vulnerability

Stock markets remain slightly in the red on Tuesday but activity should pick up with the return of Wall Street from the long bank holiday weekend. The focus this week remains on the central banks and whether we are as close to the end of the tightening cycle as everyone wants to believe. While there is the temptation to take what the Fed and others say with a small pinch of salt given their record over the last couple of years and the fact that any pivot was always likely to come late, they have been proven more accurate recently on their assertion that rates need to keep rising.   Markets have been overly optimistic this year and there may be an element of luck on the central bank side – keen to not underestimate inflation again, they were always going to remain hawkish as long as feasibly possible – but the data simply hasn’t justified changing course yet.   That may change over the next couple of months but so far, especially in the UK, the turnaround in inflation has been more akin to a container ship performing a U-turn than a speedboat as many hoped. That may not dramatically increase the terminal rate but it may ensure it remains there much longer. Rate cuts this year look more fantasy than reality now.   The BoE will be hoping for some good news from the UK inflation data tomorrow but I’m guessing policymakers are approaching it with a sense of dread rather than hope. We’re not likely to see any significant progress from the May data but avoiding another nasty surprise may be viewed as a win, allowing the MPC to proceed with 25 basis points rather than 50 which markets are pricing in a 30% chance of at this stage.   Bitcoin’s recent trend remains against it despite recovery Bitcoin drifted a little higher at the start of the week and is continuing to do so today. The move back toward $25,000 may have worried some but it’s recovered relatively well since then. The recent trend remains against it and until it breaks the pattern of lower highs – recovery rallies that fall short of recent peaks before falling again – it will continue to look vulnerable. A break below $25,000 could be another blow although gains this year would still remain extremely healthy.  

European and US stock markets have seen a significant shift in sentiment over the past few days when it comes to the global economy. Rising bond yields, driven by more hawkish central banks, which has prompted investors to reassess the outlook when it comes to valuations and growth.     While European markets saw their biggest weekly loss since March, US markets also took a tumble, albeit the first one in 8 weeks, as a succession of central banks pledged that they had significantly further to go when it comes to raising rates. Bond markets also started to flash warning signs with yield curves becoming more inverted by the day whether they be France, Germany, or the UK. Friday's weak finish hasn't translated into a strongly negative vibe as we start a new week for Asia markets, even allowing for events in Russia at the weekend which aren't likely to have helped the prevailing mood, with the US dollar slightly softer this morning after getting a haven bid at the end of last week.     With economic data continuing to show varying signs of vulnerability, particularly in manufacturing the situation could have got even spicier over the weekend when Wagner Group boss Yevgeny Prigozhin set his troops on the road to Moscow in an insurrection against the Kremlin, and Russian President Vladimir Putin.   As it turns out a crisis was quickly averted when it was announced that Prigozhin would go into exile in Belarus, with any charges against him dropped, and Wagner troops would return to their bases. One can only imagine the reaction if that news had broken if markets had been open at the time, however it only adds to the general uncertainty surrounding the war in Ukraine and how quickly things can start to unravel.   This weekend's events also serve to indicate how fragile Vladimir Putin's position is given that one of his most trusted advisors suddenly went rogue.   As we look ahead to the final week of June and the end of the quarter, as well as the first half of the year we can reflect to some extent that markets have held up rather well when all things are considered. They have been helped in that by the sharp falls in energy prices back to pre-Russian invasion of Ukraine levels, as well as the low levels of unemployment which have served to keep demand reasonably resilient.     The elephant in the room has been the stickiness of core inflation as well as signs that demand is starting to falter, and this week we could get further confirmation of that trend.   Today we get the latest Germany IFO Business Climate survey for June, which if last week's flash PMI numbers are any guide could well show that the confidence amongst German business is faltering, with expectations of a slowdown to 90.6, from 91.7.     We also get flash CPI inflation numbers from Germany, France and the EU where headline prices are likely to show further signs of softening, with core prices set to remain sticky. At around the same time we get the latest PCE inflation numbers from the US for May.   These are likely to be important in the context of the Federal Reserve's stated intention to raise interest rates at least twice more before the end of the year.     In April the core PCE Deflator edged up from 4.6% to 4.7%, an area it has barely deviated from since November last year. You would have thought that even with the long lags seen from recent rate hikes they would start to have an impact on core prices.   This perhaps explains why central banks are being so cautious, even as PPI prices are plunging and CPI appears to be following.       EUR/USD – pushed briefly back above the 1.1000 level yesterday before slipping back, with the main resistance at the April highs at 1.1095. This remains the next target while above the 50-day SMA at 1.0870/80 which should act as support. Below 1.0850 signals a move towards 1.0780.     GBP/USD – currently holding above the lows of last week, and support at the 1.2680/90 area. Below 1.2670 could see a move towards the 50-day SMA. Still on course for a move towards the 1.3000 area but needs to clear 1.2850.      EUR/GBP – failed to rebound above the 0.8630/40 area last week. The main support is at last week's low at the 0.8515/20 area. A move through 0.8640 could see a move towards 0.8680. While below the 0.8630 area the bias remains for a return to the recent lows.     USD/JPY – has finally moved above the 142.50 area, which is 61.8% retracement of the 151.95/127.20 down move, as it looks to close in on the 145.00 area. This now becomes support, with further support at 140.20/30.      FTSE100 is expected to open 6 points higher at 7,468     DAX is expected to open 28 points higher at 15,858     CAC40 is expected to open 8 points higher at 7,171

