Weekly Market Wrap

By David Morrison  |  18/05/2018 15:26

This article looks at the events over the past week including the continued rally in the dollar, US Treasury yields and oil

Overview

Despite a relatively strong performance so far this month, and a decent recovery from the February lows, most US stock indices have failed to break out to the upside. This means that the S&P 500, Dow Jones and even the NASDAQ 100 still have some way to go to recapture the all-time highs made in January. The exception to this is the broad-based US-focused Russell 2000 which hit a fresh record close on Thursday. The reason for this outperformance is the predominance in the index of domestically-focused US corporations which look set to benefit from a stronger dollar. Meanwhile, those indices made up of large multinational companies (such as the S&P, NASDAQ and Dow) have come under pressure as the US dollar has risen. The concern is that overseas sales will suffer as US manufactured goods become more expensive to non-dollar holders.
Meanwhile, the FTSE 100 hit a record high last week, boosted by both the ongoing sell-off in sterling and by the rally in oil which lifted the energy sector. The German DAX and French CAC also posted solid gains as exporters got a boost from euro weakness. But the Italian FTSE-MIB came under pressure following news of a possible power-sharing agreement between two Eurosceptic parties – the Five Star Movement and Northern League. The news saw Italian bond yields spike higher. 

Following the tit-for-tat tariff squabble earlier this year, the US and China sat down for a second round of trade talks in Washington last week. The hope is to avoid an all-out global trade war. However, on Thursday evening President Trump downplayed the likelihood of a deal and this saw US stock indices retreat on Thursday night. However, in pre-open trade on Friday investors were betting that this was nothing but a ploy by Trump to manage expectations and that both sides would ultimately reach a deal.

Traders are keeping a close eye on oil prices, the dollar and US Treasury bonds. So far, higher crude prices, a rising dollar and the sharp pick-up in bond yields have all been shrugged off by equities which continue to push higher, recovering from the sharp sell-off seen at the beginning of February. Equities have been supported by a strong US earnings season while higher oil prices have given the energy sector an extra lift. However, now that the first quarter earnings season is ending, some market participants are worried that the stronger dollar and ongoing rally in oil prices may become a headwind for US equities going forward. At the same time, the yield on the 10-year Treasury is now bedding in above 3.00%. This can be viewed as a positive if accompanied by stronger US growth. But there are signs that this may have peaked while inflation is picking up. If so, then we may see a move out of equities, particularly if volatility spikes higher again.

FOREX

The biggest story in FX is the ongoing rally in the US dollar, although the corollary of this, the slump in emerging market currencies, is causing the most market damage. At the beginning of the week the Dollar Index bounced off support around 92.00 and buying momentum (as overleveraged shorts rushed to cover their positions) helped drive the index through 93.00. A quick look at the daily chart shows initial resistance around 94.00 – a level which marked both shoulders of the ‘head and shoulders’ pattern which formed between October and December last year. The top of the ‘head’ comes in just shy of 95.00. Looking at the EURUSD the corresponding levels of shoulder support come in around 1.1700 with the ‘head’ of the inverse ‘head and shoulders’ showing quite clearly at 1.1600.

The EURUSD is facing a perfect storm as Euro zone economic data releases continue to disappoint while US Treasury yields push higher. The yield on the 10-year hit a seven-year high last week topping 3.12% at one stage. This pick-up in borrowing costs comes on the back of a rise in inflation expectations, driven in part by the rally in oil, and as the Federal Reserve is expected to continue to tighten monetary policy.

Lat week the GBPUSD fell further as support around 1.3500 appeared to crumble. While most of sterling’s losses is a result of dollar strength, weaker GDP growth and inflation data have convinced investors that the Bank of England is in no hurry to raise rates again following a 25-basis point hike last November. Earlier this month the Bank’s Monetary Policy Committee (MPC) voted 7-2 in favour of keeping rates unchanged. The MPC also revised down its future growth and inflation expectations. Yet just a few weeks previously, analysts had expected a rate rise at the May meeting while Governor Mark Carney suggested there could be further tightening this year. There’s some mild support around 1.3400 and in the absence of a countertrend bounce back up to 1.3600 a retest of support around 1.3200 can’t be ruled out.
 
