Summary: Markets rolled over badly yesterday as global bond yields surged anew in the wake of the ECB meeting yesterday, one that failed to support the euro even as forward rate tightening expectations from the central bank rose higher still. Today, the US CPI release for May is a critical focus on strong market hopes that inflationary pressure in the US is set to roll over, in part due to the base effects from last year set to shift in coming months. The market will not take an upside surprise well.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I)
Nasdaq 100 futures broke down below the lower end of the consolidation range hitting the opening print from Friday’s big session two weeks ago. Unless we see a close above the 12,500 level in Nasdaq 100 futures our view is that the rebound trade has lost its momentum to the upside and a bigger consolidation range will establish itself. The hawkish narrative from ECB and rates moving higher yesterday are adding pressure to high equity duration assets such as technology stocks. Finally, the NHTSA is upgrading its probe into Tesla’s Autopilot software which could lead to Autopilot cars being recalled or even worse temporary pause on selling of Autopilot software. Given Tesla’s influence on the US equity indices this is a hidden risk to the market that cannot be underestimated.
Hong Kong’s Hang Seng (HSI.I) and China’s CSI300 (000300.I) ...
... recovered from early losses and were little changed. The resumption of temporary lockdown to do PCR testings in some districts in Shanghai, and the CSRC saying that the regulator has not been evaluating or reviewing any IPO application from Ant Financials have initially set up for a weak tone at the open. Yesterday, a Bloomberg report suggested that Ant Financials was closed to getting approval from the Chinese regulator to list in overseas exchanges. Alibaba (09988/BABA) was down as much as 3.9% at the open but managed to rebound to the positive zone. Bilibili (09626/BILI) and NIO (09866/NIO) reported inline revenues but larger than expected losses due to deteriorating margins. Their share prices were down 9% and 1% respectively. China’s May PPI and CPI came at 6.4% YoY and 2.1% YoY broadly in line with expectations.
USDJPY and JPY crosses
The JPY managed to rally yesterday despite the general push higher in global bond yields, with the EURJPY reversal back lower particularly sharp in the wake of the ECB meeting and despite a huge rush higher in yields there. Peripheral spread widening (more below) may be the reason there. Generally, we expect USDJPY to follow the lead from US Treasury yields at the long end of the curve, with today’s US CPI a critical focus on whether it supports the narrative that US inflationary pressure are easing (more below). A new burst higher in US 10-year yields above 3.20% could set the focus higher in USDJPY once again, with some modest JPY support in the crosses if risk sentiment is spooked by this development.
EURUSD and EUR crosses
The euro reversed hard to the downside after what appeared a rather hawkish ECB meeting that managed to clear the bar in terms of general rate expectations for the forward curve from the ECB (more below) as the German 2-year Schatz rose an impressive 13 basis points yesterday, further closing the yield gap with its US counterpart. And yet, the blow out in EU peripheral bond spreads despite ECB announcements that it will manage its PEPP portfolio reinvestments to prevent “fragmentation” is a euro-negative, with the euro falling against CHF, JPY and the USD after the meeting announcement. As well, the ECB has no real plans for actual quantitative tightening as the Fed does. In EURUSD watching 1.0500 as perhaps the last area of support ahead of the 1.0350 low.
Crude oil (OILUKAUG22 & OILUSJUL22)
Crude oil remains caught near a three-month high with strong demand for fuels, tight supply and sanctions being offset by global economic growth worries and signs China’s exit from virus restrictions is unlikely to be smooth. EIA’s weekly inventory report showed that stockpiles of crude and gasoline continue to shrink, while OPEC Sec-Gen said most members are ‘maxed out’. China’s effort to reopen the economy has received a setback as Shanghai will lock down seven districts this weekend for mass testing. Having been rejected twice at $124.40 this week, Brent may now spend some more time consolidating.
Gold trades softer ahead of today’s US inflation print, and after the ECB said it would start raising rates from July, thereby joining other central banks in combating rising inflation. The less hawkish outcome (see below) helped send the euro lower versus the dollar (see above), thereby adding downward pressure on bullion. Gold remains stuck in a range with leveraged traders in futures and investors in ETF’s currently showing no clear conviction with positions in both having been rangebound for the past month. For that to change we need to see a clear break above $1870, the key level of resistance
US Treasuries (TLT, IEF)
US treasury yields rose yesterday, partially in response to a tremendous surge higher in European yields in the wake of the ECB meeting yesterday. The US 2-year yield closed at a new high for the cycle yesterday above 2.80% as the focus turns today to the US CPI release and whether US inflation, particularly at the core, will show signs of cooling (more below). The focus at the longer end of the curve is on the 3.20% cycle high in US 10-year Treasury yields and the 3.26% high water mark from 2018, which is an 11-year high.
