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Futures, Commodities Jump After China Cuts Quarantine

Futures, Commodities Jump After China Cuts Quarantine

US stock futures rebounded from Monday’s modest losses and traded near session highs…

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Futures, Commodities Jump After China Cuts Quarantine

US stock futures rebounded from Monday's modest losses and traded near session highs after China reduced quarantine times for inbound travelers by half - to seven days of centralized quarantine and three days of health monitoring at home -  the biggest shift yet in a Covid-19 policy that has left the world’s second-largest economy isolated as it continues to try and eliminate the virus. The move, which fueled optimism about stronger economic growth and boosted appetite for both commodities and risk assets, sent S&P 500 futures and Nasdaq 100 contracts higher by 0.6% each at 7:15 a.m. in New York, setting up heavyweight technology stocks for a rebound. Mining and energy shares led gains in Europe’s Stoxx 600 and an Asian equity index erased losses to climb for a fourth session. 10Y TSY yields extended their move higher rising to 3.25% or about +5bps on the session, while the dollar and bitcoin were flat, and oil and commodity-linked currencies strengthened.

In premarket trading, the biggest mover was Kezar Life Sciences which soared 85% after reporting positive results for its lupus drug. On the other end, Robinhood shares fell 3.2%, paring a rally yesterday sparked by news that FTX is exploring whether to buy the company. In a statement, FTX head Sam Bankman-Fried said he is excited about the firm’s business prospects, but “there are no active M&A conversations with Robinhood." Here are some of the other most notable premarket movers"

  • Playtika (PLTK US) shares rallied 11% in premarket trading after a report that private equity firm Joffre Capital agreed to acquire a majority stake in the gaming company from a Chinese investment group for $21 a share.
  • Nike (NKE US) shares fell 2.3% in US premarket trading, with analysts reducing their price targets after the company gave a downbeat forecast for gross margin and said it was being cautious in its outlook for the China market.
  • Spirit Airlines (SAVE US) shares rise as much as 5% in US premarket trading after JetBlue boosted its all-cash bid in response to an increased offer by rival suitor Frontier in the days before a crucial shareholder vote.
  • Snowflake (SNOW US) rises 3.3% in US premarket trading after Jefferies upgraded the stock to buy from hold, saying its valuation is now “back to reality” and offers a good entry point given the software firm’s long-term targets.
  • Sutro Biopharma (STRO US) shares rise 34% in US premarket trading after the company and Astellas said they will collaborate to advance development of immunostimulatory antibody-drug conjugates, which are a modality for treating tumors and designed to boost anti-cancer activity.
  • State Street (STT US) shares could be in focus after Deutsche Bank downgraded the stock to hold, while lowering EPS estimates and price targets across interest rate sensitive coverage of trust banks and online brokers.
  • US bank stocks may be volatile during Tuesday’s trading session after the lenders announced a wave of dividend increases following last week’s successful stress test results.

Stock rallies have proved fleeting this year as higher borrowing costs to fight inflation restrain economic activity in a range of nations. European Central Bank President Christine Lagarde affirmed plans for an initial quarter-point increase in interest rates in July, but said policy makers are ready to step up action to tackle record inflation if warranted. Some analysts also argue still-bullish earnings estimates are too optimistic. Earnings revisions are a risk with the US economy set to slow next year, though China emerging from Covid strictures could act as a global buffer, according to Lorraine Tan, Morningstar director of equity research.

“You got a US slowdown in 2023 in terms of growth, but you have China hopefully coming out of its lockdowns,” Tan said on Bloomberg Radio.

In Europe, stocks are well bid with most European indexes up over 1%. Euro Stoxx 50 rose as much as 1.2% before drifting off the highs. Miners, energy and auto names outperform. The Stoxx 600 Basic Resources sub-index rises as much as 3.5% led by heavyweights Rio Tinto and Anglo American, as well as Polish copper producer KGHM and Finnish forestry companies Stora Enso and UPM- Kymmene. Iron ore and copper reversed losses after China eased its quarantine rules for new arrivals, while oil gained for a third session amid risks of supply disruptions. Iron ore in Singapore rose more than 4% after being firmly lower earlier in the session, while copper and other base metals also turned higher. Here are the biggest European movers:

  • Luxury stocks climb boosted by an easing of Covid-19 quarantine rules in the key market of China. LVMH shares rise as much as 2.5%, Richemont +3.1%, Kering +3%, Moncler +3%
  • Energy and mining stocks are the best-performing groups in the rising Stoxx Europe 600 index amid commodity gains. Shell shares rise as much as 3.8%, TotalEnergies +2.7%, BP +3.4%, Rio Tinto +4.6%, Glencore +3.9%
  • Banco Santander shares rise as much as 1.8% after a report that the Spanish bank has hired Credit Suisse and Goldman Sachs for its bid to buy Mexico’s Banamex.
  • GN Store Nord shares gain as much as 4.2% after Nordea resumes coverage on the hearing devices company with a buy rating.
  • Swedish Match shares rise as much as 4% as Philip Morris International’s offer document regarding its bid for the company has been approved and registered by the Swedish FSA.
  • Wise shares decline as much as 15%, erasing earlier gains after the fintech firm reported full- year earnings. Citi said the results were “mixed,” with strong revenue growth being offset by lower profitability.
  • UK water stocks decline as JPMorgan says it is turning cautious on the sector on the view that future regulated returns could surprise to the downside, in a note cutting Severn Trent to underweight. Severn Trent shares fall as much as 6%, Pennon -7.7%, United Utilities -2.3%
  • Akzo Nobel falls as much as 4.5% in Amsterdam trading after the paint maker announced the appointment of former Sulzer leader Greg Poux-Guillaumeas chief executive officer, succeeding Thierry Vanlancker.
  • Danske Bank shares fall as much as 4%, as JPMorgan cut its rating on the stock to underweight, saying in a note that risks related to Swedish property will likely create some “speed bumps” for Nordic banks though should be manageable.

