US and European stock were set for their best month since November 2020 following blowout earnings from the likes of Amazon and Apple last night, and record profits from energy giants Exxon and Chevron this morning, boosted by expectations of shallower Federal Reserve monetary tightening now that the US is technically in a recession. S&P futures rose 0.6% following yesterday's meltup while Nasdaq 100 futures rose more than 1% after US stocks hit a seven-week high Thursday, as record underinvested hedge funds are forced to chase the move higher now that most downside catalysts (peak inflation, hawkish Fed, earnings disappointment) have been eliminated. The dollar was flat, and 10Y yields rose slightly to 2.70% after plunging as low as 2.65% yesterday after the Q2 GDP print confirmed news of the unofficial US recession.
In premarket trading, Amazon soared as much as 13% in premarket trading on Friday, after the e-commerce giant reported better-than-expected 2Q results and gave an upbeat forecast. Apple rose 2.8% after the iPhone maker reported third-quarter revenue that was stronger than expected. US energy giants Exxon and Chevron both rose sharply higher in premarket trading after reporting record profits for Q2. here are some other notable premarket movers:
- Roku (ROKU US) tumbles 26% after the video-streaming platform company issued a 3Q revenue forecast and reported 2Q results that were weaker than expected, citing a slowdown in TV advertising spending.
- Intel (INTC US) slumps 9.4% after the chip manufacturer reported lower-than-expected 2Q earnings and cut its full-year forecasts
- US-listed Chinese stocks fall in premarket trading, following Asian peers lower, amid a lack of new stimulus policies from China’s top leadership.
- Avantor Inc. (AVTR US) analysts pointed to several factors weighing on the life sciences firm’s results, including its exposure to the European market, forex and Covid. Avantor’s shares slid 11% in US postmarket trading on Thursday.
- Dexcom Inc. (DXCM US) shares slumped as much as 18% in premarket trading, with analysts pointing to disappointing US growth and a delay to the US launch of the medical device maker’s G7 glucose- monitoring system used by people with diabetes. Analysts said the reaction was overdone and a buying opportunity given the growth outlook.
- Edwards Life (EW US) down after posting second- quarter results below analyst expectations, as hospital staff shortages and FX headwinds weigh on the medical technology company’s growth.
Global shares are set for a second weekly advance, paring this year’s rout. The risk is that the recent bout of optimism eventually gets a reality check if inflation stays stubbornly elevated, leaving interest rates higher than investors would like amid an economic downturn.
“At some point, the Fed will pivot policy and that should be better for risk markets, but in the meantime, they’re so bent on quelling inflation that we prefer not to buy the dip here,” Thomas Taw, head of APAC iShares Investment Strategy at BlackRock Inc., said on Bloomberg Radio.
Elsewhere, a call between US President Joe Biden and China’s Xi Jinping underlined bilateral tension even as the leaders sought an in-person meeting.
European stocks also rallied into the month-end after positive earnings buoyed sentiment. The Euro Stoxx 600 rose 0.9%, with Italy's. FTSE MIB outperforms peers, adding 1.6%, FTSE 100 lags, adding 0.6%. Construction, retailers and consumer products are the strongest performing sectors. The banking sector outperformed after a slate of better-than-expected results from Banco Bilbao Vizcaya Argentaria SA, Standard Chartered Plc and BNP Paribas SA. Hermes International rose about 6% after joining LVMH and Kering SA in posting strong results, showing the luxury consumer is resilient so far to high inflation and worries over a potential economic downturn. Here are some other notable European movers:
- NatWest shares surge as much as 9.5% after the UK lender reported second-quarter earnings that beat estimates, also announcing a special dividend with analysts seeing consensus upgrades ahead.
- Allfunds jumps as much as 14%, most since May, after reporting adjusted Ebitda ahead of Morgan Stanley’s expectations and providing a “reassuring outlook.”
- Zalando rises as much as 8.7% alongside other European ecommerce stocks following blowout results from US giant Amazon, which sent its shares surging in premarket trading.
- Hermes climbs as much as 9.6% to an almost 6-month high after the maker of Kelly handbags reported what Bernstein called a “very strong” beat, with 2Q sales almost 9% ahead.
- L’Oreal jumps as much as 5.2% after it reported 2Q like-for-like sales that beat estimates, with Jefferies calling the performance “another quarter of gravity- defying growth.”
- Fluidra gains as much as 12%, the most intraday since October 2020, despite a guidance cut as analysts remain optimistic on longer-term prospects.
- Kion rises as much as 9.6%, the most since March, bouncing after a post-results decline in the prior session. UBS said it’s positive on the forklift maker’s outlook.
- Signify slumps as much as 11% after reporting 2Q Ebita below consensus and flagging margin headwinds, which Citi expects will lead to low-single-digit downgrades to full-year estimates.
- AstraZeneca slides as much as 3.1% on its latest earnings, which exceeded estimates. Analysts say the beat, however, was fueled by one-time items.
- EssilorLuxottica dips as much as 5.1% after the eyewear firm reported interim results. Jefferies noted the “understandably circumspect” tone of the company’s near-term outlook.
- Fresenius Medical Care declines as much as 5.7%, extending Thursday’s 14% fall, as the market continued to digest the guidance downgrade. JPMorgan cut its price target by more than 50%.
