2024.06.24 Weekly
Too dovish?
Short-term inflation expectations selling off on softening inflation data has pushed up real rates, which as an imperfect gauge of the neutral policy rate (r*), suggests some adjustment cuts from the Fed is warranted.
However, as argued in last week’s note captioned “reflexivities”, inflation coming down is likely to lead to reflexive economic strength — i.e. disinflationary sentiment will bolster business and consumer sentiment, causing the Fed to be patient for longer as they are unable to take full comfort that upside risks have fully dissipated before cutting. Sure — inflation may have been largely beaten, but I think the Fed believes the economy is still strong enough such that it is vulnerable to upside risks or unforeseen shocks that could potentially derail disinflationary progress.
As a result of recent data falling short of expectations, US10yr is almost 25bps lower so far this month and -50bps off the April peak. But has market got too pessimistic on economic prospects? The bar will likely be even lower on future economic data expectations and together with some reflexivity risk, I see risks skewed towards a rebound. Over the longer run, high US deficit spending is likely to not only keep US economic resilience going, it will also keep upward term premium pressure on US yields.
Part of my positive risk view was based on inflation coming down while economic data stayed resilient and that we have hit max-hawkish when the market was priced for 1 cut at the April peak. Now, the market is priced for roughly 2 cuts this year and while economic data may have moderated over recent months, a review of the data suggests the consumer and labour market remains in decent shape. Assuming it is next to impossible that we price in any more than 2 cuts as things stand, I think we’ve hit max-dovish here, adding to the idea that risks are skewed towards dovish expectations paring back, as well as a a risk that the market may not even see a cut this year if those reflexivity risks materialise.
Data review
Relative growth trajectories implied by latest PMIs shows US exceptionalism to be alive and well and, once again diverging against other major economies after some convergence earlier in the year.
Of the major economies whose Flash PMIs came in last week, US is the only one maintaining an accelerating expansion while others have slumped.
The divergence is particularly evident in Services. US Services Business Activity index accelerated to its fastest pace in 26 months .
US manufacturing sentiment is solid, UK continues to improve, Japan factory activity has stalled, others continues to be a slump.
US retail sales missed expectations but a closer look shows a very solid report. Strong spending particularly in the more durable items suggests consumer spending is indeed healthy.
To contrast with the nominal retail sales report, May saw an uptick in real terms too (Blue).
Initial claims saw a sharp rise while Continuing claims is beginning to move higher again eyeing the prior peak at the beginning of the year. Many point to Jobless claims as a sign the Labour market is beginning to ‘crack’ — these may be some early signs but we are still far from it with initial claims still well off the peaks over the last 2 years.
Volmageddon
SPX 1-month implied correlation is and back to levels that preceded the 2018 volmageddon, the 3-month is at an all-time-low.
There is a lot of talk about the overly crowded dispersion trade — i.e. the lack of index vs single stock volatility, and where elevated volatility resides in just a handful of stocks, making the market (broader indices) vulnerable to outsized sell-offs.
There is some angst developing around European politics that could open some risks around European sovereign debt and this post from Johnny Mathews of SuperMacro appears to suggest that there is potential for this to weigh on the broader risk complex saying “SX5E (Europe large-cap equities index) leads the way”, and he may have a point …
1-month STOXX50 and SPX volatility indicies has historically shown it has tended to lead a rise in SPX volatility.
A widening in European peripheral spreads have tended to linger than recover immediately, and such episodes have tended to see higher spikes and elevated Stoxx volatility.
Looking ahead
A lot of data over the coming weeks and expectations are currently looking fairly soft across the board. Bonds and Equities are looking a little too bid to me at the moment and as outlined above, I see risks skewed to the downside for both at these levels — i.e. they probably wouldn’t rally much on some softer data, but could easily sell-off and reverse some of the recent rallies on some better than expected data.
NEWSFLOW
MARKETS
- Stocks Show Signs of Buyer Exhaustion After Rally (BBG). Stocks Face Meager Upside After 2024 Gains, Survey Shows (BBG). Goldman ups S&P 500 target for a third time and says 6,300 is possible — now sees the record-busting index SPX ending 2024 at 5,600, from a prior 5,200 thanks to “milder-than-average negative earnings revisions and a higher fair value price/earnings multiple” (MW).
- France Keeps Markets on Edge With Le Pen Fighting Left for Power — An election that asks voters to choose a new parliament will keep investors on their toes as the far right fights a leftist alliance (BBG). French Business Body Slams Le Pen, Left as Danger to Economy (BBG). Options Market Signals Volatility on French Vote Likely to Last — Traders position for weaker euro against dollar, Swiss franc, French benchmark option volatility premium over Germany soars (BBG).