In the Bavarian Alps, limiting Russia’s profits from rising energy prices that fuel its war in Ukraine have been among the main topics of discussion at a Group of Seven summit. G-7 leaders agreed that they want ministers to urgently discuss and evaluate how the prices of Russian oil and gas can be curbed.

Earlier in the session, Asian stocks erased earlier losses as China’s move to ease quarantine rules for inbound travelers bolstered sentiment. The MSCI Asia Pacific Index rose as much as 0.6% after falling by a similar magnitude. The benchmark is set for a fourth day of gains, led by the energy and utilities sectors. BHP and Toyota contributed the most to the gauge’s advance, while China’s technology firms were among the biggest losers as a plan by Tencent’s major backer to further cut its stake fueled concern of more profit-taking following a strong rally.   A move by Beijing to cut quarantine times for inbound travelers by half is helping cement gains which have made Chinese shares the world’s best-performing major equity market this month. The nation’s stocks are approaching a bull market even as their recent rise pushes them to overbought levels.

Still, the threat of a sharp slowdown in the world’s largest economy may pose a threat to the outlook. “US recession risk is still there and I think that’ll obviously have impact on global sectors,” Lorraine Tan, director of equity research at Morningstar, said on Bloomberg TV. “Even if we do get some China recovery in 2023, which could be a buffer for this region, it’s not going to offset the US or global recession.”  Most stock benchmarks in the region finished higher following China’s move to ease its travel rules. Main equity measures in Japan, Hong Kong, South Korea and Australia rose while those in Taiwan and India fell. Overall, Asian stocks are on course to complete a monthly decline of about 4%.   

Meanwhile, the People’s Bank of China pledged to keep monetary policy supportive to help the nation’s economy. It signaled that stimulus would likely focus on boosting credit rather than lowering interest rates.

Japanese stocks gained as investors adjusted positions heading into the end of the quarter.  The Topix Index rose 1.1% to 1,907.38 as of the market close in Tokyo, while the Nikkei 225 advanced 0.7% to 27,049.47. Toyota Motor contributed most to the Topix’s gain, increasing 2.2%. Out of 2,170 shares in the index, 1,736 rose and 374 fell, while 60 were unchanged. “As the end of the April-June quarter approaches, there is a tendency for institutional investors to rebalance,” said Norihiro Fujito, chief investment strategist at Mitsubishi UFJ Morgan Stanley. “It will be easier to buy into cheap stocks, which is a factor that will support the market in terms of supply and demand.”

India’s benchmark stock gauge ended flat after trading lower for most of the session as investors booked some profits after a three-day rally.  The S&P BSE Sensex closed little changed at 53,177.45 in Mumbai, while the NSE Nifty 50 Index gained 0.1%.  Six of the the 19 sector sub-gauges compiled by BSE Ltd. dropped, led by consumer durables companies, while oil & gas firms were top performers.  ICICI Bank was among the prominent decliners on the Sensex, falling 1%. Out of 30 shares in the Sensex index, 17 rose and 13 fell.

In rates, fixed income sold off as treasuries remained under pressure with the 10Y yield rising as high as 3.26%, following steeper declines for euro-zone and UK bond markets for second straight day and after two ugly US auctions on Monday. Yields across the curve are higher by 2bp-5bp led by the 7-year ahead of the $40 billion auction. In Europe, several 10-year yields are 10bp higher on the day after comments by an ECB official spurred money markets to price in more policy tightening. WI 7Y yield at around 3.32% exceeds 7-year auction stops since March 2010 and compares with 2.777% last month. Monday’s 5-year auction drew a yield more than 3bp higher than its yield in pre-auction trading just before the bidding deadline, a sign dealers underestimated demand. Traders attributed the poor results to factors including short base eroded by last week’s rally, recently elevated market volatility discouraging market-making, and sub-par participation during what is a popular vacation week in the US. Focal points for US session include 7-year note auction at 1pm ET; a 5-year auction Monday produced notably weak demand metrics.

The belly of the German curve underperformed as markets focus  on hawkish comments from ECB officials: 5y bobl yields rose 10 bps near 1.46%, red pack euribors dropped 10-13 ticks and ECB-dated OIS rates priced in 163 basis points of tightening by year end.

In FX, Bloomberg dollar spot index is near flat as the greenback reversed earlier losses versus all of its Group-of-10 peers apart from the yen while commodity currencies were the best performers. The euro rose above $1.06 before paring gains after ECB Governing Council member Martins Kazaks said the central bank should consider a first rate hike of more than a quarter-point if there are signs that high inflation readings are feeding expectations. Money markets ECB raised tightening wagers after his remarks. ECB President Lagarde later affirmed plans for an initial quarter-point increase in interest rates in July but said policy makers are ready to step up action to tackle record inflation if warranted. The ECB is likely to drain cash from the banking system to offset any bond purchases made to restrain borrowing costs for indebted euro-area members, Reuters reported, citing two sources it didn’t identify.

Elsewhere, the pound drifted against the dollar and euro after underperforming Monday, with focus on quarter-end flows, lingering Brexit risks and the UK economic outlook. Scottish First Minister Nicola Sturgeon due to speak later on how she plans to hold a second referendum on Scottish independence by the end of next year. The yen gave up an Asia session gain versus the dollar as US equity futures reversed losses. The Australian dollar rose after China cut its mandatory quarantine period to 10 days from three weeks for inbound visitors in its latest Covid-19 guidance. JPY was the weakest in G-10, drifting below 136 to the USD.