Oil It’s going to take a lot to change the minds of energy traders. Fears of a weaker global growth outlook are not going away anytime soon. In the US, good news is bad news as that will suggest the Fed might have to do more tightening. ​ Inflation is stubbornly high in Europe that could trigger a lot more rate hikes and a harsher recession. ​ Even comments from Delta CEO about demand outpacing expectations was unable to provide a boost for oil prices. ​ Oil is looking very vulnerable here as it is getting close again to the spring lows near the upper mid- $60s. One more plunge and that should make OPEC+ very nervous. A drop below the $67.50 level could ​ trigger momentum selling that won’t stop until the $62.50 region.   Gold Gold remains under pressure as the US consumer still looks strong. Today’s economic data in the US painted a picture of a resilient economy that could be subject to further Fed tightening. The ECB also signaled there is no end in sight for their rate hiking cycle and that has also helped send Global Bond yields higher. It has been pretty ugly for gold since early May and if expectations grow for further Fed tightening, that could send gold tentatively below the $1900 level.      

The irony of the financial system’s largest ‘known unknown’ Regulation helped Non-Bank Financial Institutions surpass banks in size. They are an increasingly important competitor, source of funding and client to banks. But their vulnerability and lack of transparency create the largest "known unknown" risk for the banking sector. Regulation will take time. Meanwhile, central banks may be forced to help out.   Why you should know about NBFIs Non-Bank Financial Intermediaries (NBFIs) have grown significantly since 2008 and as a result, the sector's influence has come under increasing scrutiny. Last year's UK gilt crisis was another wake-up call for regulators, with concerns rising over the growing vulnerabilities. Regulators across the globe are now asking for more and stricter regulation of these activities. In contrast to NBFIs, banks have seen stricter regulation since the global financial crisis, leaving room for NBFIs to develop. However, in the face of the increasing complexity and interconnectedness of the sector, a severe shock to NBFIs could spread to banks, creating a new type of risk for the traditional banking sector.   NBFIs have many faces, including ones that can look like a bank The term NBFI is used to describe a large variety of institutions. We are classifying them all as non-banks that take in cash and use it to generate a return. Most NBFIs take in cash, just as banks do, and deploy it in various securities and derivatives. The Financial Stability Board (FSB) monitors NBFI activity and divides the sector in two: NBFIs not engaging in credit intermediation nor bank-like activities (about 75% of the sector). All the entities which have bank-like activities, also called the “narrow measure”, where Money Market Funds and Fixed Income Funds make up the largest part (for other economic functions, see annex). Another way of looking at NBFIs is simply by dividing them into the main components such as: Insurance Corporations (ICs) Pension Funds (PFs) Other Financial Institutions (OFIs), such as Investment Funds and Money Market Funds Financial Auxiliaries (FAs), such as insurance brokers and captive financial institutions.   Fast growth made NBFIs much larger than the banking sector The stricter capital and liquidity requirements on banks put in place after the global financial crisis - notably through the implementation of Basel III - made some parts of lending less attractive for the banking sector. NBFIs were already present before 2008 but stepped in to take over portions of this business as regulatory requirements grew for banks. The IMF highlights that NBFIs have become a crucial driver of global capital flows for emerging markets and developing economies. Looking into the different NBFI components and sampling 21 major global economies and the euro area (list of countries in the annexes), the FSB reported strong growth for the sector in 2021, at 8.9% year-on-year. This is a significant development as the sector has seen average growth of just 6.6% over the last five years.   The NBFI sector has grown in every component since 2019 to reach $239.5tn

