Summary: Equity markets fell sharply on Friday, erasing the steep rally of the prior session, as US treasury yields rose and the US dollar closed the week on a strong note. After a retreat on Friday, the pound sterling is attempting a comeback on hopes that the new Chancellor will reverse more of the struggling new government’s original tax cut plans. The focus for the week ahead will likely be on corporate earnings, with Tesla, the world’s most heavily traded stock, set to report Wednesday.
A steep drop in equities Friday erased the odd-ball rally of the prior session as the US equity market heads into Q3 earnings season on its back foot, trading heavily near the cycle lows. The next focus lower could be on the major high posted pre-pandemic in the S&P 500 near 3,400. For the Nasdaq 100, the equivalent level would be near 9,750, some 1,000 points lower from the current level. The earnings season kicks into gear this week with especially Wednesday being important for sentiment in equities as Tesla and ASML reports earnings.
Hong Kong’s Hang Seng (HSIV2) and China’s CSI300 (03188:xhkg)
Stocks in Hong Kong and mainland China retreated after the selloff in the US markets last Friday. In addition, General Secretary Xi’s speech yesterday hailed China’s “Dynamic Zero-Covid” strategy and gave no hint of shifting policy priorities toward economic growth as some investors had hoped for. Hang Seng Index lost 1.1% and CSI300 slid 0.4%. China Internet stocks traded in Hong Kong declined from 2% to 8%. CNOOC (00883:xhkg) climbed 0.7% after preannouncing strong net income, benefiting from higher energy prices.
The US dollar quickly recovered lost ground on Friday after the big correction Thursday, in correlation with the return of weak risk sentiment and a fresh rise in US treasury yields back toward the cycle highs. After Chinese leader Xi Jinping's speech at the party congress this weekend, the USDCNH exchange rate remains pinned near the 7.20 area that was the previous high from 2019 and 2020, USDJPY continues to run higher amidst broad JPY weakness (EURJPY is nearing a multi-year high above 145.00). Elsewhere, EURUSD seems reluctant to make a statement with 0.9800 and 0.9536 the two levels of note there, and GBPUSD has pushed higher on hopes that the recent volatility in UK gilts and sterling will see the government retract its budget-busting policy moves, with likely further political turmoil ahead as Prime Minister Truss fights to stay in office.
Crude oil (CLX2 & LCOZ2)
Crude oil dropped sharply on Friday after a strong comeback for the US dollar and with little to help sentiment as the week gets under way after Chinese leader Xi doubled down once again on his commitment to Zero Covid policy. The bigger focus in energy markets is on the weak supply situation in diesel amidst concerns of shortages in both Europe and the US. In Europe, strikes at French refineries are aggravating the supply situation, while US storage levels are at their lowest for this time of year ever.
US treasury yields pulled back higher on Friday to close the week near the highs for the cycle, with the 10-year Treasury yield benchmark near 4.00% once again and a very light US data calendar for the week ahead, although important housing data like the October NAHB Survey is up tomorrow and September Housing Starts/Building Permits data follows on Wednesday. The most interesting auctions this week are a 20-year US Treasury auction on Wednesday and a 5 year TIPS auction on Thursday.
General Secretary Xi Jinping made a speech to present the Work Report of the 19th Central Committee to the 20th National Congress. In the speech, he reiterated the current policies of the new development paradigm, common prosperity, dual circulation, and dynamic zero-Covid, as well as strong language on Taiwan. As we remarked in a recent note, General Secretary Xi is set to continue the key policy priorities that he launched over the past 10 years into the five years ahead. Investors hoping for major shifts in economic policies in China or the Chinese authorities ditching the dynamic Covid-zero strategy after the 20th National Congress will most likely be disappointed.
Due to US export restrictions Apple has decided to halt the usage of memory chips from the Chinese company YMTC. The chips are cheaper than other manufacturers of memory chips but were only supposed to have been used for the Chinese market, so the immediate impact on iPhone pricing is low. However, it underscores the long-term risks to inflation from the ongoing reshoring of the global supply chain.
On a positive note, the US preliminary October University of Michigan sentiment indicator rose slightly, with the headline at 59.8, up from 58.6 in September. This is the highest print since April 2022. This is partially explained by an easing of supply constraints. But concerns over inflation and the ongoing economic slowdown remain. On a negative note, U.S consumer spending was flat last month. Retail and food services sales were little changed after an increase of 0.4 % in August. This is actually much worse than it looks like. Retail sales numbers are not adjusted for inflation which means that real spending actually retreated for the month. However, it is unlikely to prevent the U.S. Federal Reserve from raising the Fed funds rate by at least 75 basis points at the November FOMC meeting (current market pricing is +78 basis points).
In the Australian state of Victoria at the weekend floods decimated some wheat crops, which has resulted in the price of Wheat futures contracts for March and May 2023 lifting in anticipation that supply issues will worsen. The Australian Federal Emergency Management Minister said parts of Australia face ‘some serious flooding’ with more rain forecast later this week, with 34,000 homes in Victoria potentially expected to be inundated or isolated. The Bureau of Meteorology forecasts the La Lina event to peak in spring that’s underway in the Southern Hemisphere, before turning to neural conditions early next year.
… as rumors swirl of a rebellion in the Tory ranks. New Chancellor Jeremy Hunt is scheduled to speak today and may announce further reversals of the budget-busting adjustments to tax policy that got the fledgling government into trouble so quickly and helped trigger the recent turmoil in sterling and the UK gilt market. Sterling has started the week on a hopeful note as we also wait and see how well the gilt market functions after the Bank of England wound down its emergency QE programme last week. The UK CPI data on Wednesday is the data highlight of the week for the UK, with headline CPI expected at 10.0% YoY and core at +6.4%.
This is the first full week for the quarterly earnings cycle, with intense focus on Tesla’s earnings report up on Wednesday as the stock closed a new low for the year on Friday as concerns rise of cracks in the company’s growth story. Given the pressure on the semiconductor industry from US export restrictions earnings from ASML and Lam Research are also our focus on Wednesday.
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