Crude oil

Crude continued its seemingly relentless upward march last week with another milestone being reached when Brent traded above $80 per barrel for the first time since November 2014. Global demand growth is forecast to pick up steadily. At the same time there are concerns about supply as Venezuela’s economy crumbles and the US renews sanctions against Iran. Analysts estimate that sanctions could take anything between 200,000 and 500,000 barrels per day (bpd) off the world market, although it’s worth bearing in mind that Iranian exports have grown to 1 million bpd since sanctions were lifted in January 2016, so it could potentially be more.
While the US has acted unilaterally, it is proving difficult for other signatories to the Iranian nuclear deal to ignore the sanctions call. Even China is understood to be considering the implications of continuing to trade with Iran. On average, China imported more than 25% of Iran’s total crude oil exports in the first quarter of 2018, around 165,000 bpd. It’s possible that China will look elsewhere for this supply.

At the same time, the OPEC/non-OPEC production cut agreement remains in place. While Saudi Arabia seems happy to keep this going to the end of this year or even beyond, Russia may agitate to end the agreement sooner. We’ll find out more at next month’s OPEC meeting.
Crude was also helped along last week by news of a drop in US crude inventories. On Wednesday, the Energy Information Administration (EIA) reported that inventories fell by 1.4 million barrels last week, more than the 1.1-million-barrel decline expected. Traders ignored news that US production rose once again, and has now topped 10 million barrels a day every week since early February. Analysts cite a lack of infrastructure to process the output as another reason for prices holding at elevated levels.
 
Precious metals

Gold experienced a vicious sell-off last week which saw it scythe below the 200-day simple moving average (SMA) around $1,307 to hit its lowest level this year. The last time this happened so decisively was in December 2017. Back then gold fell around 3% from the 200-day SMA to bottom out around $1,236. It then rallied 10% over the next six weeks hitting $1,366 – a level which remains the high for this year.

If gold were to repeat December’s move, then a 3% pull-back from the 200-day SMA would now take it down to around $1,267 although some traders haven’t ruled out a retest of the December 2017 low. However, if gold can now steady above $1,280 and we see evidence of a sharp reduction in speculative long positioning, then we could see a rapid rebound in prices.

The frustration for gold bulls is the feeling that there is so much uncertainty around the world and that this should be keeping a solid bid under the precious metal. Last week North Korea said it was prepared to pull out of the talks with President Trump planned for June 12^th. The state has no wish to give up its nuclear weapons and It appears that Kim Jong un is concerned that the US may engineer regime change as in Libya. In addition, Italy is back in the spotlight as it looks as if the two Eurosceptic parties, Northern League and Five Star Movement, have reached agreement to form a coalition government. This caused Italian bond yields to surge. Unfortunately for gold bulls this also saw the euro fall sharply and the US dollar make further gains, providing another excuse to sell the precious metal.
 
 
 
Key events next week

Monday -             Bank Holidays – Canada, France, Germany and Switzerland

Tuesday -             JPY BOJ Core CPI; GBP Public Sector Net Borrowing, CBI Industrial Order Expectations; CNY CB Leading Index; USD Richmond Manufacturing Index

Wednesday -     JPY Flash Manufacturing PMI; AUD Construction Work Done; EUR French, German and Euro zone Flash Manufacturing and Services PMIs; GBP CPI, RPI and HPI; USD New Home Sales, Crude Oil Inventories, FOMC minutes

Thursday -           GBP Retail Sales, Inflation Report Hearings; EUR Eurogroup Meetings, ECB Monetary Policy Meeting Accounts, Weekly Jobless Claims, Existing Home Sales

Friday -                 EUR German Ifo Business Climate; GBP Second Estimate GDP; USD Durable Goods, Consumer Sentiment, Inflation Expectations.

The first quarter earnings season is now winding down, but main releases include Autodesk, Gap, Hewlett Packard, Kohl’s, Marks & Spencer and Tiffany.
 
 
 
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