Once again, the interconnectedness between the traditional banking industry and the NBFI sector greatly varies between countries. Data from the FSB allows us to investigate banks’ exposures and use of funding from different NBFIs in 2021 at a national level (for the 29 countries selected), showing significant differences.   Important variations in banks' use of funding from NBFIs as percentage of total bank assets in 2021 In Europe, Luxemburg is the front-runner with nearly 25% of its total bank assets funded by NBFIs     Important variation in banks' exposure to NBFIs as percentage of total bank assets in 2021 In the EU, Belgium is the most exposed to NBFIs, at 9% followed by the UK at nearly 7%     The importance of these three main risk categories also varies depending on the NBFI sub-sector. The following table from the IMF estimates the financial leverage, liquidity and interconnectedness risks for each NBFI sub-sector.   Investment funds are facing high vulnerability to liquidity and interconnectedness risks As the largest sub-sector, investment funds high risk scores would imply a significant impact on the sector in the event of a major shock  

Despite positive momentum, oil falls short once more Oil prices are retreating in risk-averse trade today. The ADP report has clearly had a negative impact given it likely means we’re facing another red-hot jobs report tomorrow and the prospect of higher rates for longer. It also came at an opportune time, with the price flirting with the peak from two weeks ago, only to turn south having fallen just shy of surpassing it. That means we’re seen yet another failed new high or low in recent weeks and the gradual consolidation, roughly between $72-$77 is still in play. This time it was close and there was good momentum going into the ADP release but it seems the jobs number was just too big. A repeat performance tomorrow could cement that and undo the efforts of the Saudis and Russians earlier this week in seeking to drive the price higher.   Is gold vulnerable to another big break? Gold’s brief rebound is seemingly over, with the price already struggling around $1,930-$1,940 before ADP delivered a hammer blow to it. The yellow metal is back trading just above $1,900, a level that’s now looking very vulnerable ahead of tomorrow’s jobs report. If it manages to hold above in the interim, a hot report could be the straw that breaks the camel’s back. Suddenly it will become a question of whether another hike in September is unavoidable against the backdrop of such a hot labour market. These aren’t the only figures that matter but they do significantly weaken the case for another pause.