- AMS-Osram shares fall as much as 9.7% after its new guidance consensus estimates, with the chipmaker saying production volumes were hit by increasingly unfavorable end markets.
Euro-zone GDP rose by more than three times the amount economists expected, putting it on a firmer footing as surging inflation and a possible Russian energy cutoff threaten to tip it into a recession. On the other hand, inflation in the region soared to another all-time high, supporting calls for the European Central Bank to follow up its first interest-rate hike since 2011 with another big move.
The tone was more somber in Asia, hampered by a tumble in Chinese tech shares that dragged Hong Kong toward a correction of more than 10% from a June high. Asian stocks slumped as losses in Chinese equities offset gains in the rest of the region, after the nation’s Politburo refrained from announcing new stimulus. The MSCI Asia Pacific Index swung between small gains and losses on Friday. Alibaba and Tencent were among the biggest drags, countering gains in heavyweights including TSMC and Reliance Industries. The Hang Seng Index entered a technical correction, while a gauge of Hong Kong’s tech shares tumbled close to 5%. Sentiment was damped by Chinese leaders’ downbeat assessment of growth and the lack of new measures to boost the economy from a highly anticipated Politburo meeting. Shares of Alibaba tumbled after a report said that Jack Ma was planning to give up control of his fintech unit Ant Group, ahead of the tech giant’s earnings report next week.
“We were kind of looking for more policy” from the Chinese government before the National Party Congress later this year, Thomas Taw, head of APAC iShares Investment Strategy at BlackRock Inc., said on Bloomberg Radio. “I think the offshore, foreign sentiment towards China is very, very bearish at the moment.” Investors are also monitoring the latest corporate results while keeping an eye on the property crisis and Covid situation in China. Major overseas earnings before the Asian open were a mixed bag, with strong reports from Apple and Amazon while Intel disappointed. The key Asian stock gauge is still on track for its biggest monthly gain so far in 2022. While stocks in Hong Kong and mainland China are set for a monthly loss, the region’s other markets such as India, Japan and South Korea are poised for their best months of the year.
Japanese stocks dipped in afternoon trading as the yen resumed strengthening against the dollar. The Topix fell 0.4% to close at 1,940.31, while the Nikkei was down 0.1% to 27,801.64. Still the Nikkei closed July with a 5.3% gain, its best month since November 2020. The yen rose 0.9% to around 133 per dollar, pushing its three-day advance to 2.8%. Yen Advances to Level That Threatens This Year’s Big FX Short Keyence Corp. contributed the most to the Topix decline, decreasing 2.8% after it missed earnings expectations. Out of 2,170 shares in the index, 601 rose and 1,469 fell, while 100 were unchanged.
In FX, the Bloomberg dollar spot index falls 0.3%. GBP and CAD are the weakest performers in G-10 FX, JPY continues to outperform, trading at 133.11/USD.
In fixed income, Treasuries were cheaper across the curve with losses led by the long-end, where yields are higher by around 4bp. Wider losses seen across bunds and gilts, weighing on Treasuries as ECB rate-hike premium is added in after a mix of CPI and GDP data out of Eurozone. US 10-year yields around 2.70%, cheaper by 2bp on the day and outperforming bunds and gilts by 3.5bp and 4.5bp in the sector; long-end led losses steepens 2s10s, 5s30s spreads each by around 2bp on the day. IG issuance slate empty so far; four names priced $5.1b Thursday, paying 15bp in concessions on order books that were 3 times oversubscribed.
WTI trades within Thursday’s range, adding 2.1% to trade around $98. Spot gold rises roughly $8 to trade close to $1,765/oz. Most base metals trade in the green; LME zinc rises 3.9%, outperforming peers.
Looking to the day ahead, data includes the employment cost index, PCE, income, and spending data in the US, Tokyo CPI, consumer confidence, jobless rate, retail sales, industrial production, and starts in Japan, CPI and GDP in France, GDP in Germany, and GDP in Canada. It’s another full slate of earnings which will include Sony, Exxon, Procter & Gamble, Chevron, AbbVie, AstraZeneca, Colgate-Palmolive, BNP Paribas, Eni, Intesa Sanpaolo, LyondellBasell, Engie, BBVA, NatWest, and Citrix.
