Weekly Note 2022.07.25

Sidewinder markets

A bizarre week…

Had it not been for a high fever that came spontaneously the day before my birthday (July 20), I would have most certainly lost some money given the views I had on the market last week. In fact the fever was so high it’s kept in bed up until Saturday and I’m only just feeling like I’m nearly at full recovery. A birthday blessing in disguise perhaps…

Returning to markets, I am still compelled to be on the bearish side this week for reasons I have outlined in prior week’s notes and with FOMC, PCE, and ongoing earnings releases in mind. I expect some weakness this week and should the market sink far enough, I would be inclined to be tactically bullish to trade what I think will be a rangey ‘sidewinder’ market for the weeks ahead.

MAJOR HEADLINES

MARKETS

• Weak Earnings Reports Aren’t Fazing Investors After Brutal Year for Stocks (WSJ) Shares of Bank of America, Tesla and Netflix rise after posting better-than-feared results; Will the Federal Reserve kill the stock-market bounce? (MarketWatch) “I expect we will continue to see market volatility until investors have seen more convincing evidence that this period of Fed hawkishness is behind us, and I do not expect that to be the message” when central bankers conclude a two-day meeting on July 27; Until the Fed toggles down, market rallies can’t be sustained, says Wells Fargo’s Chris Harvey (CNBC)
• Treasuries Surge as Traders Dial Back Fed Bets on Recession Fear (Bloomberg) Swap market tilt toward hike of 50 rather than 75 in September, Business activity in US contracts for first time since 2020; ECB Rushes to Tighten as Half-Point Hike Matched by Crisis Tool (Bloomberg) First increase in more than a decade brings deposit rate to 0%, New instrument designed to avoid market jitters as rates rise; Bank of Japan board reshuffle brings in less dovish member (Reuters) Former economist Takata, ex-banker and bond market expert Tamura join BOJ board, replaces dovish member Kataoka
• Gold Prices Hit by Renewed Bets on Higher Yields and Stronger Dollar (WSJ) The precious metal is on track for its fourth-consecutive monthly decline; Oil extends losing streak on fears Fed hike will dampen fuel demand (Reuters); Oil and interest rate futures point to cyclical downturn before end of 2022: Kemp (Reuters); This Could Be the Start of a Dollar ‘Doom Loop’ Like No Other (Bloomberg Odd Lots) A reverse currency war beckons

US

• Almost all the economic numbers are aligned: A U.S. recession is now likely (MarketWatch) Most economic indicators are signaling a slump — except the strong jobs market. Is that enough to keep the expansion going? Cheaper Beer, Cigarettes Gain Favor as Inflation Pinches Shoppers (WSJ) Shoppers are trading down to cheap beer brands and discount cigarettes as they feel more pressure on their pocketbooks.
• Rich Americans Keep Borrowing, Defying Economic Gloom (WSJ) The increase came from well-heeled clients taking out mortgages and loans backed by assets like stock-and-bond portfolios; Consumers Beware: Credit Card Rates Are Reaching Record Highs (Barrons) Average interest rates on credit cards are heading toward an all-time high. With average rates potentially climbing to 18% in the coming months, it would take an additional two months to pay the balance off. “If you look at cash buffers in the lower income segments and early delinquency roll rates in those segments, you can maybe see a little bit of an early warning signal,”
• U.S. Continues to Swelter Under Record-Breaking Heat Wave (WSJ) Millions of people were under heat advisories or excessive heat warnings on Sunday, as some areas hit triple-digit temperatures; Heat Wave Hits U.S. Farms, Stressing Crops and Ranchers’ Herds (WSJ) Weather issues give U.S. growers anxiety in a year when a banner harvest would help global food concerns; More Investors Vote Against Corporate Directors Over Climate Change (WSJ) Investors are increasingly voting against the election of corporate directors to get companies they see as laggards on climate change to raise their ambitions;

EUROPE

• Italy’s Prime Minister Mario Draghi Resigns as Support Crumbles (WSJ) Southern European nation to hold election in September amid political crisis and surging inflation
• Russia Resumes Nord Stream Natural-Gas Supply to Europe (WSJ) Despite the pipeline’s restart, European governments are bracing for permanent instability in the Russian energy supply; Putin Says Russia to Meet Gas Commitments to Europe but Warns of Nord Stream Cuts (WSJ) Russia’s president says sanctions could prevent additional maintenance on components for the pipeline carrying Russian gas to Europe
• Russia and Ukraine sign UN-backed deal to resume grain exports via the Black Sea (CNBC); Russian missiles hit Ukraine port; Kyiv says it is still preparing grain exports (Reuters) Zelenskiy called the strike blatant “barbarism” showing Moscow could not be trusted to implement the deal. Britain says ‘inconclusive fighting’ continues in Ukraine’s Donbas and Kherson (Reuters)
• Europe’s Record-Breaking Heat Wave Scorches the Continent (WSJ) Temperatures have climbed to their highest in history in parts of Spain, France and the U.K; Wildfires burn coastal homes, forests in Greece as Europe’s heatwave spreads east (Reuters)

