Global Market Quick Take: Europe – June 13, 2023

What is our trading focus?

US equities (US500.I and USNAS100.I): bubble dynamics are intensifying

US equities extended their clear bubble dynamics yesterday with Nasdaq 100 futures rallying 1.7% from the open to the close smelling of strong bets on a surprise lower US May inflation figure today. If the May inflation figures indeed surprise with lower-than-expected core inflation, then it could fuel the melt-up scenario even more. Key risk intraday is naturally the US CPI report at 12:30 GMT.

FX: Choppy day for yields and cable

The US dollar chopped around from weakness and back to strength yesterday ahead of the critical incoming event risks of today’s May US CPI data and tomorrow’s FOMC meeting (preview below). Sterling was particularly volatile on the day as GBPUSD touched highs of 1.2600 before the rally was rejected and slid all the way to sub-1.25 at one point ahead of this morning’s UK labor market data. UK gilt yields rose higher, with 2-year yields revisiting the September highs, on BOE Mann warning of persistent inflation, but failed to support cable as fiscal concerns rose. AUDUSD continued to surge on China stimulus hopes, rising above 0.6750 before retreating and then getting a small additional boost overnight on China’s rate-cut.

Crude oil: will OPEC defend $70 in Brent as prices hold near three-month low

Crude oil prices fell sharply on Monday on continued worries about demand outlook before a surprise rate cut from China’s PBoC helped steady the ship. Saudi Arabia’s decision to cut production to boost the price has fallen on death ears and the market may even attempt to challenge the Kingdom’s resolve with Brent trading near $70, a potential line in the sand. Futures markets continue to signal weakness in the physical market despite Saudi warnings, but the macroeconomic outlook will need to stabilize before that changes. Iran confirmed that it was not in talks with the US about a nuclear deal after the market was spooked by rumours last week that it was making progress in talks over its nuclear program. Focus turns to OPECs monthly oil market report due today followed by the IEA on Wednesday. Brent trades near support at $71.75 ahead of $70.

Gold: all eyes on central bank decisions

Gold fell on Monday as bond yields rose ahead key cental bank meetings this week, but overall, it remains rangebound as it struggles for momentum ahead of key central bank decisions this week. Unless today’s US CPI springs an upward surprise, the FOMC is expected to introduce a hawkish pause on Wednesday. During the past week gold has been drifting lower along the line created by the 21-day moving average, today at $1962 while support looks firm below $1940.

Demand at yesterday’s US Treasury auctions was solid. Today the market prepares for 52- and 6-week bills and 30-year bond auctions (2YYM3, 10YM3, 30YM4  TBIL:xnas)

Demand for yesterday’s bills and coupon issuances was good despite the 10-year auction tailed by 1.5bps. If today’s CPI data surprise on the upside, the selloff in US Treasury might accelerate, especially in the front part of the yield curve. Yields have the potential to rise across the yield curve, in particular in the front part. Two-year yields are testing resistance at 4.60%; once broken, they’ll find resistance at 4.75% next. Ten-year yields are testing 3.75% if broken, they’ll find new resistance to 3.9%.

A hawkish ECB and BOJ ight accelerate the selloff in European sovereigns (EXHB:xetr, D5BC:xetr, DE000BU22015)

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.

What is going on?

UK employment, earnings data and revisions change the plot

The UK employment data this morning was far better than expected,with strong revisions to April data changing the picture on the strength of the UK labor market for now, particularly on the “payrolled employees” front, as the terrible April figure of –136 was revised sharply up to +7k, while the May figure came in at +23k as expected. More good news was in the May Jobless Claims numbers, which fell –13.6k, while April figures there were revised down to +23k from +47k. The April Employment Change figure was +250k, a new high since May of last year and the April Unemployment rate dropped to 3.8% from 3.9% and versus 4.0% expected. Average Hourly Earnings for April were far higher than expected, at +7.2% ex Bonus #M/gbpusdgpc YoY vs. 6.9% expected and 6.8% in March.

Chip designer Arm is going ahead with the largest IPO this year

The arms race in the semiconductor industry continues at a blistering pace with the US, Europe, and Japan changing the regulatory framework for incentivizing semiconductor manufacturing locally to reduce geopolitical risks. Key in the semiconductor industry is the designs and patents of various chip designs with many of them owned by Arm. Nvidia attempted to acquire the chup designer but got refuted by Chiense regulators and thus the shareholder SoftBank Group is now considering an IPO. The latest news is that SoftBank is druming up strategic partners with Intel now in play which would fit well into the US government’s strategy of making Intel a powerhouse again in general purpose chips.

China delivers surprise rate cut

China’s PBOC surprised consensus with a 10 basis point cut to its 7-day reverse repo rate, the first cut from the central bank to that rate since August of last year. The timing of the move was seen as unusual as the PBOC is scheduled to announce any changes to its one-year “medium term lending facility” On Thursday. The move in the reverse repo rate overnight suggests some urgency in signaling support for the economy. USDCNH posted new highs for the cycle above 7.15 on the move, which also boosted risk sentiment in the Asian session with copper and iron ore both bouncing following earlier weakness.