The British pound has strengthened its leadership in the G10 currency race thanks to the U.S. employment report. The increase of 209,000 jobs in June disappointed USD supporters, causing GBP/USD quotes to soar to the highest level since April 2022. However, it failed to consolidate at that level as the unemployment rate dropped to 3.6% and average wages accelerated to 4.4%, indicating that the Federal Reserve still has a lot of work ahead. The Bank of England also faces challenges. Wage growth in the United Kingdom is outpacing that of the United States. Bloomberg experts forecast a 7.1% increase in May.   The current values, along with sustained elevated inflation at 8.7%, are perceived by companies as a greater incentive for price increases than the BoE's optimistic forecasts of CPI slowdown. BoE Governor Andrew Bailey and his colleagues are determined to prevent inflation from solidifying at elevated levels, but their actions could lead to a recession. Indeed, the short-term market expects the repo rate to reach 6.5% by March 2024. Such a high borrowing cost could risk a recession. Additionally, the yield curve inversion signals an impending downturn.     At first glance, the pound is at a turning point: the projected 150 basis points increase in borrowing costs could trigger a GDP contraction. Markets generally perceive this negatively, as was the case with the U.S. dollar at the turn of 2022–2023, when its quotes were falling. However, it's important to remember that in any currency pair, there are two currencies. The current success of GBP/USD is only partially related to expectations of a repo rate increase to 6.5%.   It's also influenced by some weakening of the U.S. dollar against major global currencies. Some Forex experts believe that the most aggressive monetary restriction by the Federal Reserve in decades will eventually worsen the health of the U.S. economy. Meanwhile, Bloomberg experts predict a slowdown in U.S. consumer prices to 3.1% in June, causing the USD index to decline. The pound faces a test with the release of UK labor market data by July 14. Alongside the previously mentioned wage growth of 7.1%, Bloomberg experts forecast a slowdown in employment from +250,000 to +158,000.   According to Pantheon Macroeconomics, this change will not be sufficient to stop the Bank of England. The repo rate hike toward 6.5% will continue. Considering that markets were anticipating 5.3% a month ago, the pound's successes are logical.     In my opinion, investors have been somewhat excessive in selling the U.S. dollar based on mixed U.S. employment statistics. This vulnerability makes sterling positions vulnerable. Technically, on the daily GBP/USD chart, a reversal pattern like a Double Bottom may form, or an upward trend may resume. In the first case, we sell the pair on a breakthrough of the pivot level at 1.2785. In the second case, on the contrary, we buy it upon a new local high at 1.285.  

GBP: Softer into the CPI risk event The pound has continued to show more vulnerability than most of its G10 peers at the start of this week. EUR/GBP has crept higher in the past few sessions, back to the 0.8600 gauge as volatility in global central bank tightening expectations after the US CPI slowdown seems to have asymmetrically hit those curves that had more room for a dovish repricing, like the GBP one. We are also observing some positioning ahead of tomorrow’s key release of the UK inflation numbers. As discussed by our colleague James Smith here, CPI data will make or break a 50bp August rate hike by the Bank of England. Markets continue to lean on the hawkish side with their pricing: 44bp for August, 116bp in total. Still, peak rate expectations have remained volatile and were scaled back by nearly 15bp yesterday. Today, the UK calendar is empty. We suspect EUR/GBP can remain broadly supported into tomorrow’s CPI.

EUR/USD excessively overbought? The euro-dollar ascent was mostly a one-way move for most of July.  After inflation eased to the slowest pace in more than two years, the dollar tumbled.  With the Fed entering their blackout period before the July 26th FOMC meeting, the lack of hawkish pushback has allowed the dollar to remain vulnerable to further pain just ahead of the 1.1300 handle.  Bullish momentum has cleared multiple hurdles but the 1.1350 level should prove to be rather strong. While the end of the Fed’s tightening cycle appears to be in place, expectations are shifting that the ECB might not be that far from pausing their rate hiking cycle.  Today’s comment from ECB’s Knot, a well-known hawk, suggested that they could be ready to pause in September and that it might hinge on the inflation data going forward. All eyes will be on the Wednesday’s second reading of euro-area inflation. The EUR/USD daily chart displays a potential bearish butterfly pattern. Point D is targeted with the 1.414 1.414% Fibonacci expansion level of the X to A move and the B to C leg.  If dollar strength emerges here, downside could target the 1.1050 level. If invalidated, bullish momentum could surge above the 1.1300 region, potentially targeting the 1.1450 resistance zone.     USD/JPY dead-cat-bounce or sustainable rally? The plunge for dollar-yen accelerated after last week’s cooler-than-expected inflation report shifted Fed rate hike expectations. The macro backdrop has mostly seen investors calling for pain for the Japanese yen since 2021.  Hedge funds ramped up bearish yen bets(according to the COT report for the week through July 11th), taking their net short positions to the largest level since last May. Now the focus also includes the BOJ, which includes some disappointment with keeping the BOJ keeping Yield Curve Control intact. Yen volatility could remain excessive if the Fed signals more tightening might need to be done after the July 26th FOMC meeting and if BOJ doesn’t tweak their policy. Over the next couple of weeks, it seems that the yen rally will either cool towards 141.50 (a temporary recovery) or we will see it surge below 136.00 (the downtrend remains in place).        