ASIA

• China Covid-19 Cases Hit Two-Month High (WSJ) Infections jump in less-developed regions while authorities keep a lid on the virus in major export and commercial hubs; China Covid Cases Drop as Macau, Shanghai Ramp Up Mass Testing (Bloomberg)
• China Evergrande CEO, CFO step down after probe into property services unit (Reuters); China Property Stocks, Bonds Rally on Reported Fund Help (Bloomberg) Fund move stronger than guiding bank lending, Fund has secured 80 bililon yuan and can be upsized
• Chinese Regulators Refund More Customers Caught in Alleged Rural Bank Fraud (WSJ) Investigation finds collusion between Henan New Wealth and staff at five lenders to skim off deposits
• China Bets Big on Basic Chips in Self-Sufficiency Push (WSJ) Chip makers boost production of mature semiconductors now in high demand, which could add to their global influence; US, Japan to Agree on Improving Chip Supply Chain (Bloomberg)
• Faster Singapore Inflation Bolsters Case for More Tightening (Bloomberg) Core inflation jumps to 4.4% in June, highest in 14 years; Trade Deficit, Equity Outflows Signal More Losses for Korean Won (Bloomberg) BofA sees currency slumping to 1,350 per dollar by year-end

LAST WEEK’S ACTION

Risk assets were optimistic off the back of higher rate expectations and USD gains being pared back, Commodity prices were generally softer on growing recession/demand-slowdown concerns, TRY continues to weaken towards the Dec’2022 crash lows and JPY is starting to hint a turn.

EQUITIES

Global Equity Indices MTD Performance (Koyfin)

Except for China, Global equities finished positive last week.

MSCI World and ex-US indices validated the prior week’s reversal bar leaving the weekly structure as being mildly bullish. The bullish impulse following that reversal signal is on the relatively weak side however.

A look at Developed vs Emerging markets shows EM’s have been struggling to keep up; understandably so given global cyclical slowdown concerns.

Looking at SPX and NDX, not only has last week’s action been lacking serious volume with some weakness coming through off the Friday close, down-ticks far outweighed up-ticks, and the NYSE Advance-Decline has provided zero support to the extended Wednesday to Friday rall

In spite of the poor breadth however, sector performances is suggesting a more healthy sentiment with technology and cyclical sectors outperforming.

With this week’s event risks in mind — earnings, FOMC and PCE, I think US equities will trade cautiously for most of the week with a mildly bearish bias. While I believe it is much too early to talk the Fed pivot, unless PCE sharply misses expectations, I expect a sideways market in the coming weeks with current levels marking the top end of that range and the lower end roughly 4-5% lower. I will be looking to trade that tactically both ways.

RATES

Wk/wk change in the US yield curve shows a deeper inversion of the belly. Short-term interest rates are higher while all tenors from the 1yr finished lower.

Trend in inflation expectations suggests further curve flattening with nearer-term inflation expectations still moving gradually higher and the 5yr-5yrfwd gradually moving lower.

Eurodollar futures rallying last week is rather interesting — appears to coincide with the surprise 50bps hike last week suggesting the rates market is believing further hikes being less likely, perhaps due to ECB finally joining the chorus of major central banks hiking aggressively. At any rate, with Eurodollar Dec’2022 at the 97.00 mark, I’m inclined to see this is a reversion move as I would be surprised to see it trade any higher and see year-end expectations pare back further.

COMMODITIES

Commodities broadly looking to turn up again led by Energy, Nat-Gas in particular; Metals have put in a near term bottom helped by better sentiment and softening US yields and dollar; Agricultural prices looks ready to recover losses considering the adverse hot weather affecting harvests.

Precious metals have benefited from the softer dollar and 10year real yields which made new ~6 week lows last week. This may support a move back to 1800 for Gold, especially should there be no surprises from the Fed this week.

For long Gold ideas, long’s vs EUR looks attractive both technically (long-legged doji) and fundamentally (being relatively more bearish EUR than USD especially with Italian politics, adverse weather conditions and Europe still at the Mercy of Russian gas.

CURRENCIES

While on the topic of EURUSD from the Gold discussion above, there is some room to the upside til the pair can make a strong case for a pivot lower with the 1.0360 pivot level left untested from below.

• USD — surge looks to have fizzled out, and I think the bar is now high for the greenback to surge to new highs in the near term, unless the FED surprises with a 100bps this week.
• JPY — looking increasingly constructive technically and attractive given the trend in yield curves flattening. I am beginning to favour long JPY ideas going forward as we start to venture into the maturer part of the tightening cycle.
• EUR and GBP —the most challenged of major currencies and remains a sell on rallies, and as preferred funders vs long higher-beta fx trades.
• CHF —starting to look overbought but the index remains strong being pinned to the top end of recent ranges. Short USDCHF comes to mind as an idea that I think could work based on the no FOMC surprises scenario.

• AUD NZD and CAD — long AUD and NZD are looking like strong ideas: AUDUSD about to breakout, NZDUSD already done so, and both AUD and NZD have broken out against EUR. I have had a preference for long CAD on the crosses but I think that trade is now looking done and I expect CAD weakness on the crosses to have some legs, e.g. long AUDCAD NZDCAD.

• NOK and SEK — with Scandies being very oversold with positioning at extremes, on top of a softening dollar, short USDNOK and USDSEK are looking attractive once again.
• MXN and ZAR —US bond volatility calming down should help to take the edge of USD-EM’s while the charts are suggesting USD-EM rally is out of steam and pointing to a short-term pivot lower.

Stay humble, don’t tumble.