In commodities, oil rose for a third day with global output threats compounding already red-hot markets for physical supplies and as broader financial sentiment improved. Brent crude breached $117 a barrel on Tuesday, but some of the most notable moves in recent days have been in more specialist market gauges. A contract known as the Dated-to-Frontline swap -- an indicator of the strength in the key North Sea market underpinning much of the world’s crude pricing -- hit a record of more than $5 a barrel. The rally comes amid growing supply outages in Libya and Ecuador, exacerbating ongoing market tightness.

Oil prices also rose Tuesday as broader sentiment was boosted by China’s move to cut in half the time new arrivals must spend in isolation, the biggest shift yet in its pandemic policy. Meanwhile, the G-7 tasked ministers to urgently discuss an oil price cap on Russia. 

Finally, the prospect of additional supply from two of OPEC’s key producers also looks limited. On Monday Reuters reported that French President Emmanuel Macron told his US counterpart Joe Biden that the United Arab Emirates and Saudi Arabia are already pumping almost as much as they can.

In the battered metals space, LME nickel rose 2.7%, outperforming peers and leading broad-based gains in the base-metals complex. Spot gold rises roughly $3 to trade near $1,826/oz

Looking to the day ahead now, data releases include the FHFA house price index for April, the advance goods trade balance and preliminary wholesale inventories for May, as well as the Conference Board’s consumer confidence for June and the Richmond Fed’s manufacturing index. From central banks, we’ll hear from ECB President Lagarde, the ECB’s Lane, Elderson and Panetta, the Fed’s Daly, and BoE Deputy Governor Cunliffe. Finally, NATO leaders will be meeting in Madrid.

Market Snapshot

  • S&P 500 futures up 0.5% to 3,922.50
  • STOXX Europe 600 up 0.6% to 417.65
  • MXAP up 0.4% to 162.36
  • MXAPJ up 0.4% to 539.85
  • Nikkei up 0.7% to 27,049.47
  • Topix up 1.1% to 1,907.38
  • Hang Seng Index up 0.9% to 22,418.97
  • Shanghai Composite up 0.9% to 3,409.21
  • Sensex down 0.3% to 52,990.39
  • Australia S&P/ASX 200 up 0.9% to 6,763.64
  • Kospi up 0.8% to 2,422.09
  • German 10Y yield little changed at 1.62%
  • Euro little changed at $1.0587
  • Brent Futures up 1.4% to $116.65/bbl
  • Gold spot up 0.3% to $1,828.78
  • U.S. Dollar Index little changed at 103.89

Top Overnight News from Bloomberg

  • In Tokyo’s financial circles, the trade is known as the widow- maker. The bet is simple: that the Bank of Japan, under growing pressure to stabilize the yen as it sinks to a 24-year low, will have to abandon its 0.25% cap on benchmark bond yields and let them soar, just as they already have in the US, Canada, Europe and across much of the developing world
  • Bank of Italy Governor Ignazio Visco may leave his post in October, paving the way for the appointment of a high profile executive close to Premier Mario Draghi, daily Il Foglio reported
  • NATO is set to label China a “systemic challenge” when it outlines its new policy guidelines this week, while also highlighting Beijing’s deepening partnership with Russia, according to people familiar with the matter
  • The PBOC pledged to keep monetary policy supportive to aid the economy’s recovery, while signaling that stimulus would likely focus on boosting credit rather than lowering interest rates

A more detailed look at global markets courtesy of Newsquawk

Asia-Pac stocks were mixed with the region partially shrugging off the lacklustre handover from the US. ASX 200 was kept afloat with energy leading the gains amongst the commodity-related sectors. Nikkei 225 swung between gains and losses with upside capped by resistance above the 27K level. Hang Seng and Shanghai Comp. were pressured amid weakness in tech and lingering default concerns as Sunac plans discussions on extending a CNY bond and with Evergrande facing a wind-up petition.

Top Asian News

  • China is to cut quarantine time for international travellers, according to state media cited by Reuters.
  • Shanghai Disneyland (DIS) will reopen on June 30th, according to Reuters.
  • PBoC injected CNY 110bln via 7-day reverse repos with the rate at 2.10% for a CNY 100bln net daily injection.
  • China's state planner official said China faces new challenges in stabilising jobs and prices due to COVID and risks from the Ukraine crisis, while the NDRC added they will not resort to flood-like stimulus but will roll out tools in its policy reserve in a timely way to cope with challenges, according to Reuters.
  • China's state planner NDRC says China is to cut gasoline and diesel retail prices by CNY 320/tonne and CNY 310/tonne respectively from June 29th.
  • BoJ may have been saddled with as much as JPY 600bln in unrealised losses on its JGB holdings earlier this month, as a widening gap between domestic and overseas monetary policy pushed yields higher and prices lower, according to Nikkei.

European bourses are firmer as sentiment picked up heading into the cash open amid encouraging Chinese COVID headlines. Sectors are mostly in the green with no clear theme. Base metals and Energy reside as the current winners and commodities feel a boost from China’s COVID updates. Stateside, US equity futures saw a leg higher in tandem with global counterparts, with the RTY narrowly outperforming. Twitter (TWTR) in recent weeks provided Tesla (TSLA) CEO Musk with historical tweet data and access to its so-called fire hose of tweets, according to WSJ sources.

Top European News

  • UK lawmakers voted 295-221 to support the Northern Ireland Protocol bill in the first of many parliamentary tests it will face during the months ahead, according to Reuters.
  • Scotland's First Minister Sturgeon will set out a plan today for holding a second Scottish Independence Referendum, according to BBC News.
  • ECB’s Kazaks Says Worth Looking at Larger Rate Hike in July
  • G-7 Latest: Leaders Want Urgent Evaluation of Energy Price Caps
  • Ex- UBS Staffer Wants Payout for Exposing $10 Billion Swiss Stash
  • SocGen Blames Clifford Chance in $483 Million Gold Suit
  • GSK’s £40 Billion Consumer Arm Picks Citi, UBS as Brokers
  • Russian Industry Faces Code Crisis as Critical Software Pulled

ECB

  • ECB's Lagarde said inflation in the euro area is undesirably high and it is projected to stay that way for some time to comeFragmentation tool, via the ECB.
  • ECB's Kazaks said 25bps in July and 50bps in September is the base case, via Bloomberg TV. Kazaks said it is worth looking at a 50bps hike in July and front-loading hikes might be reasonable. Fragmentation risks should not stand in the way of monetary policy normalisation. If necessary, the ECB will come up with tools to address fragmentation.
  • ECB's Wunsch said he is comfortable with a 50bps hike in September; adds that 200bps of hikes are needed relatively fast, and anti-fragmentation tool should have no limits if market moves are unwarranted, via Reuters.
  • Bank of Italy said Governor Visco's resignation is not on the table, according to a spokesperson cited by Reuters.

