2024.07.01 Weekly

Fed needs to cut now!!! But will they?

There’s a growing chorus calling for the Fed to cut sooner at the risk of reacting too late with inflation slowing to below 3% and the fed funds rate still above 5%. The labour market has also significantly loosened with V/U back to pre-pandemic levels and continuing claims on the climb. It’s difficult to argue against that simple math and macro indications, which I’d fully agree with. But I’m at odds with what I fully agree with in the practical sense versus what I think the Fed will end up doing.

Powell reiterated that the Fed needs to see more to bolster confidence inflation is moving sustainably towards 2% at the last FOMC meeting just weeks ago. Other Fed comments have also implied the need for more data to compel them before starting to lower rates, and with such comments coming in alongside 2.5% annualised core inflation, it’s as if they want to see more economic slowing to neutralise upside risks. Whether that may agree with other market participants or not, this language continues to give me confidence on what I think the Fed will end up doing.

As touched on in prior weeks, I presume those upside risks to come in the form of reflexive economic resilience/strength (in response to inflation decelerating again and expectations of imminent cuts) that may show up in economic data over the coming months. But regardless of what anybody thinks, it changes little — the Fed has 1) clearly set a high bar for when it wishes to start the easing cycle, whether that may turn out to be a major policy error or not, and 2) it’s all dependent on the data. What is likely to be the straw that breaks the Fed’s back is unemployment, and although hiring intentions have softened significantly, there isn’t any sign of labour market stress, yet. Business sentiment remains strong as we saw in the flash PMIs with services activity accelerating to its fastest pace in 26 months, and I look to this week’s ISM to provide support to my reflexivity thesis.

I’m still in the 1 cut in November or December camp, but if this week’s data stokes unemployment concerns, that could sway me to lean towards sooner cuts. Lots of data to digest along with CPI the week after.

Data review

Slight dip in both the Conference Board consumer confidence index and UoM consumer sentiment index. in June. Final UoM Consumer sentiment index was revised up to 68.2 from the initial preliminary estimate of 65.6, but still down from the prior month of 69.1. Sentiment on current conditions deteriorated though at a much slower pace than the prior month while sentiment on future economic prospects improved in June after monthly declines from the March peak. 1year inflation expectation drops to 3% from 3.3% the prior month.

Individual components of the CB survey show consumers are net positive on current business conditions and more so on the state of the labour market, but 6-month expectations show they remain deeply concerned about the future though income expectations stay positive.

Initial claims pulled back slightly while continuing claims surpassed the prior peak and appears as though it may reach the pre-pandemic 5yr-average (dashed lines) by the end of the year on its current trajectory.

Seasonality

Given that I knew Q3 is historically a weak period for stocks, to my surprise I was told July was the strongest month of the year — he wasn’t kidding… well, sort of…

Global equities via the MSCI All Countries World Index shows July to be the strongest month of the year since its inception in 2008 with the highest average return of 2.79% and 81% win rate. Quite a compelling stat.

But with a longer look back via ES S&P500 futures, we see a notable difference where July was one of the weakest months of the year in the 10-year period prior to 2008.

And over a 50 year history of the SPX, July has essentially been a coin-flip with the 2nd lowest win rate of all months at 53%. What’s more statistically significant is that the months with the lowest win rates of the year all fall in the 3rd quarter.

And what about election years? Over the last 100-years, July has seen decent performance on average but again, what looks much more statistically significant for election years also, is that Q3 has been historically weak.

While I do like to factor in seasonality into my trading ideas and views, I certainly don’t give it much weight. The first half of July does tend to perform well — there is the idea that with H1 over, books get a refresh and new money is put to work for H2; then begins to drop off midway through the quarter — possibly some profit harvesting after earnings expectations have been realised? Whatever the case may be to explain such patterns, the stats are relatively strong and may be worth keeping in consideration for this quarter.