What is going on?
Clear commitment from the ECB to tighten monetary policy, but euro drops
The ECB said it would start with a 25 basis point rate hike in July and could move by 50 basis points in September, depending on the inflation backdrop. Beyond September, the ECB appeared committed to a gradual rate path, a less hawkish outlook taking into consideration the risk of lower growth (especially if cost of living continues to rise, thus pushing consumption down). Following the press conference, the EUR/USD has fallen sharply, and core/periphery spreads have widened significantly. The gap between the German and Italian 10-year government bond yields continues to widen (near 220 bps yesterday and up over 15 bps). The ECB will have no other choice but to unveil a facility to manage sovereign spreads in the short-term in order to avoid a financial fragmentation within the eurozone. However, this won’t be easy. Designing such a weapon is more complex than many investors think. All the pre-existing solutions (OMT, especially) come with major political and technical drawbacks.
Investing legend Druckenmiller says bear market set to continue
The former trader for George Soros and head of the Duquesne Family Office said yesterday that “For those tactically trading, it’s possible the first leg [of a bear market] has ended. But I think it’s highly, highly probable that the bear market has a ways to run.” He added that “If you’re predicting a soft landing, it’s going against decades of history.”
Consumption will drop
In its latest forecasts, the OECD expects that real wages will fall in most developed and developing countries in 2022. In Europe, Greece is one of the most vulnerable countries with an expected drop of 7 % this year. This reminds us of the European sovereign debt crisis. There is one major exception within large European economies: France. The OECD forecasts that real wages will increase marginally by 0.24 % on average this year. This is probably a bit optimistic. At Saxo Bank, we believe that real wages are highly likely to decrease in France too. The combination of higher cost of living and higher interest rates will have a detrimental impact on consumption from H2 onwards in most countries.
DocuSign shares plunge 23% on lower billing outlookWhile quite a few technology companies have recently surprised the market with stable revenue growth outlook and improved profitability through cost cutting, DocuSign delivered a downward revision revenue due to a lower billing forecast that outweighed its slight improvement on profitability. The size of the move in extended trading shows the current intrinsic risks in technology related to their earnings releases.
Shifts in Saxo client behavior worth notingOver the last two weeks, across APAC when it comes to Stocks (shares and CFDs) clients are increasingly selling or shorting. We have observed Saxo clients changing their stance over the last couple of months. Large caps like Tesla (TSLA), Microsoft (MSFT), as an example, are increasingly being sold, or potentially shorted by clients, compared to prior months ago when larger positions were longs. As for what APAC Client are trading in FX: the most transacted pair is the USDJPY and a slightly larger majority are selling/shorting it. For Indices, APAC clients are seen increasingly selling/shorting the Nasdaq, the S&P500, Japan 225 and the Hong Kong Index.
Japan PPI unchanged from last monthJapan’s May PPI rose 9.1% y/y but remained flat on a m/m basis. The y/y number was also slower than last month’s 9.8%. Increased fuel subsidies, along with other support measures, may have helped put a cap on rising price pressures. Still, the yen continues to weaken and likely to bring more inflationary pressures. The BoJ, Ministry of Finance and Financial Services Agency are set to meet today at 4 p.m. local time to discuss “international financial markets”.
What are we watching next?
U.S. May CPI today and its possibly considerable market impact
The market is generally anticipating that inflation will roll over lower to some degree in coming months due to the “basing effects” of a string of strong rises in the inflation data a year ago that is easing out of the year-on-year comparisons this month and in following months. The focus will be mostly on core CPI with another strong increase expected at 0.5% month-over-month and the year-on-year readings for headline and core CPI are expected at +8.3%/5.9% versus 8.3%/6.2% in April. Risks are tilted to the upside, and the equity market may take this poorly, given that it will require more pricing of Fed tightening and higher bond yields. We think the data will show a continued pick-up in services prices, especially. This would be a further sign that too-tight labor markets are a key driver behind high inflation.
Earnings WatchThere are no earnings releases today, so we have filled out the list below with next week’s earnings releases which are running low. The key focus next is Oracle and Adobe, with especially latter holding the biggest potential impact on the technology sector.
- Monday: Oracle
- Tuesday: DiDi Global, Ferguson, Ashtead
- Wednesday: JD Sports
- Thursday: Adobe, Kroger, Jalma
Economic calendar highlights for today (times GMT)
- 0700 – Czech May CPI
- 1230 – Canada May Payrolls Change/Unemployment Rate
- 1230 – US May CPI
- 1400 – US Jun. Preliminary University of Michigan Sentiment
- 1600 – USDA's World Agriculture Supply/Demand Estimates
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