Fixed Income

  • Bond reversal continues amidst buoyant risk sentiment, hawkish ECB commentary and supply.
  • Bunds lose two more big figures between 146.80 peak and 144.85 trough, Gilts down to 112.06 from 112.86 at best and 10 year T-note retreats within 117-01/116-14 range

FX

  • DXY regroups on spot month end as yields rally and rebalancing factors offer support - index within 103.750-104.020 range vs Monday's 103.660 low.
  • Euro continues to encounter resistance above 1.0600 via 55 DMA (1.0614 today); Yen undermined by latest bond retreat and renewed risk appetite - Usd/Jpy eyes 136.00 from low 135.00 area and close to 134.50 yesterday.
  • Aussie breaches technical and psychological resistance with encouragement from China lifting or easing more Covid restrictions - Aud/Usd through 10 DMA at 0.6954.
  • Loonie and Norwegian Krona boosted by firm rebound in oil as France fans supply concerns due to limited Saudi and UAE production capacity - Usd/Cad sub-1.2850 and Eur/Nok under 10.3500.
  • Yuan receives another PBoC liquidity boost to compliment positive developments on the pandemic front, but Rand hampered by latest power cut warning issued by SA’s Eskom

Commodities

  • WTI and Brent futures were bolstered in early European hours amid encouragement seen from China's loosening of COVID restrictions.
  • Spot gold is uneventful, around USD 1,825/oz in what has been a sideways session for the bullion since the reopening overnight.
  • Base metals are posting broad gains across the complex - with LME copper back above USD 8,500/t amid China-related optimism.

US Event Calendar

  • 08:30: May Advance Goods Trade Balance, est. -$105b, prior -$105.9b, revised -$106.7b
  • 08:30: May Wholesale Inventories MoM, est. 2.1%, prior 2.2%
    • May Retail Inventories MoM, est. 1.6%, prior 0.7%
  • 09:00: April S&P CS Composite-20 YoY, est. 21.15%, prior 21.17%
  • 09:00: April S&P/CS 20 City MoM SA, est. 1.95%, prior 2.42%
  • 09:00: April FHFA House Price Index MoM, est. 1.4%, prior 1.5%
  • 10:00: June Conf. Board Consumer Confidenc, est. 100.0, prior 106.4
    • Conf. Board Expectations, prior 77.5; Present Situation, prior 149.6
  • 10:00: June Richmond Fed Index, est. -5, prior -9

DB's Jim Reid concludes the overnight wrap

It's been a landmark night in our household as last night was the first time the 4-year-old twins slept without night nappies. So my task this morning after I send this to the publishers is to leave for the office before they all wake up so that any accidents are not my responsibility. Its hopefully the end of a near 7-year stretch of nappies being constantly around in their many different guises and states of unpleasantness. Maybe give it another 30-40 years and they'll be back.

Talking of unpleasantness, as we near the end of what’s generally been an awful H1 for markets, yesterday saw the relief rally from last week stall out, with another bond selloff and an equity performance that fluctuated between gains and losses before the S&P 500 (-0.30%) ended in negative territory.

In terms of the specific moves, sovereign bonds lost ground on both sides of the Atlantic, with yields on 10yr Treasuries up by +7.0bps following their -9.6bps decline from the previous week. That advance was led by real rates (+9.6bps), which look to have been supported by some decent second-tier data releases from the US during May yesterday. The preliminary reading for US durable goods orders surprised on the upside with a +0.7% gain (vs. +0.1% expected). Core capital goods orders also surprised on the upside with a +0.8% advance (vs. +0.2% expected). And pending home sales were unexpectedly up by +0.7% (vs. -4.0% expected). Collectively that gave investors a bit more confidence that growth was still in decent shape last month, which is something that will also offer the Fed more space to continue their campaign of rate hikes into H2. This morning 10yr USTs yields have eased -2.45 bps to 3.17% while 2yr yields (-4 bps) have also moved lower to 3.08%, as we go to press.

Staying at the front end, when it comes to those rate hikes, if you look at Fed funds futures they show that investors are still only expecting them to continue for another 9 months, with the peak rate in March or April 2023 before markets are pricing in at least a full 25bps rate cut by end-2023 from that point. I pointed out in my chart of the day yesterday (link here) that the median time historically from the last hike of the cycle to the first cut was only 4 months, and last time it was only 7 months between the final hike in December 2018 and the next cut in July 2019. So it wouldn’t be historically unusual if Fed funds did follow that pattern whether that fits my view or not.

Over in Europe yesterday there was an even more aggressive rise in yields, with those on 10yr bunds (+10.9bps), OATs (+11.0bps) and BTPs (+9.1bps) all rising on the day as they bounced back from their even larger declines over the previous week. That came as investors pared back their bets on a more dovish ECB that they’d made following the more negative tone last week, and the rate priced in by the December ECB meeting rose by +8.5bps on the day.