S&P 500 futures up 0.7% to 4,103.00
Gold spot up 0.4% to $1,763.27
U.S. Dollar Index down 0.36% to 105.97
Top Overnight News from Bloomberg
- Euro-zone inflation climbed to another all-time high, supporting calls for the European Central Bank to follow up its first interest-rate hike since 2011 with another big move
- The euro-zone economy expanded by more than three times the amount economists expected, putting it on a firmer footing as surging inflation and a possible Russian energy cutoff threaten to tip it into a recession
- Stocks in Europe and the US are set for their biggest monthly advance since November 2020 on positive earnings and expectations of shallower Federal Reserve monetary tightening
- China’s top leadership is committing to ample liquidity as the nation contends with a slowdown. So far, a lot of that cash is sitting in the financial system instead of being transmitted to the real economy
- Biden, Xi Plan In-Person Meet as Taiwan Tensions Intensify
- Amazon, Apple Poised to Add $230 Billion After Resilient Results
- Citigroup Drops Some Clients to Boost Trading Returns
- Credit Suisse Woes Spread to Singapore With $800 Million Trial
- Bitcoin and Ether Are on Track for Their Best Month Since 2021
- Russia Is Wiring Dollars to Turkey for $20 Billion Nuclear Plant
- Alibaba Slumps as Traders Assess Earnings Risk, Ant Report
- BofA Says Too Soon for Bull Rally as Investors Pile Into Stocks
- Singapore, New York Tie for Highest First Half Rental Growth
- Morgan Stanley Hires Shen as Head of China Onshore Equities
- Alito Mocks Foreign Leaders Who Attacked His Abortion Opinion
A more detailed look at global markets courtesy of Newsquawk
APAC stocks traded mixed despite the positive lead from Wall Street, with Chinese markets lagging. ASX 200 was lifted by gold names amid the recent rise in the precious metal. Nikkei 225 saw mild gains throughout the session but eventually fell into the red amid notable JPY strength, whilst Nissan shares fell over 4% at one point after earnings. KOSPI was propelled by its Telecom sector, with Financials and Industrials also aiding. Hang Seng slipped over 2% with Alibaba shedding 6% after WSJ reported that Jack Ma intends to relinquish control of Ant Group. Headlines pointed out the Hang Seng index has fallen 10% from its June peak. Shanghai Comp held a negative bias as traders reacted to the Biden-Xi call, which included no rollback of Trump-era tariffs. Selling thereafter resumed following downbeat commentary from China's MOFCOM, suggesting the outlook for H2 trade growth is not optimistic.
Top Asian News
- China's Commerce Ministry said China's foreign trade faces higher risks; the outlook for China's H2 trade growth is not optimistic, via Bloomberg. MOFCOM said they will study targeted measures for foreign trade, and will step up support for export credit insurance in H2 and expand imports actively and ensure domestic commodity supply, via Reuters.
- China's Commerce Ministry official said foundation for consumption recovery is not solid yet, more efforts needed to boost consumption, via Reuters.
- Japanese government decided to tap JPY 257bln in budget reserves to help with rising oil and broader inflation, according to the MoF.
- PBoC injected CNY 2bln via 7-day reverse repos with the maintained rate of 2.10% for a net drain of CNY 1bln and for a weekly drain of CNY 12bln
- PBoC set USD/CNY mid-point at 6.7437 vs exp. 6.7414 (prev. 6.7411)
- Japan's Finance Minister Suzuki provides no comment on day-to-day FX moves, closely watching moves with a sense of urgency while working with the BoJ; Japan's MOF said it did not intervene in FX in the June 29th to July 27th period.
European bourses are firmer across the board, Euro Stoxx 50 +0.9%, and are set to post their best monthly performance since Nov'20. Stateside, the NQ continues to outperform, +1.2%, amid after-market earnings from AMZN and AAPL; US PCE Price Index ahead.
Top European News
- Germany Stagnates as Rest of Europe Beats Estimates: GDP Update
- UK June Mortgage Approvals Fall to 24-Month Low of 63.7k
- Ukraine Latest: Lavrov in No Rush to Respond to Blinken Request
- Amundi Defies Gloom Among Managers With $1.8-Billion Inflows
- Biden, Xi Plan In-Person Meet as Taiwan Tensions Intensify
- Yen recovery momentum gathers pace and extends beyond Dollar pairing to JPY crosses, USD/JPY slides over 2 big figures to test 132.50, EUR/JPY down to 137.56 from 137.32.
- DXY loses grip of 106.000 post-negative US GDP print and looking for support from PCE, ECI and/or Chicago PMI.
- Euro fades again irrespective of some encouraging Eurozone data and option expiry interest may be capping, EUR/USD tops out just over 1.0250 yet again and circa 3bln rolling off between 1.2045-50.
- Rand underpinned by Gold gains and Lira holds above 18.0000 as Turkish trade deficit narrows and Russia transfers funds for a nuclear facility.
- Sterling fades amidst mixed BoE consumer credit and housing metrics, Cable sub-1.2150 vs 1.2245 at best and EUR/GBP probing 0.8400 vs low around 0.8346 yesterday.
- Marked debt retracement following run of even more pronounced recovery gains.
- Bunds fade just shy of 158.00 again and retreat to 156.21, Gilts reverse around 100 ticks from 118.36 and T-note to 120-21+ from 121-08 at best.
- Stronger than expected Eurozone data also in the mix along with buoyant risk sentiment and firm oil.
- Bonds braced for busy pm agenda comprising US PCE, ECI and Chicago PMI.
- WTI Sep’22 and Brent Oct’22 are posting gains in excess of 2.0% on the session but remain capped by USD 100/bbl and 105/bbl respectively.
- Dutch TTF Sep’22 has pulled back to modestly below the EUR 200/mWh mark, but remains bid after several sessions of pronounced price action.
- Spot gold is relatively contained and resides just above the unchanged mark but continues to be dictated by the USD with the JPY-induced pressure lifting the yellow metal briefly overnight.
- Saudi Energy Minister and Russian Deputy PM Novak met in Riyadh and discussion cooperation between the two nations, according to Twitter, via Reuters.
- Senior US admin official said US President Biden and China's President Xi discussed face-to-face meeting and directed teams to follow up; did not discuss any potential lifting of US tariffs on Chinese products.
- White House said presidents Biden and Xi discussed a range of issues important to bilateral relationship and other regional/global issues.
