Last week was some ride, and I feel like I’ve aged 10 years, but what have we learnt?
The US Federal Reserve (Fed) and the European Central Bank (ECB) are almost done tightening, and market pricing (in swap markets) shows this front and centre. In the case of the US, core PCE inflation and the Employment Cost Index (ECI) showed that price pressures and wages are abating. The US Q2 GDP print grew at an above-trend pace (at 2.4%). Risky assets find inspiration at a resilient economy at a time when the Fed is close to completing its cycle and inflation grinds lower.
Add in a 4.5% rally in Chinese equity on the week, and the word ‘Goldilocks’ and ‘immaculate disinflation’ comes up liberally in conversation. It’s no wonder the chase for performance is on, and those underweight equities are feeling the heat.
The positive growth factor seen in the US economy is certainly not true of Europe and China, where growth has been consistently missing the mark. The US exceptionalism story is therefore firmly in play and keeps me constructive on the USD, even if the technicals/price action are not showing any strong bias to own USDs over other G10 FX.
We see that the bullish trend in equity markets is mature and, in some cases, owned/loved. However, new highs seem more likely than not. Apple NASDAQ:AAPL will need to impress in earnings this week. In Asia, it feels hard to trust the late-week rally in the HangSeng50 or CHINAH, but I’m skewed long for another 3-5% upside. Huge inflows into mainland Chinese equities last week suggest more is to come.
Bank of Japan bridges volatility
The Bank of Japan (BoJ) threw a curve ball into the market on Friday with its cosmetic change to YCC. In essence, it was a brilliant move by the central bank, and they’ve managed to bridge the volatility that would come with a straight change to a -/+ 1% range in the YCC band. They’ve given themselves all the flexibility should they wish to tighten policy in the future without tidal waves in global bond markets.
After the fourth biggest trading range of 2023 on Friday in USDJPY, we should see the daily ranges settle in the days ahead. Again, I don’t trust the last session sell-off in the JPY, notably vs the ZAR, MXN, and GBP, and we watch to see if the JP 10yr Japanese Government Bond grinds towards 75bp and above.
We look forward to another big week of event risk. The Bank of England (BoE) should hike by 25bp, while the Reserve Bank of Australia (RBA) meeting is perhaps underpriced but line ball, and we know once we get the policy call, the AUDUSD should revert to following USDCNH. US Non Farm Payrolls should again highlight that the US labour market is in fine health, and EU inflation should offer a view that the ECB can’t be complacent but are close to the end.
It’s another week in paradise and managing risk and achieving correct position sizing will help you stay solvent.
- Navigating market reversals and key risk events
- Pivotal week for growth jitters as geopolitical risk ratchets up
- Sentiment sours as US exceptionalism looks more fragile
The marquee event risks for the week ahead:
US Q2 earnings: while the bulk of the S&P500 market cap has reported Q2 earnings, in the week ahead, we get a further 15% of the market cap reporting. Numbers from the Apple and Amazon NASDAQ:AMZN (both on 3 August) and QUALCOMM NASDAQ:QCOM get the attention. Can we continue to grind towards new highs in the S&P500 and Nasdaq100?
RBA meeting (1 August): Given the recent domestic economic data flow, it will be a close call whether the RBA leave the cash rate at 4.1% or hike by 25bp. Interest rate futures price a 21% chance that the RBA leave rates on hold. I personally lean to a hold from the RBA. However, given the strength in the labour market data, increasing unit labour costs and house price data, one could argue this is under-pricing the risk of a hike.
Bank of England (BoE) meeting (3 August): the BoE will choose between another pro-active 50bp hike or a more data-reactive 25bp hike. The market and economists see a higher probability of a 25bp hike, with the peak Bank rate expected to hit 5.83% by February 2024. We may also hear of an increased pace of quantitative tightening (QT) from October, although the BoE may wait until the September meeting to update the market on this.
US nonfarm payrolls (4 August): the US labour market remains in rude health, and there are no clear signs of a cooling in the July employment data. In the lead-up to NFP, we get ADP private payrolls and the JOLTS job openings report, so both could shape expectations for NFP. The consensus for NFP from economists is for 200,000 jobs to have been created, with the unemployment rate expected at 3.6%. Average Hourly Earnings (AHE) will be closely watched, as wages are a key consideration if the Fed are to go on an extended pause. The consensus is we see AHE +0.3% MoM / 4.2% YoY (from 4.4%).
US ISM manufacturing (2 August): The market looks for the index to come in at 46.9 (from 46.0), so a slight improvement from the June print. The ISM services print (due on 4 August) is also due this week and may be more influential on the USD. The market expects a slower pace of growth in the service sector, with the index expected to print 53.0 (from 53.9 in June). A read below 50 in services ISM would likely see broad-market volatility pick up.
Fed Senior Loan Officer Opinion Survey (1 August): the SLOOS report on bank lending standards was referred to on several occasions at last week’s FOMC meeting. We expect a slowdown in credit and tighter lending, but whether this proves to be a volatility risk for markets is a key factor. Watch the US banks closely. The XLF and KBE ETFs offer good context here.
China Manufacturing and Services PMI (31 July): after last week’s Politburo meeting, there may be a limited reaction to this PMI report, as stimulus takes time to feed through to the real economy. For now, the market looks for the manufacturing index to come in at 48.9 (from 49.0) and services PMI at 53.0 (53.2). A read below 50 shows contraction from the prior month, and above 50 signals expansion.
EU CPI inflation (31 July): the market expects the EU CPI estimate to come in at 5.3% (from 5.5%), with core CPI eyed at 5.4% (from 5.5%). The market currently prices 10bp of hikes for the next ECB meeting on 14 September; a 40% chance of a hike. An inflation print below 5.1% would be a surprise and should attract decent EUR sellers. Above 5.6%, and pricing for a September hike will increase, and the EUR should find a stronger tone.
EU manufacturing and services PMI (3 August): this data point is a revision of the numbers announced on 24 July, so unless we get a marked revision to the preliminary print, the data shouldn’t move the dial too intently. The market will be watching revisions to the service data more closely.