For equities, the major indices generally fluctuated between gains and losses through the day. The S&P 500 followed that pattern and ultimately fell -0.30%, which follows its best daily performance in over 2 years on Friday Quarter-end rebalancing flows seem set to drive markets back-and-forth price this week. Even with the decline yesterday, the index is +6.36% higher since its closing low less than a couple of weeks ago. And over in Europe, the STOXX 600 (+0.52%) posted a decent advance, although that masked regional divergences, including losses for the CAC 40 (-0.43%) and the FTSE MIB (-0.86%).

Energy stocks strongly outperformed in the index, supported by a further rise in oil prices that left both Brent crude (+1.74%) and WTI (+1.81%) higher on the day. G7 ministers reportedly agreed to explore a cap on Russian gas and oil exports, with the official mandate expected to be announced today, but it would take time for any mechanism to be developed. The impact on global oil supply is not clear: if Russia retaliates supply could go down, if this enables other third parties to import more Russian oil supply could go up. Elsewhere, political unrest in Libya and Ecuador could simultaneously hit oil supply. In early Asian trading, oil prices continue to move higher, with Brent futures up +1.13% at $116.39/bbl and WTI futures gaining +1% to just above the $110/bbl level.

Asian equity markets are struggling a bit this morning. The Hang Seng (-1.00%) is the largest underperformer amid a weakening in Chinese tech stocks whilst the Nikkei (-0.15%), Shanghai Composite (-0.15%) and CSI (-0.19%) are trading in negative territory in early trade. Elsewhere, the Kospi (-0.05%) is just below the flatline. US stock futures are slipping with contracts on the S&P 500 (-0.12%) and NASDAQ 100 (-0.18%) both slightly lower.

In central bank news, the People’s Bank of China (PBOC) Governor Yi Gang pledged to provide additional monetary support to the economy to recover from Covid outbreaks and lockdowns and other stresses. In a rare interview conducted in English, the central bank chief did caution though that the real interest rate is low thereby indicating limited room for large-scale monetary easing.

Turning to geopolitical developments, the G7 summit continued in Germany yesterday, and in a statement it said they would “further intensify our economic measures against Russia”. Separately, NATO announced that it will increase the number of high readiness forces to over 300,000, with the alliance’s leaders set to gather in Madrid from today. And we’re also expecting a new round of nuclear talks with Iran to take place at some point this week, something Henry mentioned in his latest Mapping Markets out yesterday (link here), which if successful could in time pave the way for Iranian oil to return to the global market.

Finally, whilst there were some decent May data releases from the US, the Dallas Fed’s manufacturing activity index for June fell to a 2-year low of -17.7 (vs. -6.5 expected).

To the day ahead now, and data releases include Germany’s GfK consumer confidence for July, French consumer confidence for June, whilst in the US there’s the FHFA house price index for April, the advance goods trade balance and preliminary wholesale inventories for May, as well as the Conference Board’s consumer confidence for June and the Richmond Fed’s manufacturing index. From central banks, we’ll hear from ECB President Lagarde, the ECB’s Lane, Elderson and Panetta, the Fed’s Daly, and BoE Deputy Governor Cunliffe. Finally, NATO leaders will be meeting in Madrid.

Tyler Durden Tue, 06/28/2022 - 08:00

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Government

Inflation

Rising price pressures, stronger and more persistent than generally expected, has been the main challenge for consumers, businesses, and policymakers. It…

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Rising price pressures, stronger and more persistent than generally expected, has been the main challenge for consumers, businesses, and policymakers. It will stay top of mind in the week ahead as both the world's two largest economies, the US and China, report July consumer and producer prices.  

During the Great Depression, the central governments discovered their balance sheets, and budget deficits became a nearly permanent fixture. This is true even for countries like Germany, which ostensibly shunned Keynesian demand management and embraced "ordo-liberalism." During the Global Financial Crisis, the central bank balance sheet was called into action as policy rates hit zero (and fell into negative territory for the members of the eurozone, Switzerland, a few other European countries, and Japan).  

After the Great Financial Crisis, many monetarists and hard-money folks warned of ruinous inflation, which did not materialize. Instead, inflation has soared over the past year or so for most high-income and emerging market countries. The hard-money and monetarists say they told us so. Yet, it took a pandemic of biblical proportions to spur inflation and the Russian invasion of Ukraine. Moreover, there seems to be no correlation between the size of the central bank's balance sheet (as a percent of GDP), government deficit spending during and after the pandemic, and the subsequent inflation.

The Bank of Japan's balance sheet is nearly 135% of GDP. The Fed's balance sheet is about 36.5% of GDP. The ECB's balance sheet is almost 69% of GDP. Japan's central government debt is more than 2.3-times larger than its GDP. In proportionate terms, US debt is less than half as much as Japan's. The eurozone's debt-to-GDP is a little more than 95%. Consider fiscal policy. The cumulative budget deficit in the US for 2020 and 2021 was a stunning 26.4% of GDP. The deficit in the eurozone was less than half the size (12.2%). Japan's was almost 16% of GDP.  

We will likely learn next week that the July US CPI (year-over-year) fell below the preliminary EMU reading of 8.9%. The median forecast in the Bloomberg survey sees a 0.2% month-over-month gain, which given the base effect, would be consistent with an 8.8% year-over-year rate.  Energy prices have pulled back.  Sept WTI fell 5.3% in June and and another 4.3% in July.  It is off almost 10% so far this month.  The average price of retail gasoline fell 13% in July.  

Japan's headline CPI was a modest 2.4% in June. The BOJ's last meeting concluded the day before the June CPI was reported. Its updated forecast put this year's CPI at 2.4% before falling back to 1.3%-1.4% for the next two years. Do not be mistaken. The BOJ's forecasts are not an outlier. Economists surveyed by Bloomberg are also convinced Japan's inflation is temporary. The median forecast is a 1.2% rise in CPI next year, followed by a 0.8% increase in 2024.  