- Switzerland makes second interest rate cut as major economies diverge on monetary policy easing (CNBC). Bank of England keeps rates at 16-year high before UK election (RTS). Traders Bet on August Rate Cut as BOE Shows Willingness to Ease (BBG). Schnabel Says Potential Shocks Mean ECB Can’t Precommit on Rates — ‘Last mile’ of disinflation is proving bumpy (BBG). Norway’s Central Bank Leaves Rates On Hold, Signals No Cut This Year (WSJ). Bank of Canada Considered Waiting Until July to Cut Rates (BBG). BOJ Summary Signals Chance of July Hike Amid Upside Price Risks (BBG). BOJ to forgo July rate hike, taper $152 bln per year, says ex-policymaker (RTS). China leaves benchmark rates steady as PBOC walks tight rope (RTS).
AMERICAS
- US Services Activity Expands by Most in More Than Two Years — S&P Global’s flash June gauge advanced to 55.1 from 54.8, Manufacturing index also rose, while price measures cooled (BBG). US Retail Sales Barely Increase In Sign of Consumer Strain — Value of purchases rose 0.1% in May after downward revisions, Households have costlier debt, delinquencies continue to rise (BBG). US shoppers tighten their belts in a most unlikely place: the grocery store (FT). US labor market, housing data point to slowing economy — Weekly jobless claims fall 5,000 to 238,000, Continuing claims increase 15,000 to 1.828 million, Housing starts drop 5.5% in May; permits slip 3.8% (RTS). US Homebuilder Confidence Slides to Lowest Level This Year (BBG). New US Home Construction Plunges to Slowest Pace Since June 2020 — Home starts slid to 1.28 million, below all but one estimate, Decline in building permits point to softer construction ahead (BBG). US Existing-Home Sales Fall a Third Month as Prices Set a Record — Contract closings dropped 0.7% in May, driven by the South, Median price climbed to $419,300 even with more inventory (BBG).
- Increased spending pushes 2024 US budget deficit estimate to $1.9 trillion — CBO said higher outlays for student loan relief, Medicaid healthcare for the poor, higher Federal Deposit Insurance Corp costs to resolve bank failures and U.S. aid to Ukraine and Israel make up the bulk of a $408 billion increase in this year’s projected deficit since February, when it forecast a $1.507 trillion deficit (RTS). US millionaires support Biden’s plan to tax super-wealthy, poll shows — President seeks to fight Trump on economy with progressive plan to make the very rich pay more (FT). Trump Catching Biden on Campaign Cash But Not on Spending It (BBG).
EUROPE
- Euro zone business recovery slows sharply in June, PMI shows — demand fell for the first time since February, bloc’s services industry showing some signs of weakening while the downturn in manufacturing took a turn for the worse (RTS). French businesses blame political uncertainty for drop in orders (FT). German Business Expectations Fall in Setback to Rebound Hope — Ifo expectations dropped to 89 in June; economists saw 90.7, Economy ‘having difficulty overcoming stagnation,’ Fuest says (BBG).
- UK Purchasing Managers Report Higher Inflation and Slower Growth (BBG), Election uncertainty pushes UK business growth to 7-month low — Composite PMI dropped to 51.7 in June from 53.0 in May, its lowest since November 2023 and below all forecasts (RTS). UK inflation drops to 2% target for first time since 2021 (RTS). Bank of England keeps rates at 16-year high before UK election — Markets increase bets on quarter-point August rate cut, Bailey says good CPI is at 2% but too soon for cut (RTS). UK markets jolted back to life by rate cut hopes, election buzz — Markets price in 48 bps of rate cuts by year end, Expectations for first BoE move in August rise, Investors see boost for UK gilts from ‘stable’ government (RTS). UK Retail Sales Jump Most Since January as Confidence Grows — Consumer confidence improves to highest level since pandemic, Figures indicate households are weathering high interest rates (BBG). Clothes and furniture spending lift British retail sales more than expected (FT). UK house prices show second monthly rise in April, ONS says (RTS). Asking prices for UK houses stagnate in June, Rightmove says (RTS). UK pay deals tick higher in May, Brightmine survey shows (RTS).
ASIA
- US unveils draft plan to restrict investment in Chinese technology — Proposal aims to make it more difficult for groups deemed a security risk to access American resources and capital (FT). China, European Union Agree to Hold Talks on EV Tariffs (BBG). German exports to China drop as trade tensions rise — Decline comes as economy minister sets off for Beijing seeking to defuse brewing spat over electric vehicles (FT).
- China’s Fiscal Income Drops at Quickest Pace in More Than a Year (BBG). Cash is leaving China again, pressuring yuan — Analysts said Hong Kong’s stockpile of yuan deposits has also grown as mainland investors use their limited offshore investment channels to seek higher yields and companies prepare to pay annual dividends, adding to the pressure on the currency (RTS). China Foreign Direct Investment Falls for 12 Straight Months (BBG). China’s factory output disappoints, property sector stuck in doldrums (RTS). China’s property measures give sales a boost, but only in big cities (RTS). China new home prices fall at fastest clip in nearly 10 years (RTS). Hong Kong Rents Reach Pre-Pandemic Levels on Mainland Demand — Mainland Chinese immigration is boosting rental prices, Singapore’s residential rents are softening as supply grows (BBG).