Oracle’s Q1 outlook fuels 3% rally

The software maker announced better than expected revenue and earnings last night driven by 23% revenue growth in its cloud services segment with management indicating that the company expects the cloud business growth rate to remain the same over the next year. Oracle issued a strong Q1 outlook with revenue growth expected at 8-10% against estimates of 8%. Shares were up 3% in extended trading following a 5% gain in the AI-fueled rally during the primary session.

Defaults on US junk debt rise for those financing on floating rates

The FT reports that there were 18 corporate defaults in the junk loan market in the US this year, worth some $21 billion, with $7.8 billion and three defaults coming in May. The totals are greater than the combined number and value of defaults for 2021 and 2022 combined. The pain is worst in the “leveraged loan” market, where many companies borrowed on floating rate terms. Overall, the total default rate has only picked up slightly for the three months through the end of April, with Goldman estimating a 3 percent annualized default rate versus 2 percent a year ago.

Weekly US crop conditions report shows decline in conditions for key crops

The USDA reported crop conditions declined for corn, soy, oats, and spring wheat in their latest weekly update. Corn conditions rated good/excellent fell 3% to 61%, below the five-year average at 70% with many states contributed to the drop amid dry conditions. Same for soybeans were conditions fell in most major states with the overall condition falling 3% to 59%, the worst for this week since 2008. New crop corn and soybeans futures have both been climbing on concerns that dry weather in the key growing areas will hurt yields in the world’s biggest producer of corn and second biggest of soybeans. Paris Milling wheat futures meanwhile trades near a one-month high on fears of an escalation in the Ukraine war and last week's dam destruction may add to supply worries as dry weather continues to negatively impact the outlook in parts of Europe and Russia.

The BTP-Bund spread falls to the lowest since April 2022 amid Silvio Berlusconi’s death

Investors’ sentiment concerning Italian government bonds recently improved as they pay the highest yield among the periphery, the country is growing, and the ECB’s anti-crisis tools help against fragmentation. Yet, it was not a coincidence that the drop in Italian government bond yields accelerated after news of Berlusconi’s death yesterday. At the age of 86, the former premier was still involved in politics. Notoriously he has always been friends with Putin, and in February, he blamed Zelenskyy for the war in Ukraine. Knowing how volatile politics in Italy are and how influential Berlusconi was, the possibility for Italy to flip from West to East was a real threat. However, with him gone that risk is removed and his party will need to find its own identity.

Gilts remain vulnerable amid strong inflationary pressures

Catherine Mann’s worries about sticky inflation were confirmed this morning as weekly earnings surprised on the upside and the unemployment rate surprised on the downside. After Mann’s remarks yesterday, yields rose by 10bps across the yield curve, and markets priced the benchmark rate to peak at 5.61%. It is likely that yields will continue to surge on the back of this morning's economic releases. We see scope for 2-year yields to rise towards 5%, testing a critical level that might provoke volatility across markets.

What are we watching next?

Technical update

• Nasdaq 100. Higher lead by Semiconductors. Uptrend stretched but no resistance until 15,265
• S&P 500. Closed above resistance at 4,325. RSI divergence cancelled indicating higher levels. No strong resistance until 4,546
• DAX likely to test previous peak at 16,331
• Brent oil. Key support at 71.25
• WTI oil key support 64.00
• GBPUSD seems likely to re-test key strong resistance at 1.2667
• AUDUSD likely to test resistance at 0.68 shortly
• EURNOK is breaking rising trendline. Support at 11.38

US CPI today, FOMC hike decision tomorrow

The market is pricing that the Fed will likely pause today its rate hike regime today, with one more 25-bp hike likely in July before beginning to cut rates as soon as at the December FOMC meeting. The odds for a hike dropped sharply last Thursday on the release of a worse than expected US weekly initial jobless claims number. Today’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 core “ex Food and Energy” figure is expected to drop to a 17-month low of 5.2% 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 after 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 Fed members 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.

Earnings to watch

Next earnings focus is Lennar earnings tomorrow after the US market close with analysts expecting revenue down 13% y/y to $7.3bn and EBITDA of $1bn down from $2bn a year ago as the US homebuilder market is seeing lower growth as the consumer is still digesting the higher interest rates. Read our Friday’s earnings preview for our take on Adobe earnings scheduled for Thursday this week.

• Tuesday: Ashtead Group
• Wednesday: Lennar
• Thursday: Adobe, Kroger, Jabil, Halma

Economic calendar highlights for today (times GMT)

• 0900 – Germany Jun. ZEW Survey
• 0900 – UK Bank of England’s Greene to testify to Parliament
• 1000 – US May NFIB Small Business Optimism
• 1230 – US May CPI
• 1700 – US Treasury to auction 30-year T-bonds
• 2030 – API's Weekly Crude and Fuel Stock Report
• During the day: OPEC’s Monthly Oil Market Report