- Senior US admin official said Biden and Xi had a 'direct and honest' discussion on Taiwan. They discussed areas of cooperation including climate change, health security and counter-narcotics. Biden brought up the long-standing concerns on human rights. Macroeconomic coordination between China and US is of great importance. Biden explained to Xi his core concerns about China's economic practices.
- China President Xi told US President Biden that the US should abide by the One China principle, and act in line with its words, according to State Media. On the Taiwan issue, Xi told Biden that 'those who play with fire will get burned'. Xi told Biden that China fiercely opposes Taiwan independence and the interference of external forces
- US President Biden told China President Xi that the US stance on One China policy remains unchanged, according to China's Global Times.
- BoJ Summary of Opinions (Jul meeting): achieving the price stability target in a stable manner is difficult given developments in the output gap and inflation expectations. The recent resurgence of COVID-19 is extremely rapid, and it is necessary to examine how this will affect financial positions, mainly of small and medium-sized firms. The Bank needs to closely monitor the impact that the recent increase in its Japanese government bond (JGB) purchases to contain upward pressure on interest rates has on the functioning of the JGB market.
- ECB's de Guindos says EUR depreciation has been one of the factors behind high inflation, main factor that guides decisions is the evolution of inflation.
- HKMA buys around HKD 9.656bln from the market to defend the peg.
US Event Calendar
- 08:30: 2Q Employment Cost Index, est. 1.2%, prior 1.4%
- 08:30: June Personal Income, est. 0.5%, prior 0.5%
- June Personal Spending, est. 0.9%, prior 0.2%
- June Real Personal Spending, est. 0%, prior -0.4%
- June PCE Deflator MoM, est. 0.9%, prior 0.6%; PCE Deflator YoY, est. 6.8%, prior 6.3%
- June PCE Core Deflator MoM, est. 0.5%, prior 0.3%; Core Deflator YoY, est. 4.7%, prior 4.7%
- 09:45: July MNI Chicago PMI, est. 55.0, prior 56.0
- 10:00: July U. of Mich. Sentiment, est. 51.1, prior 51.1;
- Expectations, est. 47.5, prior 47.3
- Current Conditions, est. 57.1, prior 57.1
- 1 Yr Inflation, est. 5.2%, prior 5.2%; 5-10 Yr Inflation, est. 2.8%, prior 2.8%
DB's Jim Reid concludes the overnight wrap
Morning from sunny Frankfurt. Today we wave goodbye to July which after the worst first half returns since 1788 in treasuries and 1962 for the S&P 500, is set to launch us into a very strong start to H2. A reminder that in a chart of the day I did back in June, it showed that the worst 5 H1s for equities all saw a big H2 rebound. However there are five long months to go before we can relax.
The key questions from the last 24 hours were 1) Did the Fed pivot on Wednesday? And 2) Is the US in a recession? Treasury markets continued to think the answer to both was yes, which boosted risk sentiment by further capping how far the market thinks the Fed can go. Meanwhile, Presidents Biden and Xi held a phone call, the markets continued to digest the Inflation Reduction Act, the US did see it's second successive quarter of negative growth, German CPI beat expectations and Amazon and Apple impressed the market with earnings after the bell.
The main macro driver continued to be the interpretation of the July FOMC. Specifically, that the Chair said at some point in the future it may be appropriate to slow the pace of tightening and that he and the Committee paid heed to slowing activity data (more below). The current interpretation being that factors other than inflation were seeping into the Fed’s reaction function. Global yields rallied hard yesterday. 2yr yields were -13.6bps lower at 2.86% while 10yr Treasuries were -10.9bps lower at 2.68%, their lowest since early April. Notably, real yields drove the decline, falling -13.1bps (-26.2bps lower over the last two days, their largest two-day decline since the invasion in early March), suggesting easier expected policy without an impact on inflation, with breakevens up a modest +2.1bps. This is a market believing the Fed will be forced into a pivot, and that slowing activity figures will soon translate into lower inflation. This morning in Asia, yields on 10yr USTs (-1.80 bps) are extending their decline, trading at 2.66% as I type.
Europe outpaced the US with 2yr bunds -18.7bps lower at 0.22%, their lowest since mid-May. 10yr bunds were -11.8bps lower and OATs fell -13.4bps. 10yr BTPs outperformed on the perceived shift in policy tone, down -14.9bps.
Regular readers will know we are skeptical things will work out as the market is increasingly pricing in. Real policy rates remain deeply in negative territory despite the Fed believing they are at neutral. Furthermore, policy works on long and variable lags, not only is 5 months (the amount of time until the market is pricing cuts) a very short amount of time for today’s tightening to bring inflation back from 9%, but the very reaction we’re witnessing in markets means financial conditions have actually eased since the June FOMC meeting. So the Fed has instituted back-to-back 75bp hikes and financial conditions haven’t gotten any tighter. DB research has been putting out a number of pieces addressing this of late. Matt Luzzetti and Peter Hooper put out a piece yesterday showing that the Fed is historically more cautious about cutting rates when core PCE is above 4% (see here), while Tim Wessel on my team showed that markets overestimate how large those cuts will be ahead of time when inflation is that high (see here). However, one needs to be wary of summer seasonals, where August is usually the strongest month of the year, when deciding whether to fight the move now or wait until September.