- Japan’s demand-led inflation slows, clouds BOJ rate hike path — core CPI up 2.5% y/y vs forecast +2.6%, ex-food & energy slows to 2.1% in May, Service inflation slows in sign of weak wage pass-through (RTS). Japan’s June factory activity eases as costs rise, PMI shows (RTS). Japan core machinery orders down in April (RTS).
- Australia’s central bank holds cash rate at 4.35% (RTS). New Zealand Economy Returns to Growth, Exiting Recession — GDP gains 0.2% in first quarter, beating economist forecasts, Per-capita GDP declines for a sixth straight quarter (BBG).
EQUITIES
Country-specific indices are beginning to diverging performances, most notably Europe giving back some year to date gains.
All countries world index has been in a state of indecision over the past month, while ex-US index has rolled over and threatening to technically threatening to breakdown further.
Emerging markets index is showing resilience, particularly the ex-China index on the right but technical strength has been fading.
US equities are showing some strong topping signals. SPX put in a lower low and close on Friday after a bearish engulfing and demark 13 countup, while NDX has put in a lower low and close after a evening-star type of structure as well as a weekly long-legged reversal doji and 13 countup in the week prior.
NYFANG index has finally printed a reversal bar with bear divergence above the RSI 70 line.
Looking at SOXX US semiconductors index whose stocks have largely been powering the SPX rally that made 31 new ATH’s this year — weekly chart has printed bearish harami with a Demark 13 setup and a 13 combo the week prior, daily has closed back into the channel projection and channel projection and showing 3–5% of room to the downside before finding meaningful support.
Most-shorted-stocks index has closed below the upper trendline which has served as a good pivot so far this year. It has closed below the trendline after a series of indecision and bearish reversal bars suggesting deteriorating underlying sentiment.
Looking at Europe where we are seeing the most risk aversion sentiment, Stoxx50 is coming off a double top structure and broken below the neckline but has been finding relief last week as peripheral yield spreads have also come in slightly. It’s retraced into a key pivot area and I think this is a good opportunity to gain some downside exposure to Europe at these levels as well as playing for an outsized correction in US equities.
As with European index volatility tending to lead as noted above, we have also seen European cyclicals also tending to lead US cyclical sentiment also. Stoxx cyclicals-defensive spread continues to look heavy and looks set to weigh on the US spread.
COMMODITIES
Agricultural commodities have slumped back to a key area of support, Energy June bounceback is beginning to fade, Precious metals looks increasingly heavy after the recent rally, while Industrial metals are drifiting around a key pivot level.
2 trades I’m interested in for this space…
1. Gold short — price action is looking interesting and though 1month risk reversals lean bullish this month, I think it will follow price action lower particularly if it breaks down from the neckline. It will need to take some strong US data to catalyse such a move and as I’ve noted in my opening notes, I think the bar for beats is looking very low.
2. Crude short — I posted this chart on twitter after the demark 9 countup printed at a key pivot area, and we are now seeing some confirming price action since. Global manufacturing data has been soft recently and I think this will help to see Oil prices pullback slightly if anything.
RATES
Bond yields saw a slight reversal last week.
US 10yr has been consolidating around this key area between 4.2 and 4.3% and I suspect it may have hit a short-term floor here:
- As noted, I think the market has hit max dovish here with the market priced for 2 cuts this year, and 92bps of cuts next year;
- upside risks to longer run inflation could prove stickier on ‘reflexivity risk’ which, could open up the risk that the Fed may not be comfortable enough to cut this year at all; and
- should the labour market also prove resilient, longer-end yields may be reflecting too much economic pessimism.
If those points materialise or should head in that direction, I think the bond yields are potentially mispriced here and together with the expanding US deficit spending, I expect the 2s5s10s fly to rebound from these lows, and
term premiums to go positive again.
CURRENCIES
- EUR is seeing some relief but I think this bounce is an opportunity to get short around the 20wma. GBP rally has stalled and struggling for direction, and I think it may continue to do so given some optimism towards Labour winning the general election compared to Conservatives will offset some downside fundamental and interest rate risks. CHF printed a bearish reversal bar off a key area last week, and while it may continue to pullback, I think CHF strength will hold out in the end on European political risks, and less costlier to hold than the JPY amid more risk aversion.
- USD I expect to maintain an upward drift as I see it benefiting from both risk aversion and exceptionalism scenarios. CAD I continue to believe has a lot of negativity in the price and risks are skewed towards more strengthening. That said, it has put in a strong bounce already and I think it will take its cue from it’s neighbour USD.
- AUD and NZD action has been resilient, and I think there is an opportunity to get short at these levels given the broad risk views expressed above. JPY despite some prior tactical attempts to look for long trades, it still retains a short bias and still heavily difficult to get behind longs especially as seeing upside risks to bond yields.
That’s all for now. Good luck trading quarter-end!