Conventional wisdom is that monetary policy will not change until Governor Kuroda steps down next April. The inflation forecasts, if accurate, suggest the new governor will find that the deflation demon has not been slain after all. Although the BOJ's policy rate is -0.1%, it has been trading at -0.009%. The swaps market has it at 0.01% in a year, 0.07% in two years, and 0.11% in three years.  

After arguably waiting too long to get going, the Federal Reserve has stepped up its game. It persuaded many, even if not everyone, that it is so determined to bring inflation down that it is willing to risk an economic contraction. This is important because it shows that inflation expectations are anchored. Consider the 10-year breakeven peaked in mid-April a little above 3.05% and fell to the year's low slightly below 2.27% a few weeks ago. It is now hovering in narrow band around 2.50%.  In the middle of last month, the two-year breakeven fell to 2.85%, the lowest since October 2021. It popped back to around 3.25% but is approaching the low again.  Recall it peaked shortly after the first rate hike was delivered in March 16, near 5%.  Doesn't this say something about the Fed's anti-inflation credibility? 

While the breakevens have been consolidating, we note the correlation between the changes in the 10-year yield breakeven and oil prices increased to almost 0.60 over the past 30 days, the highest in more than three months. The correlation between the changes in oil and the US two-year breakeven is around 0.83, the highest since the end of 2020. Surely, most observers would agree that whatever attenuated relationship there may be between fiscal and monetary policy on one hand and oil prices on the other, it is overshadowed by several other factors.

Last week, the Bank of England warned that inflation was likely to peak near 13%. That is twice as much as it anticipated at the end of last year when it began its tightening cycle. The main culprit is not monetary or fiscal variables but the supply shock from the energy sector. The BOE is also the first major central bank to acknowledge a recession. Indeed, it warns that the economy will contract for five consecutive quarters, which does not include the second quarter. The UK reports Q2 GDP on August 12, and the median forecast (Bloomberg survey) is for a small contraction.  

Nevertheless, the  BOE is clearly determined to continue to tighten monetary policy. Governor Bailey is cagey about the pace of hikes going forward, like many other central banks, including the Fed, ECB, and the Reserve Bank of Australia. Yet, the market remains fairly convinced that the central BOE will hike rates by at least another 100 bp in the last three meetings of the year. The BOE is also the first major central bank to announce intentions of actively selling some of its sovereign and corporate bond holdings to shrink its balance sheet quicker than the passive approach of allowing maturing issues to roll off.  

The cottage industry of critics put the Federal Reserve in a "damned if they do and don't if they don't" box. First, many wanted the central bank to be more aggressive than even the hawks at the Fed advocated. Then as the economy slows, they are among the first to condemn the Fed for inducing a recession. Endless fodder for the large pipes that deliver the streaming news.  

We have staked out a middle ground between those pundits and cynics who have been saying the US is in a recession for a few months and several Fed officials who suggest there is little sign of a broad economic slowdown. Yet, even Powell acknowledges the path to a soft landing is getting narrower. While recognizing we live in a probabilistic world, we see the odds of a soft-landing as minuscule at best. 

It is not just because of monetary policy, which is tightening aggressively. Indeed, after the stronger than expected employment report, which saw a new cyclical low in the unemployment rate (3.5%) and the strongest jobs growth in five months (528k), the Fed funds futures were discounting around a 75% chance of another 75 bp hike at next month's meeting that concludes on September 21. The 2-10-year yield curve is inverted by the most since 2000 (almost 40 bp).  Fiscal policy is tightening too, and aggressively at that. The OECD projects government spending to fall by 0.1% this year. The median forecast in Bloomberg's survey is for the budget deficit to fall to 4.4% of GDP this year from 10.8% last year. The two-month 25% slide in oil prices is helpful for the soft-landing scenario, but they have still doubled since early 2021, which proceeded the end of the last few business cycles.  

Also, the inventory cycle has matured, and from a tailwind last year, it has turned into a headwind. If it weren't for the inventory adjustment, the US economy would have expanded in H1. The good news here is that the drag from inventories may be winding down. Another drag that may replace it is that some sectors that saw strong demand during the pandemic may have built too and cut back. Given that it was slow to take its foot off the accelerator, the Fed's biggest mistake would be to declare victory too early. This risk-reward assessment also injects a human element into the risks of a hard-landing. 

The July CPI should offer some comfort that inflation, which jumped in Q2, is steadying at the start of Q3. After rising by 1.0% in May and 1.3% in June, the July CPI is expected to edge up by 0.2%. If so, it would match the smallest monthly increase since November 2020. It would also be consistent with a small decline in the year-over-year rate, which has only happened one other time since last August (in April). However, the core rate may tick up. The median forecast (Bloomberg survey) sees a 0.6% increase, which is the average over the last nine months. This would produce the first increase in the year-over-year core CPI since March. It peaked then at 6.5% and fell to 5.9% in June.  

The market still expects the Fed to raise rates aggressively and double the pace of the roll-off from its balance sheet starting next month. The market is now looking for the Fed to hike rates by 125 bp in the last three meetings of the year. Look at what has happened. The year-end Fed funds rate has mostly been between 3.25% and 3.50% for the past two months. It pushed through the upper end after the jobs report.  

Moreover, the Fed's hawkish rhetoric and the jobs report did not manage to dissuade the market from pricing in a cut in the Fed funds rate next year.  Even if the terminal rate is a bit higher than the market previously thought, it seems more confident of a rate cut in H2 23.  Specifically, the implied yield of the December 2023 Fed funds futures is about 33 bp below the yield of the December 2022 contract.  Over the course of the week the chances of a cut in Q3 23 were downgraded. At the end of July, the September Fed funds yielded 32 bp less than the December 2022 contract. It closed last week at  a 12 bp discount.  

The team of economists at ITC found that since 1990, the first Fed cut has come on average 10.6 months after the last hike. It is in a range of five months to 18 months. If the market is right and the Fed finishes its tightening this year, or even early next year, it appears to be pricing in a fairly typical gap.  