NEWSFLOW

MARKETS

• S&P 500 gain in first half of 2024 blows historical average ‘out of the water’ (MW). Japan’s Topix Index Reaches Highest Intraday Level Since 1990 — Banks, insurers have contributed to the Topix index’s gain, Nikkei 225 Stock Average reached record high earlier this year (BBG).
• Central banks should set a ‘high bar’ for interest rate cuts, BIS warns (FT). Federal Reserve’s preferred inflation metric edges down to 2.6% (FT). Fed’s Cook Says Rate Cut Needed at Some Point But Timing Unclear (BBG). Fed’s Bowman: need steady policy rate ‘for some time’ to beat inflation — “Inflation in the U.S. remains elevated, and I still see a number of upside inflation risks that affect my outlook” (RTS). Barkin Says Economy Is Withstanding Fed’s Inflation Battle — Consumers, job market likely to stay resilient despite rates, there’s still work to do on inflation (BBG). El-Erian Says Key Support for US Markets Is Looking Shaky — “I do worry that the more likely error right now is the Fed will not start cutting early enough” (BBG), “July interest-rate cut is unlikely but shouldn’t be” (BBG).
• Asian Currencies Slump to Lowest Since 2022 on Dollar Strength — Bloomberg Asia FX index falls to lowest in more than 19 months, Bets on elevated US rates, weak China hurt Asian currencies (BBG). Japan names new FX diplomat as yen hits 38-year low (RTS). Bank of Japan opens door for a hawkish double surprise — Bank of Japan is dropping signals its QT plan in July could be bigger than markets think, and may even be accompanied by an interest rate hike; Hawkish hints delivered over the past week highlight the pressure the central bank faces in the wake of renewed yen falls, which could push inflation well above its 2% target by raising import costs (RTS). Forget 160, Traders See Yen Slumping as Far as 170 This Time — The currency is within range of recent intervention level (BBG).

AMERICAS

• US Economy Shows Further Signs of Slowing Under High Rates — Thursday data show downward revision to 1Q personal spending, Core capital goods orders, pending home sales dropped in May (BBG). US inflation cools in May, boosting hopes of Fed rate cut — PCE price index flat in May; up 2.6% on year-on-year basis, Core PCE edges up 0.1%; rises 2.6% on year-on-year basis, Consumer spending gains 0.2%; personal income up 0.5% (RTS). US consumer confidence retreats slightly; house prices remain elevated — “mild decrease in confidence isn’t consequential and we think there are sufficient tailwinds to keep consumers spending, the economy is on a glide path to normalized conditions” (RTS). US Consumer Sentiment Falls by Less Than Initially Estimated — Year-ahead inflation views drop to 3% in June from 3.3%, University of Michigan final sentiment index at 68.2 (BBG). US weekly jobless claims, equipment spending data point to slowing economy — Weekly jobless claims fall 6,000 to 233,000, Continuing claims increase 18,000 to 1.839 million, Core capital goods orders drop 0.6% in May, Goods trade deficit widens 2.7%; inventories rise (RTS). US Pending Home Sales Index Slides to Record Low on High Rates (BBG). Highest Inventory of New US Homes Since 2008 Threatens Building — Rising inventories come amid slowdown in new construction, Housing is set to drag on US economy again in second quarter (BBG). Housing market to remain ‘stuck’ until at least 2026, Bank of America says (CNBC). IMF warns US must ‘urgently’ address debt burden (FT).
• Barclays Says Buy Inflation Protection to Prepare for Trump Win — Strategists recommend going long five-year TIPS breakevens, Trump policies are ‘more likely to be inflationary’ (BBG).
• Canada inflation surprisingly rises in May, markets trim July rate cut bets — Inflation accelerates to 2.9% from 2.7% in Apr, Markets see below 50% chance of July rate cut, Core inflation up for first time in five months (RTS). Canada’s economy expands 0.3% in April; another gain seen in May (RTS).