Adding to the yield rally justification, advanced US GDP came in at -0.9% in 2Q, that is in negative territory for a second straight quarter. This has driven much hand-wringing about whether or not the US is currently in a recession. We won’t know for a while if the NBER officially calls this a recession, as the growth data will undergo plenty of revisions before we have a final number. Further, the NBER actually doesn’t use GDP as one of their indicators for defining recessions, funnily enough, instead amalgamating personal income, payrolls, real PCE, retail sales, household survey employment, and industrial production (which eventually wind up looking a whole lot like GDP). Some of those underlying figures still look quite strong even if the headline GDP figure is not. In the end, whether or not the NBER decides in the future that we are in recession today is almost beside the point: markets will continue to trade based on their perception of the Fed’s responsiveness to slowing activity weighed against runaway inflation.
On that note, the overwhelming perception over the last two days is that slowing activity, will become increasingly more important for policy going forward. This drove risk assets higher for a second straight day across the Atlantic. The S&P 500 increased +1.21% with all but one sector higher, while the NASDAQ was up +1.08%, bringing them +11.06% and +14.24% higher since terminal rates first fell from above 4% in mid-June. In Europe, the STOXX 600 climbed +1.09%, while the DAX and CAC increased +0.88% and +1.30%, respectively.
On the earnings front, Mastercard said that card spending and use of its payments infrastructure have picked up in a big way amidst runaway inflation, pushing the company’s revenue forecast for the year higher. Hard to see how inflation slows if consumers are spending like that.
After the close Apple and Amazon reported earnings on the stronger side of what we’ve seen for mega-caps so far, with both releases containing optimism around supply chains and consumer spending. Apple’s revenues and earnings figures beat street estimates, despite supply chain disruptions from China covid lockdowns, on the back of stronger-than-expected iPhone and iPad sales, with shares rising around +3% after hours. Amazon shares rose more than +12% in after hours trading after beating revenue estimates and revising forecasts higher. While hiring appears to be slowing, Amazon also looks to be unwinding storage capacity, again another sign that supply chain pressures may be easing, while cutting costs.
We got more international data on the great slower activity versus high inflation dichotomy, with German CPI increasing +0.9% MoM versus expectations of +0.6%, bringing YoY to +7.5% versus +7.4% expectations. The EU harmonised measures also beat expectations, climbing +0.8% MoM versus +0.4% expectations while YoY ticked up to +8.5% versus +8.1% expectations.
Asian equity markets are mixed this morning with the Hang Seng (-2.19%) sharply lower and with the Shanghai Composite (-0.71%) and CSI (-1.02%) also slipping on rising expectations of China's economic growth outlook remaining subdued in H2 after yesterday’s high-level Communist Party meeting omitted its full-year GDP growth target and will instead strive to achieve the best results for the economy this year. Elsewhere, the Nikkei (+0.46%) and the Kospi (+0.43%) are trading in positive territory and more matching western markets.
Talking of which, stock futures in the US are pointing to a strong start with contracts on the S&P 500 (+0.57%) and NASDAQ 100 (+1.21%) both higher on the positive earnings from Amazon and Apple.
Early morning data showed that Japan’s industrial output jumped +8.9% m/m in June (v/s +4.2% expected) posting the biggest one-month gain in nine years as disruptions due to China's COVID-19 curbs eased. It followed a -7.5% drop last month. But retail sales (-1.4% m/m) unexpectedly contracted in June (v/s +0.2% expected) after an upwardly revised +0.7% increase in May. Separately, July Tokyo CPI advanced to +2.5% y/y in July (v/s +2.4% expected, +2.3% in June) on the back of a hike in utility prices. Meanwhile, labour market conditions in the nation remained relatively healthy as the jobless rate stayed at 2.6% in June (v/s 2.5% market consensus) albeit the job-to-applicants ratio improved to 1.27 in June (v/s 1.25 expected) from 1.24 in May.
Elsewhere, Presidents Biden and Xi had a two-hour phone call. The call covered foreign policy issues surrounding Taiwan and Ukraine. The two leaders reportedly covered areas of mutual cooperation, as well, including using their economic might to prevent a global recession and tasking aides to follow up on climate and healthy security issues. Aides have been tasked with setting up a face to face meeting which seems an impressive development even with the tensions there obviously are between the two sides.
To the day ahead, data includes the employment cost index, PCE, income, and spending data in the US, Tokyo CPI, consumer confidence, jobless rate, retail sales, industrial production, and starts in Japan, CPI and GDP in France, GDP in Germany, and GDP in Canada. It’s another full slate of earnings which will include Sony, Exxon, Procter & Gamble, Chevron, AbbVie, AstraZeneca, Colgate-Palmolive, BNP Paribas, Eni, Intesa Sanpaolo, LyondellBasell, Engie, BBVA, NatWest, and Citrix.
Will Powell Pivot? Don’t Count On It
Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For…
Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For fear of missing out on the next great bull run, many investors are blindly buying into this new Powell pivot narrative.
What these investors fail to realize is the Fed has a problem. Inflation is raging, the likes of which the Fed hasn’t dealt with since Jerome Powell earned his law degree from Georgetown University in 1979.
Despite inflation, markets seem to assume that today’s Fed has the same mindset as the 1990-2021 Fed. The old Fed would have stopped raising rates when stocks fell 20% and certainly on the second consecutive negative GDP print. The current Fed seems to want to keep raising rates and reducing its balance sheet (QT).