Much to the chagrin of some of the Fed's critics that put the hawks at the Bundesbank to shame, the market is confident that the economy will reach a point later this year or early next year that will prompt the Fed to ease off its drive. This is the real meaning of the central bank put. They will not pursue the old Mellon recommendation:  liquidate, liquidate, and liquidate. The hawks do not have a constituency for it. And that seems global, not just limited to the US. But, of course, like playing three-card Monty, it always looks easy from the sidelines.  

China's inflation will be reported after it its reserves (lower), trade surplus (smaller), and lending figures (less). The June CPI was at 2.5% year-over-year, roughly the midpoint seen since the onset of Covid (-0.5%-5.4%). It is expected to have edged up to 2.8% in July. The recovery in pork prices led to the acceleration in food inflation (2.9% vs. 2.3%). The core measure, which excludes food and energy, rose 1.0% year-over-year in June from 0.9% in April and May.   Meanwhile, China's PPI is expected to lurch down, possibly below 5%, to its lowest level since March 2021. It peaked at 13.5% last October, and the decline in July will be the ninth consecutive monthly decline.

The subdued price pressures may give the PBOC room to ease policy, but it seems to be in no rush. It is encouraging lending and has offered some fiscal support. It has been mild. There appears to be a window to ease policy in the next couple of weeks. Liquidity conditions have tightened due to several factors, including PBOC draining operations and tax payments, and on August 16, a CNY600 bln medium-term lending facility matured. There are several ways that the PBOC could provide more liquidity, including a new medium-term lending facility, reverse repos, and a cut in reserve requirements.  


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Spread & Containment

Inflation Breakeven and Term Spreads Adjusted for Premia

Expected inflation inferred from the Treasury-TIPS spread is tainted by risk and liquidity premia. The difference between expected future short rates and…

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Expected inflation inferred from the Treasury-TIPS spread is tainted by risk and liquidity premia. The difference between expected future short rates and current short rates is also obscured by risk premia. Here are adjusted spreads:

Figure 1: Five year inflation breakeven calculated as five year Treasury yield minus five year TIPS yield (blue, left scale), five year breakeven adjusted by inflation risk premium and liquidity premium per DKW (red, left scale), both in %. NBER defined recession dates shaded gray. Source: FRB via FRED, Treasury, NBER, KWW following D’amico, Kim and Wei (DKW) accessed 8/4, and author’s calculations.

The adjusted series suggests an upward movement in expected inflation with the expanded Russian invasion of Ukraine, but less than that indicated by the simple Treasury-TIPS spread (and no downward movement recently).

How have recent releases affected inflation expectations? Figure 2 presents a detail.

Figure 2: Five year inflation breakeven calculated as five year Treasury yield minus five year TIPS yield (blue, left scale), five year breakeven adjusted by inflation risk premium and liquidity premium per DKW (red, left scale), both in %. Source: FRB via FRED, Treasury, KWW following D’amico, Kim and Wei (DKW) accessed 8/4, and author’s calculations.

The inflation breakeven rises with the GDP advance and PCE deflator releases, but stays constant with today’s employment numbers (strangely). However, to the extent that the Treasury-TIPS spread mismeasures expectations, we should be a bit wary of this result (inflation expectations do drop with the GDP release with the adjusted measure).

What about the 10yr-3mo spread? The unadjusted has taken a big dive in recent weeks, coming close to inversion.

Figure 3: 10 year-3 month Treasury spread (dark blue), and implied future nominal rates over next ten years (pink), both in %. NBER defined recession dates shaded gray. Source: FRB via FRED, Treasury, NBER, KWW following D’amico, Kim and Wei (DKW) accessed 8/4, and author’s calculations.

 

The gap between 10yr-3mo went negative in 2019, and again with the onset of the pandemic. The yield curve steepened sharply with the Georgia special election outcomes, and then counterintuitively rose again with the Russian expanded incursion into Ukraine. The spread dropped sharply from May 6th onward.

The spread incorporates a inflation risk premium so that on average, the yield curve slopes up. Hence, the standard 10yr-3mo spread does not necessarily equal the difference between 3 month yields over the next 10 years vs the current 3 month yield. I show the sum of the future 3 month real yields and future 3 month inflation rates over the next ten years as the pink line in Figure 2. This line probably better shows the heightened expectations of growth in 2021Q1-Q2, as well as the dropoff in perceived growth prospects in May.

The detail suggests the expected asset price responses to the recent releases as well.

Figure 4: 10 year-3 month Treasury spread (dark blue), and implied future nominal rates over next ten years (pink), both in %. Source: FRB via FRED, Treasury, KWW following D’amico, Kim and Wei (DKW) accessed 8/4, and author’s calculations.

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Economics

Sixth recession red flag raised, despite strong jobs report

On the same day, the BLS revealed that we’ve recovered all the jobs lost to COVID-19 and I am raising my sixth recession red flag.
The post Sixth recession…

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What a crazy day for my economic model! On the same day, the Bureau of Labor Statistics (BLS) revealed that we’ve recovered all the jobs lost to COVID-19 and I am raising my sixth recession red flag.

When I wrote the America is back recovery model on April 7, 2020, and then retired it on Dec. 9, 2020, I knew one data line would lag the most: jobs! I have talked about how job openings would move toward 10 million and that we should get all the jobs we lost to COVID-19 back by September 2022. Well, I was off by two months: Today, the BLS reported that 528,000 jobs were created with positive revisions of 28,000, which gave us just enough to pass the February 2020 levels.

From BLS: 
Total nonfarm payroll employment rose by 528,000 in July, and the unemployment rate edged down to 3.5 percent, the U.S. Bureau of Labor Statistics reported today. Job growth was widespread, led by gains in leisure and hospitality, professional and business services, and health care. Both total nonfarm employment and the unemployment rate have returned to their February 2020 pre-pandemic levels.