EUROPE

• French bond market gets taste of euro zone ‘periphery’ turmoil (RTS). ECB faces speculation over market intervention after French elections — Bank has ‘transmission protection instrument’ in its armoury to help Eurozone countries in crisis by buying up their debt (FT). Le Pen Is Mightier: Conservative National Rally Crushes Macron, Socialists In 1st Round Of French Election (ZH). Far right wins first round in France election, final result uncertain, exit polls show (RTS). France’s election has the ability to rock wider European stocks, Citi strategist says (CNBC). Germany’s Lindner says planned income tax relief is not negotiable — Lindner said he would not bow to pressure from members of his government coalition to roll back his plans for billions of euros in personal income tax cuts to mitigate the creeping effects of inflation (RTS).
• ECB Can Disregard Bumps in Disinflation, Villeroy Says (BBG). ECB Will Be Agile in Deciding on Interest-Rate Path, Lane Says (BBG). ECB May Only Cut Rates Once More This Year, Kazimir Says (BBG). ECB’s Rehn Sees Bets for Two More Cuts in 2024 as Reasonable (BBG). ECB survey shows consumers becoming more optimistic on inflation — expectation for price growth for the next year cut to 2.8% in May from 2.9 and for three years ahead to 2.3% from 2.4%; Economic growth expectations for the next 12 months unchanged at minus 0.8% while expectations for unemployment rate decreased to 10.7% from 10.9%,(RTS). You can continue to cut rates, researchers tell ECB (RTS). Football fans and Swifties rattle inflation-wary central bankers — Major sporting and cultural events fuel surge in hotel room prices and airline tickets in Europe (FT). SNB Held Off on Interventions in First Quarter Amid Franc Slump — Central bank bought currencies worth just 281 million francs, Franc slumped against euro and dollar after record high (BBG). Riksbank Signals as Many as Three More Rate Cuts This Year (BBG).
• UK economy picks up in early 2024, too late for election boost — UK economy grows 0.7% QQ in Q1 vs 0.6% initial estimate, Overall growth has been weak since last election in 2019, UK GDP grew 1.8% since Q4 2019, second-lowest in G7, Household incomes remain lower than in Q4 2019 (RTS). Starting pay for UK jobs up 6.5% on year in May, job ads show — outstrips the 6.0% rise in official wage data for the three months to April (RTS). New FDI projects in UK fall to near 12-year low (FT). Defaults on leveraged loans soar as BoE warns on private equity’s ‘challenges’ — Central bank concerned that risks in sector backing 2mn UK private-sector employees could spill over to rest of economy (FT).

ASIA

• Tokyo Inflation Quickens, Output Gains Keeping BOJ on Hike Path — Industrial production increases more than expected in May, Rise in natural gas prices drives CPI growth in latest mont (BBG). Inflation in Japan’s capital accelerates, keeps BOJ rate hike prospects alive — June Tokyo core CPI up 2.1% yr/yr vs f’cast 2.0 (RTS). Japan’s business-to-business service inflation hits 2.5% in May (RTS).
• China’s June factory activity contracts again, services slows — NBS PMI at 49.5 in June, unchanged from May and in line with a median 49.5 Reuters forecast (RTS). Keep faith in China, Li Qiang tells business at ‘Summer Davos’ (FT).
• Australia’s Households Remain Pessimistic on RBA Rate-Rise Fears — Sentiment edged up in June while remaining in pessimistic zone, Tax cuts and energy rebates from next week may lift households (BBG). Australia inflation jumps to 6-mth high in May, ramps up rate hike risks (RTS). High RBA Rates Driving Some Home Borrowers to Sell, Kent Says (BBG). Westpac Boss Warns on Economic Risk From Sticky Australia Prices (BBG). Empty Wellington Shops Send Grim Economic Message to RBNZ Hawks — Barring pandemic, economy on track for worst year since GFC, Retailers ‘can’t see the light at the end of the tunnel’ (BBG). New Zealand Pricing Intentions Signal Slower Inflation, ANZ Says (BBG).

EQUITIES

Technical signals are mounting that the Global equities rally is exhausted.

SPX and NDX have put in a 2nd consecutive weekly indecision bar with weekly RSI above the 70 threshold. Contrary to what July seasonal patterns suggest, I’m still a seller of rallies here for reasons I’ve outlined over many weeks. At this juncture, I don’t see where further positive catalysts comes from as I don’t think economic data will deteriorate sharply to warrant more/sooner easing than is already priced by the market, and moderating data trend also points to moderation in earnings outlooks.

Stoxx 50 and 600 are slowing rolling over.

Theres a notable divergence in sentiment between Europe and the US…

European stock volatility has been easing off after the initial thrust higher, but elevated political and debt uncertainties should keep vols elevated as I don’t expect the smoke to clear anytime soon especially with the 2nd round of French elections next weekend. SPX volatility is still low but elevated vs prior month lows.

Skewdex showing demand for downside protection is a little more elevated than we saw mid-June. Given some exhaustion signals on the index charts, I would expect put premiums to stay well off the lows and ahead of some big data in the coming weeks.

1–month implied correlation for SPX has sunk to new ATL into Q2-end and if the market is to make a broad pullback as I expect, this indicator would need to bounce back to support the idea of dispersion trades unwinding and more elevated volatility at the index level.

