX: Strong US data boost US yields, but not the US dollar

Treasury yields jumped yesterday on US economic indicators (more below) pointing to a reheating of the economy. The US dollar initially rose yesterday but fell versus the JPY in particular late yesterday and overnight as the impact of tighter financial conditions (long end of US yield curve rising in particular) drove a decline in risk sentiment. JPY strength is likely in part on May Earnings data for Japan overnight coming in stronger than expected (more below), which leads to more anticipation of a policy tweak at the July 28 BoJ meeting. USDJPY trades sub 144.00 again this morning, near yesterday’s lows prior to the US data. The JPY strength and higher US yields is putting recently popular carry trades under pressure, with MXN suffering a sharp correction yesterday, while traditionally pro-cyclical currencies like AUD and CAD remained broadly weak, even against the weaker US dollar into this morning’s trade.

Crude oil: FOMC vs OPEC

Crude oil prices are heading for a second week of gains, but overall, they remain stuck within a relatively narrow range with a brooder risk off sentiment, driven by rising yields amid the prospect of further Fed rate hikes being offset by signs of tightness in the physical oil market with the front of the curve in WTI and Brent both trading back in backwardation. Saudi Arabia, who so far has cut supplies by 1 million barrels/day from July through August lifted official selling prices for its flagship Arab light crude to all regions, a sign of stronger demand. EIA data showed crude stockpiles dropping for a third week while implied gasoline demand hit a December 2021 high.  Given the current battle between FOMC action weighing on prices and OPEC production cuts supporting, the next focus will be today’s US job report.

Gold showing resilience despite yield surge

Gold continues to trade nervously ahead of support below $1900, a level that provided a firm buying response during a recent sell-off attempt. The same situation occurred on Thursday when ISM Services PMI and ADP Private Payroll surprises helped send US bond yields sharply higher (see below). Gold suffered with real yields across the curve spiking, especially at the front where the 2-year rose above 3% for the first time 2009. However, with two rate hikes almost priced in before November, the market may look beyond and worry the FOMC may tighten the screws to the point where something breaks. While central bank buying continues to provide a soft floor under the market, gold’s ability to hold onto the $1900-handle may in the short-term depend on the dollar, which so far has not seen any support from rising yields. Resistance remains the 21-day moving average, currently at $1930.

Strong job market sends yields higher with the belly of the yield curve underperforming (2YYN3, 10YN3)

Private sector employment increased more than double expectations, taking the market by surprise. With the job market resilient and inflation elevated, the bond market continued to push further out in the future expectations of a rate cut. It resulted into higher US Treasury yields across the yield curve, in particular the belly. Ten-year yields have broken above 4%, while two-year yields are flirting with resistance at 5%. We expect them to continue their rise with 2-year yields rising to 5.25% and 10-year yields to 4.5% by the end of the month. Today's non-farm payrolls are in focus. If they exceed expectations the selloff might continue.

The market is pricing the BOE to hike rates another 150bps to 6.5% (IGLS:xlon, GLTS:xlon)

The selloff in Gilts intensified yesterday as investors ramped up the BOE rate hikes bets. The real BOE base rates is at -200bps. For the central bank to bring it into restrictive territory it will need to hike its benchmark rate by 100-150bps, assuming that inflation will decline in the meanwhile. Only when the real BOE base rate will be in positive territory the central bank will have achieved a restrictive posture. However, we are uncertain whether the BOE will be able to hike that much due to financial instability. Gilts are the backbone of the UK financial system. As their value decreases, margins calls will increase. Therefore, we are likely to go towards another mini-budget crisis. Yet, this time around the BOE might not be able to pivot to support market stability.

What are we watching next?

June US ISM Services far stronger than expected

The US services PMI for June came in above expectations at 53.9 from 50.3 last and 51.2 expected. The jump was led by a massive surge in business activity, which rose from 51.5 to 59.2, well above the 51.9 forecast. The employment metric saw a strong rise, returning to expansionary territory at 53.1 from 49.2, which serves as an upside risk to today's NFP data due. New Orders also rose to 55.5 from 52.9, laying the path for future activity. Prices paid component cooled but remained in expansion at 54.1 from 56.2.

US June ADP private payrolls post massive rise

The June US ADP private payrolls showed an astounding rise of 497k, well above the prior 267k and expected 225k, and far and away above any single month’s growth in payrolls in the period the data began reporting in 2010 until early 2020 (pre-pandemic). Job creation surged in June with strong gains in leisure and hospitality, trade and transportation, and education and health services, with total services gains coming is at a solid 373k. While the ADP data can encounter double counting issues and lacks can lack month-to-month direct correlation to the NFP data due today, the market will lean for an upside surprise in the nonfarm payrolls data today too after a series of strong economic data indicators over the last two weeks. The July Fed rate hike probability has jumped to 89% from 85% previously, and terminal rate forecast rose to 5.5% from 5.4% previously.

Twitter threatens Meta with lawsuits over Threads app

According to Meta it gained 30mn users for its new Threads app in the first 24 hours after the launch making it one of the most successful product launches of all time. Twitter is not sitting idle and has threaten Meta with lawsuits over allegations that Meta stole trade secrets from Twitter allowing to build a competing product in an accelerated way.

Japan’s wages jumped in May

Japan’s nominal labor cash earnings for May came in at 2.5% YoY, above the 1.2% expected and 0.8% in April. Real cash earnings were still negative at -1.2% YoY but better-than-expected -2.7% YoY. The numbers suggest that the higher pay negotiated at the spring wage negotiation in March may be now filtering through and may prompt the central bank to consider tweaking its policy as market pressure sustains. BoJ Deputy Governor Uchida was on the wires saying that they will continue YCC “for the time being” to keep monetary conditions easy. He also noted there is still a long way to go before rate hikes and there are no plans to change the 2% inflation target.

What are we watching next?

US June jobs report the next test for treasury yields

While the June ADP private payrolls data out yesterday suggested a viciously tightening US labor market, the latest US weekly initial jobless claims data provided no additional momentum to the story: initial claims were at 248k in the week ending July 1 from the downwardly revised 236k (initially 239k), just above the expected 245k. Continuing claims dropped to a new local low of 1,720k, however, continuing a trend after peaking in early April.

The next focus is the June Nonfarm Payrolls Change number today, which could show headline gains of 225K from 339K in May, while the unemployment rate is expected to dip to 3.6% from 3.7% in April reversing part of the jump in April. Average hourly earnings are expected to slow slightly to 4.2% YoY from 4.3% previously, remaining unchanged at 0.3% MoM. Any hints of wage pressures firming could make the July rate hike a done deal, and bring the 10-year yield further above the key 4% level.

Earnings to watch

The Q2 earnings season starts next week with US banks such as Wells Fargo, JPMorgan Chase, and Citigroup are kicking off the earnings season on Friday. Read our earnings preview from yesterday here.

Next week’s earnings releases:

• Thursday: Fastenal, Delta Air Lines, Progressive, PepsiCo, Cintas, Conagra Brands
• Friday: Wells Fargo, JPMorgan Chase, BlackRock, UnitedHealth, State Street, Citigroup

Economic calendar highlights for today (times GMT)

1200 - Mexico June CPI
1230 – US Jun. Nonfarm Payrolls Change
1230 – US Jun. Unemployment Rate
1230 – US Jun. Average Hourly Earnings
1230 - Canada June Employment Data
1430 - UK BoE's Goolsbee (Voter 2023) to speak
1430 – EIA's Natural Gas Storage Change (delayed from Thursday)
1645 - ECB President Lagarde to speak
1930 – CFTC's Weekly COT report covering a shortened week to July 3