Feb 2020: 152,504,000
July 2022: 152,536,000

The big job numbers we have seen recently are tied to the decline in the job openings data, which lags also, but we do see a decrease in this data line as it appears for now that the job openings data has peaked in this cycle. It recently went from 11.3 million to 10.7 million, and the recent peak was near 11.9 million.



We have seen increases in jobless claims and slighter increases in continuing claims. However, nothing too drastic yet. Again, at this stage of the economic cycle you should focus on the rate of change data.



A tighter labor market is a good thing; this means people with less educational backgrounds can get employed since we have many jobs that don’t require a college education. The unemployment rate did tick up for those with less than a high school diploma in this report.

Here is a breakdown of the unemployment rate and educational attainment for those 25 years and older:

—Less than a high school diploma: 5.9%.
—High school graduate and no college: 3.6%
—Some college or associate degree: 2.8%
—Bachelor’s degree and higher: 2.0%



Below is a breakdown of the jobs created. Every sector created jobs; even the government created jobs. All this was just working our way back from the losses to COVID-19, which I knew would take a bit longer than some people would have thought with the economic data we had in 2021.



Now that we have regained all the jobs lost to COVID-19, what is next?

Hopefully, people know that we weren’t in a recession in the first six months of the year. When you’re in a recession, you don’t create jobs, have positive industrial production data, or positive consumer data in GDP. We had some funky trade and inventory data that tilted the GDP negatively, but the traditional data lines that go negative in a recession are just not there yet.

Even so, because some of the more current data is trending negatively,  I am raising my sixth recession red flag today. Allow me to present my case.

Recession red flag watch

Where are we in the economic cycle? I’ve already raised five of my six recession red flags, but until they are all up, I don’t use the word recession.

Let’s review those red flags in order, as my model is based on an economic progression model:

1. The unemployment rate falls down to a level where we start to talk about Federal Reserve rate hikes because the economy doesn’t need as much stimulus for employment gains.  For this recovery, the unemployment rate getting to 4% is the level where I raised my first recession red flag. This just means that the recovery is more mature than the earlier stages of the unemployment rate falling. Today it’s currently at 3.5%.

2. The Federal Reserve starts to raise rates. The Federal Reserve started Its rate hike process this year, to start fighting inflation and has been more aggressive recently. This shows that the expansion is longer and that the Federal Reserve is in a mood to tighten policy rather than make it more accommodative.

3. The inverted yield curve. This is more of a market-driven bond yield red flag. I had been on an inverted yield curve watch since Thanksgiving of 2021. This is when the two-year yield and 10-year yield slap high fives and say hi to each other. It’s another progression red flag, reflecting that we are in a more mature stage of the economy. Traditionally you see an inverted yield curve before every recession.



4. Find the overheating economic sector where demand can’t be sustained. Once that demand comes back to normal, people will be laid off. We see this in the durable goods data. A few companies are laying people off or putting into place a hiring freeze.



5.  New home sales, housing starts, and permits fall into a recession. Once mortgage rates rise, the new home sales sector does get hit harder than the existing home sales market. The homebuilder confidence index is falling noticeably, and while we never had the housing build-up in credit and sales that we saw in 2005, the builders will slow housing production down with higher rates. I raised my fifth recession red flag in June.

Today, I am raising the last recession red flag, which considers the Leading Economic Index (LEI). This week I presented my six recession red flag model to the Committee For Economic Development of The Conference Board (CED) — the committee that created the leading economic index. “Since its inception in 1942, CED has addressed national priorities to promote sustained economic growth and development to benefit all Americans. CED’s work in those first few years led to great policy accomplishments. One is the Marshall Plan, the economic development program that helped rebuild Europe and maintain peace, the Bretton Woods Agreement that established the new global financial system, and the World Bank and International Monetary Fund.” 

6. Leading economic index declines four to six months before a recession. Historically, the LEI fades into every recession, outside a one-time huge economic shock like COVID-19. To raise this flag I needed four to six months of decline, which we saw recently. However, knowing the components of this data line, I know this data line has legs to keep going lower.

As you can see, the LEI doesn’t have a good history of reversing course when the downtrend is in place. We have had times in the mid-1990s when we saw a slowdown but didn’t get a recession.

With that in mind, how might this reverse? Well, the two easy answers are this:

1. Rates fall to get the housing sector back in line.
2. Growth rate of inflation falls, the Fed stops hiking rates and reverses course, as they did in 2018.

Most Americans are working, and job openings are still high enough that people can find work if they need to. However, if you’re asking me how we could see a reversal after all six flags are up, this is it.

So how do I square raising the last recession red flag when we had such a strong job report today? Well, the model isn’t designed to work during a recession. It’s intended to show the progression of an expansion into a recession.  As you can see below, this data line fell in 2006, and we were still creating jobs in 2006 and 2007.

During the housing bubble, we had a clear over-investment, and that was in the housing market, so the recession red flag model was evident before the recession. Only three of my recession red flags were up before the COVID-19 crisis; in fact, we were still in expansionary mode if COVID-19 hadn’t occurred.

I can’t describe it any other way: things have been crazy since April 2020. All of us that track economic data have had to adjust to the highest velocity of data movement in our lifetime and have had to make COVID-19 adjustments all the time.

At some point in the future, things will get back to normal. I’ve presented you with my data lines to show we weren’t in a recession the first six months of the year, but the economic data is getting softer and softer. I will be looking for weaker data lines getting to the point where we actually see real recessionary data, which means jobs are being lost monthly, production data falls and companies make adjustments to their business model with greater force.

I’ll take each data point one day at a time and try to make sense of it. Remember, economics done right should be very boring, and always, be the detective, not the troll.

The post Sixth recession red flag raised, despite strong jobs report appeared first on HousingWire.

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