NYFANG printed a weekly outside bar with RSI moving further above the 70 threshold after closing right on the 70 line the week before. Daily chart does suggest possible weakness however with bearish divergence to compliment the Friday reversal bar. I expect a mild correction here at the very least to start the July month.

PFRZ small/mid-caps index has shown more silience than I’d anticipated. It’s holding the weekly RSI 50 line and has rebounded back to a major pivot level which should be useful in gauging underlying market sentiment for the week(s) ahead.

Similiarly the most-shorted-stocks index has shown similar resilience around this trendline which has observed many pivots through the first half of the year. Another to watch as a signal for how well broad market sentiment is holding up.

Asian equities are in a brighter spot, though I also think the speed of rallies will be much lesser than we’ve seen earlier this year. Nikkei 40k handle and 2800’s in the KOSPI are key technical areas where I’d expect some resistance.

HSI and Shanghai composite have made the natural 38.2 fib retracement after a big recovering rally and showing technically strong arguments for support in this area.

COMMODITIES

Bloomberg commodities index is trading very heavily and while it does look set to resolve lower, I think this could be more of a long bottoming pattern than a break down.

The index slump is driven by Agriculturals and Metals. Agriculturals has slumped to new lows for the year but the weakenss is likely to be seasonally driven from the harvesting in Spring to Summer months. Metals have been coming off their recent May rally and could soon find a floor. Energy rebounded in June but beginning to ease off — particularly in NG of which I think the likes of Crude and Gasoline prices could be finding a short-term top.

RATES

Bond yields rebounded ~15bps into quarter-end with very little change in the front end. I posted on twitter that yields have likely hit a floor as I expect positive responses to lower inflation in upcoming economic data to skew risks to the upside.

10yr was at 4.29% at the time and its rebounded strongly into quarter-end above 4.4% which now makes me cautious of how much more upside there is from here. It would take some strong data to keep this bounce going but I suspect this 4.4–4.5% area will be met with a lot of resistance barring some positive data surprises.

ZN 10yr note futures is heavy and I see a bit more room til the 109 handle at the least.

10yr swaption vol is also the most elevated since the beginning of May.

CURRENCIES

G8 FX index chart

• EUR has started with a strong gap up after the first round of French elections. Unsure what would warrant such a big rally (perhaps hedges unwinding) but it looks too much relevative to the move in peripheral spreads. I’ve been a seller of this rally today, and still think its due for more downside.

Big rejection of 1.0775 so far today and back below the trendline starting from Jan-2023

• GBP is looking increasingly constructive for more upside. While August may be the base case for BoE cuts, UK economic data has been mixed. Overall, I think they’ve been quite positive (e.g. the Flash PMIs) while Wage growth still remains elevated. Labour winning the UK elections this week should provide some support for the GBP as Starmer looks to repair trade relations and undo some of the burdens brexit has cause on UK trade. There are also some options on the table being widely discussed such as vetinary/food trade deals with the EU as well as possibly joining the PEM (Pan European Mediterranean convention).
• CHF is proving a difficult currency to trade. I have favoured longs recently (particularly short EURCHF) on political uncertainties, but with SNB seemingly allowing the CHF to weaken, I’m dissauded from such ideas. In the case of European political risks, EURUSD is just a much easier trade.
• CAD benefited from some hotter inflation data. As mentioned over previous weeks, I still think it can surprise to the upside with a lot of negativity in the price and the next BoC cut fully front loaded. I do like USD to continue higher and it should benefit from those crosswinds also.
• USD I remain bullish for reasons I’ve outlined over prior weeks. Yields are on the rebound and I think it will continue to stay off the lows as I think market has hit max dovish while there is too much pessismism about the consumer, labour market, and overall outlook. Further, Trump looks set to be assuming office for the 2nd time which is likely to be USD positive.
• AUD bullish, NZD bearish — are obvious themes to me. As I’m bearish on broad risk at the moment, I like short NZDUSD and long AUDNZD.
• JPY — when will the weakness end? Perhaps no time soon. If its not a bet on the MoF intervening, then there is no reason to bet on the JPY. Policy normalisation is not tightening, and given the chance should there ben any headline driven weakness in USDJPY (e.g. slight but immaterial miss in US data or MoF/BoJ jawboning), I would definitely consider buying dips.

That’s all for now. Wish you a good start to the H2!