It's been a long time coming but inflation in the UK is finally on the decline and in a rare show of good news, it's falling at a faster pace than expected on both the headline and core levels.  We haven't been treated to many reports like this over the last couple of years, and even when we have any enthusiasm has quickly been extinguished. But this feels different. Without wanting to fall victim to the "this time it's different" mantra that often precedes a terrible turn of events, there is something more promising about this shift. It follows similar declines in the US and the eurozone in recent months, both of which were sharper than expected and at the headline and core level. Unless this is a blip across the board, which is possible, it may be a sign that inflation is on a path to more modest and sustainable levels.  Of course, there's still an awfully long way to go and the central bank is not going to declare victory on the back of one release. But those wild interest rate forecasts of 6.5%+ that we've been seeing may start to be pared back, perhaps quite significantly as it becomes clear that favourable base effects combined with lower energy and food inflation and the impact of past hikes start to have a substantial impact on the data.  The pound has fallen quite heavily on the back of the release which probably reflects those expectations now being pared back. I don't want to get too carried away but peak rate expectations may now be behind us which could make for a more hopeful second half of the year.  I say I don't want to get carried away but then, upon seeing the release, I was immediately reminded of the famous Office US "It's happening!" scene that is so often widely circulated on social media so perhaps I also, in the words of Michael Scott, need to stay calm.   Oil flat but recent developments have been positive Oil prices are a little flat early in the European session after bouncing back a little on Tuesday. Since breaking above the recent range highs late last week, oil prices have been a little choppy although importantly they have held above that prior range and, in the case of Brent crude, seen support around the previous highs. That could be viewed as a bullish technical signal, although that will naturally depend on a number of other factors including the economic data and what producers are doing. Both have been favourable for prices recently, helping Brent break back above $80 for the first time in almost three months.   Gold eyeing another move above $2,000?  Gold broke higher again on Tuesday after briefly paring gains late last week and early this. Lower yields and a weaker dollar are continuing to boost its appeal on the back of some more promising inflation data and lower interest rate expectations. The yellow metal broke above $1,960 yesterday before running into some resistance around $1,980. It's now closing in on $2,000 which is the next major barrier to the upside, a break of which may suggest traders have turned bullish on gold after two months of declines.   Is bitcoin looking vulnerable after yesterday's break?  Bitcoin is back above $30,000 today but looking vulnerable to another dip below. Broadly speaking, the cryptocurrency has been range-bound over the last month but it has drifted toward the lower end of this and the move below $30,000 yesterday may have made some nervous. If we do see a significant break lower, the next key area of support may be found around $28,000.

Energy prices Energy must be the starting point when thinking about a second wave. Our base case sees oil edging higher this year, and the risk is that we continue to see a lack of investment in upstream production while demand continues to move higher. That would point to an increasingly tight oil balance in the years ahead. Stricter legislation on new US oil/gas drilling, though unlikely, would be a key source of upside risk given America has been a major driver of supply growth over the last decade. That aside though, the US is largely energy-independent and that makes it far less exposed to 1970s-style shocks. Europe is more vulnerable, though the situation is evolving. National gas reserves are currently well filled and the eurozone looks better prepared to enter the winter heating season. Russian gas exports to Europe are marginal now, so any further supply cuts would be unlikely to take us back to 2022 highs. We’d also argue that natural gas demand has peaked and suspect it will be gradually lower over the next decade. RePowerEU, the bloc’s flagship energy strategy, puts emphasis on moving aggressively towards renewables. At the same time, last winter’s price spike appears to have resulted in a permanent demand loss in energy-intensive industries.   Still, in the short to medium term, the continent is more reliant on liquefied natural gas (LNG). The combination of strike action at Australian producers and a colder-than-usual European winter could prompt a significant price response. So, too, would any disruption to Norwegian natural gas supply.   For inflation though, remember that in Europe electricity/gas prices are still more than 50% higher than they were in 2021 in Germany, and roughly double in the UK, according to CPI data. Even if we got another 2022-style shock to wholesale prices, arithmetically, the scope for a similar shock to inflation at this point is more limited.