Global Market Quick Take: Europe – May 26, 2023

What is our trading focus?

US equities (US500.I and USNAS100.I): unchanged despite big rally in semiconductors 

Equities were mostly unchanged yesterday despite a significant rally in semiconductor (+8.8%) and software (+3.1%) stocks driven by Nvidia’s monster revenue outlook as the world goes full speed into AI technology. The US economic data from initial jobless claims to the Chicago Fed National Activity Index showed that the economy is still doing well pricing out the possibility of several rate cuts this year.

FX: Dollar posts new highs on rising US treasury yields

The US dollar continues to rally on rising US treasury yields, which posted new local highs on another solid jobless claims number (more on that below) and likely also due to hopes for a possible impending debt ceiling deal. The forward curve of Fed expectations has seen a significant repricing, with the odds for a further 25 basis point hike at the June FOMC creeping above 40% and most of the anticipated Fed rate cutting priced through this December now priced out. USDJPY toyed with the 140.00 area, EURUSD dipped below 1.0750, and NZDUSD and AUDUSD posted new lows for the year yesterday with little bounce in their step in the Asian session. If a debt deal is agreed, the USD liquidity situation could deteriorate amid a flood of treasury issuance, driving the greenback considerably higher.

Crude oil trades lower on Russian production comments

Crude oil fell more than 3% on Thursday, almost given back most of the Saudi “watch out” and falling US stocks-led rally. The drop came after Russia said the OPEC+ group wasn’t likely to make any further voluntary cuts when they meet in early June. The comments contradicting the Saudi threat earlier in the week saw the focus return to demand where the outlook remains troubled by economic slowdown worries. It highlights a market that for now is likely to remain rangebound with sharply lower prices unlikely to go unnoticed by OPEC while the upside potential can only be achieved once the economic outlook becomes clearer. In Brent, $80 remains the big level to break before talking about a change in direction.

Gold remains short-term challenged as peak rates are being delayed

Gold trades back above $1950 after slumping below on Thursday as the US economy continues to show resilience thereby raising the risk of further rate hikes and with a postponement of the timing of a gold supportive peak rate situation. An upward revision to US Q1 GDP and lower-than-expected jobless data saw traders increase bets on a July rate hike while the prospect for rate cuts this year continued to evaporate. Focus today on US income and PCE deflator data, as well as the debt ceiling standoff. Support remains at $1950 ahead of $1933 while a break back above $2001, the 21-DMA will be needed to improve sentiment.

Corn futures pop on dry US soil conditions

Corn futures in Chicago are on track for the biggest weekly rally in almost a year as dry weather threatens emerging crops in the US, the world’s biggest producer. Cool, dry weather favours planting of the remaining corn and soybean acreage, but lack of topsoil moisture is becoming more apparent. The July front month contract (ZCN3) trades up 6.9% this week to $5.925/bushel, with short covering from hedge funds, who often concentrate their activity at the front and most liquid part of the futures curve, providing some additional positive momentum. As a result, the December contract, which represents the crop that is being planted this spring for harvest in the fall, ‘only’ trades up 4% on the week.

UK Gilts continue to tumble amid inflationary fears (FLGM3, FLGU3)

Gilt yields continue to rise sharply following higher-than-expected CPI numbers on Wednesday and a selloff in US Treasuries yesterday. The front part of the yield curve rose the most, with 2-year yields soaring by 15bps on Thursday. Although 10-year yields are likely to test and break resistance at 4.59% and 2-year yields might soar to test resistance at 4.68%, its unlikely rates will soar to break 5%. We believe that as yields rise towards the 5% level, the financial sector will begin to suffer, as 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.

US rates continue their rise (2YYK3, 10YK3, 30YK3)

The yield curve becomes more inverted as markets prepare for another rate hike and price out rate cuts for this year. The Fed’s minutes on Wednesday showed that members are ready to hike if needed but reluctant to cut despite forecasting a mild recession. Yesterday's initial jobless claims indicated that the job market is tight, the quarterly PCE numbers beat expectations and growth is also beyond forecasts. Therefore, the bond market priced a rate hike in July, erasing all forecasted rate cuts for the year. That contributed to yields soaring across the yield curve. Ten-year yields broke resistance at 3.75% and find new resistance at 3.91. 2-year broke resistance at 4.49%, their new resistance is now at 4.63%. If today’s PCE numbers are higher than forecasted, and the debt ceiling impasse is resolved, we believe a June rate hike will be in play, pushing 2-year yields higher in the 4.75%

Debt ceiling saga still rattles money market (BIL:arcx)

Although there is encouraging news that GOP and the White House negotiators are close to an agreement, money markets remain volatile. The risks surrounding the debt ceiling crisis are a default or a credit downgrade. The latter can materialize even if a default is avoided. If we draw parallels with the 2011 debt ceiling crisis, long term US Treasuries gained the most as they served as a safe heaven. Ten-year yields dropped by 100bps in total, and 70bps after a rating downgrade materialized. Yet, in the long part of the yield-curve there is plenty of room for downside as a resilient US economy and persistent inflation might add upward pressure to yields.

