Weekly Market Wrap

By David Morrison  |  27/07/2018 13:37

Look-ahead

It’s set to be a busy week with monetary policy meetings from the Bank of Japan (BOJ), US Federal Reserve and the Bank of England (BoE).
We also have some key data releases including US Core PCE (the Fed’s preferred inflation measure), Euro zone Flash CPI, second quarter GDP, various Manufacturing PMIs all rounded off by US Non-Farm Payrolls on Friday.

The Non-Farm Payroll report for June surprised to the upside coming in at +213,000 on expectations of an increase of just under 200,000. Average Earnings fell back a touch to +0.2% month-on-month from +0.3% previously, suggesting that there’s little inflationary pressure from wage growth coming through. The Unemployment Rate came in at 4.0%, up from last month’s 3.8% reading. Overall, the tone was positive for equities (at least that was the initial reaction) while the dollar pulled back sharply as inflation expectations moderated. But the US Treasury yield curve flattened further, and this could be a major headwind for the dollar and equities going forward.

US yield curve steepened a touch last week taking some pressure off the financial sector. This could be the beginning of a reversal, bit it’s more likely to be a corrective move given the length and degree of recent curve flattening. If we see a further compression between long and short-term US Treasury yields, then investors will once again sell the dollar and dial back their exposure to risk assets such as equities.

Stock indices

The second quarter earnings season also shifts up a gear. Amongst the major corporates reporting are Apple, Anadarko Petroleum, Baidu, Barclays, Caterpillar, Ford Motor, Lowes Corp, Pfizer, Procter & Gamble, Tesla, Yum! Brands.

Earnings have got off to a strong start. This is helping to offset concerns over the ongoing tariff tit-for-tat between the US and China, as has the apparent love-in on trade between Trump and European Commission president Jean-Claude Junker. On Wednesday President Trump agreed to refrain from imposing car tariffs while the two sides launch negotiations to cut other trade barriers.

But there was little in the way of specifics so there’s no guarantee that the two sides will ultimately come up with a deal which is acceptable to both sides. It’s worth remembering that there were negotiations between the US and China soon after the Trump administration threatened tariffs on Chinese imports. These were initially heralded a success, but it didn’t take long for the apparent agreement to break down. Now we have Trump threatening tariffs on over $500 billion-worth of Chinese imports – in other words, on everything. Although trade war fears are currently taking a back-seat to earnings, they haven’t completely gone away.

The earnings season is helping to lift the S&P 500 and Dow back towards their January all-time highs. As of Friday 20^th July, of the 17% of S&P 500 corporates that have reported so far, around 87% have beaten consensus earnings estimates – well above recent averages. Revenues have also been better than expected.

Bear in mind, this data came out before Facebook (one of the most over-owned stocks in modern times) stunned the market by disappointing on revenues, users and forward guidance. The news knocked over 20% off the share price, while Facebook’s value fell $151 billion - the biggest one-day stock wipe-out in history. But so far, the damage has been localised and Amazon helped to counter losses on the NASDAQ after it reported a profit of $2.5 billion in the second quarter – double the consensus estimates.

However, some concerns remain. Wall Street analysts are proving reluctant to raise their forecasts for earnings and revenues in the third quarter. This may prove to be a headwind if this trend continues into the season. However, it does feel as if investors are still wedded to the idea that stocks go up forever. This could see the S&P 500, and maybe even the Dow, join the NASDAQ in making fresh all-time highs.