The market-friendly Fed we grew accustomed to over the last few decades may not be driving the ship anymore. Yesterday’s investment strategies may prove flawed if a new inflation-minded Fed is at the wheel.
Of course, you can ignore the realities of today’s high inflation and take Jim Cramer’s ever-bullish advice.
When the Fed gets out of the way, you have a real window and you’ve got to jump through it. … When a recession comes, the Fed has the good sense to stop raising rates,” the “Mad Money” host said. “And that pause means you’ve got to buy stocks.
Shifting Market Expectations
On June 10, 2022, the Fed Funds Futures markets implied the Fed would raise the Fed Funds rate to 3.20% in January 2023 and to 3.65% by July 2023. Such suggests the Fed would raise rates by almost 50bps between January and July.
Now the market implies Fed Funds will be 3.59% in January, up .40% in the last two months. However, the market implies July Fed Funds will be 3.52%, or .13% less than its January expectations. The market is pricing in a rate reduction between January and July.
The graph below highlights the recent shift in market expectations over the last two months.
The graph below from the Daily Shot shows compares the market’s implied expectations for Fed Funds (black) versus the Fed’s expectations. Each blue dot represents where each Fed member thinks Fed Funds will be at each year-end. The market underestimates the Fed’s resolve to increase interest rates by about 1%.
Short Term Inflation Projections
The biggest flaw with pricing in predicting a stall and Powell pivot in the near term is the possible trajectory of inflation. The graph below shows annual CPI rates based on three conservative monthly inflation data assumptions.
If monthly inflation is zero for the remainder of 2022, which is highly unlikely, CPI will only fall to 5.43%. Yes, that is much better than today’s 9.1%, but it is still well above the Fed’s 2.0% target. The other more likely scenarios are too high to allow the Fed to halt its fight against inflation.
Inflation on its own, even in a rosy scenario, is not likely to get Powell to pivot. However, economic weakness, deteriorating labor markets, or financial instability could change his mind.
Recession, Labor, and Financial Instability
GDP just printed two negative quarters in a row. Some economists call that a recession. The NBER, the official determiner of recessions, also considers the health of the labor markets in their recession decision-making.
The graph below shows the unemployment rate (blue), recessions (gray), and the number of months the unemployment rate troughed (red) before each recession. Since 1950 there have been eleven recessions. On average, the unemployment rate bottoms 2.5 months before an official recession declaration by the NBER. In seven of the eleven instances, the unemployment rate started rising one or two months before a recession.
The unemployment rate may start ticking up shortly, but consider it is presently at a historically low level. At 3.5%, it is well below the 6.2% average of the last 50 years. Of the 630 monthly jobs reports since 1970, there are only three other instances where the unemployment rate dipped to 3.5%. There are zero instances since 1970 below 3.5%!
Despite some recent signs of weakness, the labor market is historically tight. For example, job openings slipped from 11.85 million in March to 10.70 in June. However, as we show below, it remains well above historical norms.
A tight labor market that can lead to higher inflation via a price-wage spiral is of concern for the Fed. Such fear gives the Fed ample reason to keep tightening rates even if the labor markets weaken. For more on price-wage spirals, please read our article Persistent Inflation Scares the Fed.
Besides economic deterioration or labor market troubles, financial instability might cause Jerome Powell to pivot. While there were some growing signs of financial instability in the spring, those warnings have dissipated.
For example, the Fed pays close attention to the yield spread between corporate bonds and Treasury bonds (OAS) for signs of instability. They pay particular attention to yield spreads of junk-rated corporate debt as they are more volatile than investment-grade paper and often are the first assets to show signs of problems.
The graph below plots the daily intersections of investment grade (BBB) OAS and junk (BB) OAS since 1996. As shown, the OAS on junk-rated debt is almost 3% below what should be expected based on the robust correlation between the two yield spreads. Corporate debt markets are showing no signs of instability!
Stocks, on the other hand, are lower this year. The S&P 500 is down about 15% year to date. However, it is still up about 25% since the pandemic started. More importantly, valuations have fallen but are still well above historical averages. So, while stock prices are down, there are few signs of equity market instability. In fact, the recent rally is starting to elicit FOMO behaviors so often seen in speculative bullish runs.
Declining yields, tightening yield spreads, and rising asset prices are inflationary. If anything, recent market stability gives the Fed a reason to keep raising rates. Ex-New York Fed President Bill Dudley recently commented that market speculation about a Fed pivot is overdone and counterproductive to the Fed’s efforts to bring down inflation.
What Does the Fed Think?
The following quotes and headlines have all come out since the late July 2022 Fed meeting. They all point to a Fed with no intent to stall or pivot despite its effect on jobs and the economy.
- *KASHKARI: 2023 RATE CUTS SEEM LIKE `VERY UNLIKELY SCENARIO’
- Fed’s Kashkari: concerning inflation is spreading; we need to act with urgency
- *BOWMAN: SEES RISK FOMC ACTIONS TO SLOW JOB GAINS, EVEN CUT JOBS
- *DALY: MARKETS ARE AHEAD OF THEMSELVES ON FED CUTTING RATES
- St. Louis Fed President James Bullard says he favors a strategy of “front-loading” big interest-rate hikes, repeating that he wants to end the year at 3.75% to 4% – Bloomberg
- FED’S BULLARD: TO GET INFLATION COMING DOWN IN A CONVINCING WAY, WE’LL HAVE TO BE HIGHER FOR LONGER.