What is going on?

Nvidia ends session 24% higher adding over $200bn in market value

After a volatile session that saw shares trading as high as 394.80 and as low as 366.35, Nvidia shares closed 24% higher at 379.80 on the day and increasing Nvidia’s market cap more than $200bn. one of the largest single day increases in market cap for an equity in history.

US jobless claims and GDP data boost odds of another Fed hike

Initial jobless claims came in lower-than-forecast at 229k (exp. 245k) in the week ended May 20, with the prior revised much lower to 225k from the initial 242k, with the revision in large part on Massachusetts revising three months of jobless claims lower by an average of 14k per week due to the discovery of fraud. Continued claims dipped to 1.794mln (prev. 1.799mln), shy of the expected 1.8mln. Meanwhile, US Q1 GDP was revised higher to 1.3% from 1.1% in the second estimate, with notable increases in consumer spending. The better-than-expected data has now brought one full rate hike being priced in by the market by July and only one rate cut left in this year’s pricing.

Tokyo CPI again brings a hot core print

The headline print for Tokyo CPI for May softened to 3.2% YoY from 3.5% previously and 3.4% expected. However, the core-core print was once again firmer than expected, coming in at 3.9% YoY from 3.8% previously. This suggests that there will be continued pressure on the BOJ to tweak policy, and the recent bout of weakness in the Japanese yen may also add to these pressures.

Debt ceiling: a two-year deal in the works?

Talks yesterday between the two sides in the US debt ceiling debate appear to be moving closer to an agreement in principle, according to sources, with a two-year raise to the debt limit possibly in the works. That would put the issue to rest until the other side of the next US presidential election in November of 2024. A Bloomberg article writes that “people familiar with the matter” say that the deal would, among other points, allow a 3% increase in defense spending, some spending to upgrade the US’ electric grid infrastructure to integrate more renewable energy (a Democratic demand) as well as easing the permitting process for pipelines and other traditional fossible fuel energy projects (a Republican demand). Republican House Speaker Kevin McCarthy may face difficulties in getting the support from the House Freedom Caucus, a small group in his party that favours an uncompromising stance on limiting spending.

What are we watching next?

Market reaction function if a debt ceiling deal is agreed

It will be important to watch the market reaction function in the event a debt ceiling agreement is reached – whether today or not until next week, as this could ironically bring a wave of weaker risk sentiment. The issue at hand is that the US treasury needs to rebuild its reserves, perhaps by as much as $500 billion in net new treasury issuance in the months to come after drawing down its funds to virtually zero. This could pressure US treasury yields higher and bring a firmer US dollar as well as liquidity comes under pressure. Risky assets could perform poorly for a time. In fact, the recent rise in treasury yields may already be a function of the markets pricing in that a deal eventually will be agreed.

US April PCE inflation and May University of Michigan Sentiment up today

The US April PCE inflation data is up today and is expected at 0.3% MoM for both the headline and core “deflator” number, while the YoY numbers are expected in at 4.3%/4.6%, respectively. As well, the final May University of Michigan sentiment survey will get more play than usual after the preliminary survey for the month showed longer term inflation expectations rising to a 12-year high of 3.2%. With the momentum in yields building and these data points coming ahead of a long holiday weekend in the US (Monday is Memorial Day), together with the US debt ceiling issue in the mix, markets may prove volatile today.

Earnings to watch

The earnings calendar is getting smaller and smaller as the market waits for Q2 earnings releases to come out in mid-June. Next week’s main earnings release to watch is Salesforce which is expected to report FY24 Q1 (ending 30 Apr) revenue of $8.2bn up 10% y/y and EBITDA of $3bn up from $1.2bn a year ago

• Friday: PDD, Booz Allen Hamilton

Next week’s earnings releases:

• Tuesday: HP, HP Enterprise
• Wednesday: Salesforce, Crowdstrike, Okta
• Thursday: Broadcom, VMware, Lululemon Athletica, Dell Technologies, MongoDB, Zscaler, Dollar General, Hormel Foods

Economic calendar highlights for today (times GMT)

• 1230 – US Apr. PCE Inflation
• 1230 – US Apr. Preliminary Durable Goods Orders
• 1400 – US Final May University of Michigan Sentiment/Inflation expectations