FOREX

Heading into the weekend the dollar was rallying and on course for a positive week. Chart-wise the greenback is consolidating after breaking to the upside in mid-April, straight after China announced renewed monetary stimulus through a cut in its Reserve Requirement Ratio. The Dollar Index is oscillating around 94.00 while 95.00 is acting as upside resistance. Meanwhile, the EURUSD looks similarly rangebound with support around 1.1600 and resistance about the 1.1750 level. But perhaps most importantly, in Friday’s Asian Pacific session the dollar ended at a 13-month high against the onshore Chinese yuan. Last week the Chinese authorities announced additional fiscal stimulus alongside their loose monetary policy. This has all contributed to an 8.8% decline in the yuan against the dollar since mid-April, giving Trump fresh ammunition to label China a “currency manipulator” so raising tensions between the two countries. There’s no doubt that a weaker yuan can go a long way to offset US tariffs on Chinese imports. However, China’s economic growth rate is slowing so it is only natural that the authorities will want to keep the stimulus going to avoid the possibility of civil unrest. But expect outrage from the Trump administration should the USDCNY close in on 7.00 from 6.82 currently.

On Thursday the ECB effectively issued a repeat of its June statement. The Governing Council said that it would end its Asset Purchase Programme by the end of this year and keep rates unchanged “at least through the summer of 2019” until inflation was sustained below, but close to, 2%. The euro was little-changed on the news. However, it sold off during Mario Draghi’s subsequent press conference where, yet again, the ECB president added a dovish gloss to proceedings by warning that core inflation (excluding food and fuel) was well below target and declined last month to +0.9% year-on-year, from +1.1% previously.

The coming week sees monetary policy meetings from the BOJ, Federal Reserve and BoE. The latter will also release its quarterly inflation outlook, so this would be a good opportunity to hike by 25 basis points. However, we shouldn’t be surprised if the Bank’s MPC delays such a move given recent weaker-than-expected Retail Sales, a dip in CPI and Brexit uncertainty.

The Fed is expected to keep rates on hold. But all eyes will be on any changes to the accompanying statement and how they may play into rate hikes for the rest of the year.
Finally, Tuesday’s BOJ meeting could prove interesting after the yield on the 10-year JGB shot above the BOJ’s 0.10% ceiling for the second-time last week. The BOJ intervened to pull the yield back down. Analysts will be listening out for any policy tweaks at the meeting.
 
Gold

Last week gold came under further downside pressure as the dollar consolidated at higher levels. Gold has slumped since April as the Fed looks set to continue tightening monetary policy which supports the dollar. Even the threat of a full-blown trade war between the US and China has failed to trigger investor interest in gold as a safe-haven.
Earlier this year gold popped its head above $1,360 to hit its highest level since August 2016. It spent the next few months probing this area of resistance while occasionally dipping back below $1,320. But after another failed attempt to break and hold above $1,360 in April, gold reversed direction and sliced below previous significant support levels. In the middle of last week, it traded below $1,220 for a loss of around 10% over the last three months.

Typically, the dollar price of gold will fall when the dollar itself is going up. Since mid-April the Dollar Index is up around 5%, so that certainly explains some of gold’s losses. The rally in the dollar is a direct result of higher bond yields which are up on expectations that the US Federal Reserve will continue to tighten monetary policy. This comes as other developed-world central banks (primarily the European Central Bank (ECB) and Bank of Japan (BOJ)) keep monetary policy loose. In addition, China, the world’s second largest economy by GDP is adding stimulus.

Last week the Chinese yuan hit its lowest level against the US dollar since June last year. This represented a decline of over 8% since the middle of April which was when the Chinese authorities loosened monetary policy when they made an unexpected cut to the Reserve Requirement Ratio. On Monday China announced further fiscal stimulus. The Trump administration may label this as outright currency manipulation by the Chinese authorities – a deliberate move to devalue the yuan and thereby offset the negative effects of US tariffs on Chinese imports. But this additional monetary and fiscal stimulus is probably more in response to a slowdown in Chinese economic growth – something which may be happening at a far faster rate than indicated by official data. Whatever the reason, gold traders should pay close attention to the yuan going forward.