- “If you have to cut off the tail of a dog, don’t do it one inch at a time.”- Fed President Bullard
- “There is a path to getting inflation under control,” Barkin said, “but a recession could happen in the process” – MarketWatch
- The Fed is “nowhere near” being done in its fight against inflation, said Mary Daly, the San Francisco Federal Reserve Bank president, in a CNBC interview Tuesday. –MarketWatch
- “We think it’s necessary to have growth slow down,” Powell said last week. “We actually think we need a period of growth below potential, to create some slack so that the supply side can catch up. We also think that there will be, in all likelihood, some softening in labor market conditions. And those are things that we expect…to get inflation back down on the path to 2 percent.”
We are highly doubtful that Powell will pivot anytime soon. Supporting our view is the recent action of the Bank of England. On August 4th they raised interest rates by 50bps despite forecasting a recession starting this year and lasting through 2023. Central bankers understand this inflation outbreak is unique and are caught off guard by its persistence.
The economy and markets may test their resolve, but the threat of a long-lasting price-wage spiral will keep the Fed and other banks from taking their foot off the brakes too soon.
We close by reminding you that inflation will start falling in the months ahead, but it hasn’t even officially peaked yet.recession unemployment pandemic treasury bonds bonds corporate bonds sp 500 stocks fomc fed federal reserve spread recession gdp interest rates unemployment
Market Rally Has Some High Hurdles To Clear
One of the most exciting races in all of track and field is the 110-meter-high hurdles, a fierce event that requires extreme focus, grit and determination…
One of the most exciting races in all of track and field is the 110-meter-high hurdles, a fierce event that requires extreme focus, grit and determination to succeed in clearing all 10 hurdles without hitting one, which can easily compromise victory.
Back in 1981, Renaldo “Skeets” Nehemiah owned the track and field world as the first man to run the 110m hurdles under 13 seconds, clocking a 12.93. As a member of the Virginia Tech University Track & Field team during 1981 (Class of 1982), I had the privilege of meeting Skeets in the infield at an all-conference meet at Florida State University stretching out before the men’s 880-yard relay.
He had already torched the field in the 110 highs and was going to run the anchor leg for the Terrapins in the 880 relay. As I watched him take the baton, it was if his feet never touched the ground. He ran his leg in 19 seconds flat, an unofficial world record time for a 220 split.
It is always fun to share a memory about meeting someone who is very special and very humble, but it also makes for an abstract metaphor by which to compare to what I believe the market faces in the next several weeks ahead — a series of high hurdles to clear before it gets to what could well be the year-end handoff to a record-setting finish.
Not only did the market put up a good fight to avoid dipping below its lows in June, it made up a decent portion of year-to-date losses during the month of July. Led by the all-important big-cap technology sector, growth stocks came back into fashion as the expectations of reduced inflation and fewer rate hikes took hold of investor sentiment.
The latest stronger-than-forecast data from the labor market and manufacturing sector has the Atlanta Fed raising its gross domestic product (GDP) estimate to 1.4% from the -1.9% that I posted just a week ago in this column. That’s a notable swing of 3.3% to the good! And, with over 80% of S&P 500 companies having posted second-quarter sales and earnings that exceeded estimates, the market found some good footing upon which to build.
The first hurdle that will heavily impact market sentiment will be when the Consumer Price Index (CPI) and Producer Price Index (PPI) reports for July are released. While food and energy prices have come down, the costs of rent, professional services and skilled and hourly workers have probably increased. The market has been betting heavily of late that inflation has peaked, where any numbers that come in above consensus will take bond yields higher and stock prices lower as expectations of more Fed interest rate hikes will likely hurt investor sentiment. There is an important week ahead.
Investors shouldn’t be complacent about the market’s newfound lovefest with the change in narrative about the economy skirting a recession. There are deep problems in other major economies around the world. While inflationary forces in the United States will likely begin to diminish as the year progresses, the same cannot be said for Europe, which faces stubbornly high prices for natural gas, food and other shortages.
Europe is facing a grim winter of record inflation, if there is no relief in the price of natural gas. Russia has now stated it is slashing the supply of gas through the Nord Stream 1 pipeline to just 20% of capacity to pressure Germany and the European Union (EU) to stand down in their support of Ukraine. Top EU officials say Russia is “blackmailing” Europe and “weaponizing” its gas supplies. Moscow has repeatedly denied the accusations.
Japan’s economy is the third-largest in the world and faces the same challenges of inflation and a weakening global economy that could pressure its export-dependent economy. Japan is adding an additional $2 trillion to its mountain of debt, now at 230% of GDP. That percentage of debt to GDP is the highest in the world. The Bank of Japan has almost no choice but to keep bond rates low to be able to service debt. But as a result, the yen has lost more than 20% of its value in the past year.
For decades, the yen was considered a safe-haven currency, but now it shows what can happen when a nation’s debt soars to where it compromises the currency in a country that faces an aging society, a declining birthrate, labor shortages and highly restrictive immigration laws. Supply chain snarls and more bouts of COVID-19 only compound a very difficult set of economic conditions.
China has its own set of stiff headwinds. Its slumping property market and shadow banking industry are under serious stress, with the government having to orchestrate broad refinancing measures to avoid widespread bankruptcies. The country will be hard pressed to meet its year-end GDP goal of 5.5% if it continues to wage full lockdowns against COVID outbreaks. Data showed the world’s second-largest economy slowed sharply in the second quarter, missing market expectations with just a 0.4% increase from a year earlier.