Along with the dollar, rising bond yields also dampen demand for gold. The reason typically given is that investors can get a decent “risk free” return by holding interest-paying US Treasuries. But this ignores the effects of inflation which eats in to any interest rate gains. The fed funds rate is around 2%, the highest of any developed-world central bank and predicted to be around 50 basis points higher by year-end. But inflation is also picking up. Headline CPI stands at 2.9% - easily eating up the yield on a 2-year Treasury Bill. Even the Fed’s preferred inflation measure, Core PCE, is running at 2.0%. Considering this alone, gold may not be an unattractive asset after all.

Chart-wise, gold looks as if it is ready to break below support around $1,220. This opens the possibility of a move to $1,200 or lower. But if buyers come in around here then we may see a counter-trend correction and a test of resistance at $1,240 and then $1,260. But much depends on where the dollar, and perhaps more importantly, the yuan go from here.
 
Crude oil

Crude has put in a solid rally over the last fortnight following a sharp sell-off in the preceding week. The latest move has seen both WTI and Brent creep back up inside the upward sloping trading channel which has been building since last summer. The latest pick-up in prices comes as US crude inventories decline, while the US and EU make conciliatory noises over their trade dispute and as Saudi Arabia announced a halt to transporting crude through the Red Sea shipping lane of Bab al-Mandeb after an attack by Yemen's Iranian-backed Houthi movement.

Crude had rallied sharply in the lead up to, and following, the OPEC+ meeting on 21st and 22nd June. This was despite the expectation that the group would agree to add back supply by reducing the 1.8 million barrels per day (bpd) output cut that has been in place since the beginning of last year. There was a lack of clarity directly after the meeting. However, it subsequently emerged that OPEC+ had agreed to boost output by one million bpd. This was higher than many early forecasts but still well below the top end of estimates which coalesced around an increase of up to one and a half million bpd.
 
On top of this, the aggressive rhetoric between the Trump administration and Iran has ratcheted up a couple of notches. In a tweet last week Trump warned Iran’s president Hassan Rouhani to “NEVER, EVER THREATEN THE UNITED STATES AGAIN…” (sic). This brought an aggressive response from one of Iran’s most senior military leaders who said: "If you begin the war, we will end the war. You know that this war will destroy all that you possess." This follows on from Trump’s re-imposition of sanctions against Iran which by some estimates could remove as much as 1 million bpd of supply from global markets, although there will certainly be countries happy to accept Iranian imports.
Nevertheless, with a loss of output from other OPEC members Venezuela and Libya, there are concerns that supply could tighten going into the second half of 2018. Unless, that is, Saudi Arabia has enough spare capacity to make up any shortfall.
 
Key events

Monday -             EUR German Retail Sales, German Prelim CPI, Spanish Flash CPI; GBP Net Lending to Individuals, M4 Money Supply, Mortgage Approvals; USD Pending Home Sales

Tuesday -             CNY Manufacturing/Non-Manufacturing PMIs; JPY BOJ Monetary Policy Statement, BOJ Press Conference; EUR CPI Flash Estimate; USD Core PCE Price Index, Employment Cost Index, Personal Spending, Personal Income, S&P/CS Composite-20 HPI, Chicago PMI, CB Consumer Confidence

Wednesday -     JPY Final Manufacturing PMI; CNY Caixin Manufacturing PMI; EUR Final Manufacturing PMI; GBP Manufacturing PMI; USD ADP Non-Farm Employment Change, ISM Manufacturing PMI, Crude Oil Inventories, FOMC Statement

Thursday -           AUD Trade Balance; GBP Construction PMI, MPC Official Bank Rate, BOE Inflation Report, BOE Governor Carney Speaks; USD Challenger Job Cuts, Unemployment Claims, Factory Orders

Friday -                 JPY Monetary Policy Meeting Minutes; AUD Retail Sales; EUR Final Services PMI; GBP Services PMI; USD Non-Farm Employment Change, Unemployment Rate, Average Hourly Earnings, ISM Non-Manufacturing PMI
 
 
 
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