And capital outflows from Chinese bonds and equities continued for a sixth straight month with the United States threatening to delist major Chinese ADRs due to regulatory and disclosure violations. Tensions with the United States due to its support of Taiwan are also a possible flash point that is keeping capital away from those markets. A view of the China Large-Cap iShares ETF (FXI) shows a very troubling pattern where that market could test the 2008 low, marking a 14-year period of stagnant market conditions.
Sadly, Hong Kong, once the shining Asian light where East meets West, has seen its equity market retreat 40% from its 2018 highs after China’s pseudo-takeover. The Hang Seng Index now trades at the same level as in 2007. This week, videos of Chinese tanks on streets to disperse agitators fuming at not being able to withdraw funds from their bank accounts have gone viral as the government now grapples with growing civil unrest. So much for the great China experiment.
And the war in Ukraine only adds further uncertainty to this set of big challenges for the global economy. Because the United States accounts for roughly 25% of total global GDP, it is considered a safe and investible market for now, as economic conditions are stable, while the U.S. dollar and the labor market are strong. This is a big reason capital from around the world is seeking shelter and opportunity in the U.S. bond and equity markets.
There is still an incredible amount of uncertainty with inflation, interest rates, energy prices, commodity prices and geopolitical situations that could flare up at any time. As some of these metrics become more clear in the month ahead, investors will gain much-needed insight into these and other risks that will determine whether the recent gains will hold and build, or whether another retest of some lower level for the market is in order.recession bankruptcies covid-19 bonds sp 500 equities stocks fed etf gdp interest rates japan hong kong european europe germany russia ukraine eu china
Fed reverse repo reaches $2.3T, but what does it mean for crypto investors?
Investors avoid risk assets during a crisis, but excessive cash sitting in financial institutions could also be good for the cryptocurrencies.
Investors avoid risk assets during a crisis, but excessive cash sitting in financial institutions could also be good for the cryptocurrencies.
The U.S. Federal Reserve (FED) recently initiated an attempt to reduce its $8.9 trillion balance sheet by halting billions of dollars worth of treasuries and bond purchases. The measures were implemented in June 2022 and coincided with the total crypto market capitalization falling below $1.2 trillion, the lowest level seen since January 2021.
A similar movement happened to the Russell 2000, which reached 1,650 points on June 16, levels unseen since November 2020. Since this drop, the index has gained 16.5%, while the total crypto market capitalization has not been able to reclaim the $1.2 trillion level.
This apparent disconnection between crypto and stock markets has caused investors to question whether the Federal Reserve’s growing balance sheet could lead to a longer than expected crypto winter.
The FED will do whatever it takes to combat inflation
To subdue the economic downturn caused by restrictive government-imposed measures during the Covid-19 pandemic, the Federal Reserve added $4.7 trillion to bonds and mortgage-backed securities from January 2020 to February 2022.
The unexpected result of these efforts was 40-year high inflation and in June, U.S. consumer prices jumped by 9.1% versus 2021. On July 13, President Joe Biden said that the June inflation data was "unacceptably high." Furthermore, Federal Reserve chair Jerome Powell stated on July 27:
“It is essential that we bring inflation down to our 2 percent goal if we are to have a sustained period of strong labor market conditions that benefit all.”
That is the core reason the central bank is withdrawing its stimulus activities at an unprecedented speed.
Financial institutions have a cash abundance issue
A "repurchase agreement," or repo, is a short-term transaction with a repurchase guarantee. Similar to a collateralized loan, a borrower sells securities in exchange for an overnight funding rate under this contractual arrangement.
In a "reverse repo," market participants lend cash to the U.S. Federal Reserve in exchange for U.S. Treasuries and agency-backed securities. The lending side comprises hedge funds, financial institutions and pension funds.
If these money managers are unwilling to allocate capital to lending products or even offer credit to their counterparties, then having so much cash at disposal is not inherently positive because they must provide returns to depositors.
On July 29, the Federal Reserve's Overnight Reverse Repo Facility hit $2.3 trillion, nearing its all-time high. However, holding this much cash in short-term fixed income assets will cause investors to bleed in the long term considering the current high inflation. One thing that is possible is that this excessive liquidity will eventually move into risk markets and assets.
While the record-high demand for parking cash might signal a lack of trust in counterparty credit or even a sluggish economy, for risk assets, there is the possibility of increased inflow.
Sure, if one thinks the economy will tank, cryptocurrencies and volatile assets are the last places on earth to seek shelter. However, at some point, these investors will not take further losses by relying on short-term debt instruments that do not cover inflation.
Think of the Reverse Repo as a "safety tax," a loss someone is willing to incur for the lowest risk possible — the Federal Reserve. At some point, investors will either regain confidence in the economy, which positively impacts risk assets or they will no longer accept returns below the inflation level.
In short, all this cash is waiting on the sidelines for an entry point, whether real estate, bonds, equities, currencies, commodities or crypto. Unless runaway inflation magically goes away, a portion of this $2.3 trillion will eventually flow to other assets.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should conduct your own research when making a decision.bonds pandemic covid-19 equities crypto real estate currencies russell 2000 crypto commodities stock markets
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