Macro Matters – Weekly review, w/c July 10

TradeDay Macro Matters.

Macroeconomic / Geopolitical developments.

• Risk appetite takes a hit as Fed rate tightening expectations spike higher

• Volatility on bonds spikes as yields jump but then start to unwind

Risk appetite takes a hit. Central bankers remain hawkish in their battle to bring inflation back lower. The rhetoric from the Federal Reserve continues to suggest that the hawkish hike in the June meeting will be seen as a mere blip in the tightening cycle. The Fed minutes hawkishly suggested that “almost all” participants believed that rates would be higher than current levels by the end of the year. US labor market data had mostly shown signs of strength, which built markets up into a bit of a frenzy before a tepid Nonfarm Payrolls report has just let some of the steam out of the move. Despite the moves on Friday, government bonds have been sold off over the past week, with yields breaching notable levels. However, traders are now coming around to the realization that central banks will be tightening rates further. Nowhere more is this the case than with the Bank of England’s rate expectations. Banks such as Schroders have recently put out notes talking about the expectation of a peak at 6.50%, whilst interest rate futures now agree. We will not get the next BoE decision until early August, so there is plenty of time for speculation to run rife. This week the Bank of Canada is expected to hike by another 25 basis points to 5.50%, whilst the Reserve Bank of New Zealand is expected to have seen enough up at 5.50%.

Volatility returns to bond markets. After a period of relative calm, volatility has returned to bond markets. The hawkish Fed minutes and a string of US labor market data have thrown bond markets around in recent days. The Bank of America Merrill Lynch MOVE Index of Treasury bonds volatility has jumped decisively in the past week. This has come as bond yields around major economies have decisively picked up. The move was tempered slightly on Friday in the wake of a tepid Nonfarm Payrolls report but markets are decisively positioned for the Federal Reserve to resume its hiking of the Fed Funds rate again at the end of July. Volatility is likely to remain high this week as a crucial US CPI inflation number is released on Wednesday. Any signs of a continuation of stubborn inflation will mean that markets not only further firm pricing for a 25bps hike in July but also would bring a September/November hike further into view. Watch for the US 2-year yield holding decisively above 5.00% and the 10-year decisively above 4.00%.

United States.

• A tepid payrolls report sparks a rethink after a run of improving labor market data

• Index futures pull back

Tepid payrolls induce a bit of a rethink. Friday’s Nonfarm Payrolls left traders with a feeling of, “Well, is that it?” It certainly came at odds with some of the other labor market data we’ve had recently. Thursday’s ADP Employment (a day late due to the Independence Day holiday) came in with a whopping 497,000 (versus 228,000 expected). The Employment component of the ISM Services data improves back into expansion at 53.1 (from 49.2). The Weekly Jobless Claims have also fallen back. This had fuelled hawkish market moves in recent days, so with Nonfarm Payrolls due, there seemed to be a collective holding of breath. After the announcement that a rather tepid 209,000 jobs were added, there seemed to be a collective sigh of relief. There was volatility on the 2-year Treasury yield, which retraced an initial spike lower only to drop back decisively below 5.00% again. Longer-duration yields also fell back slightly but in a less dramatic fashion. Despite this, Fed Funds futures continue to price for at least one more hike, whilst also looking at April/May 2024 before the first cuts arrive. The US dollar seems to have been where the primary reaction has been seen. The rally that had been building on the Dollar Index has unwound decisively. The losses were seen across major forex, but the retracement versus the rallying Japanese yen is the one that has really caught the eye.

US index futures turn lower. With the sharp rise in bond yields, equity markets have finally started to sit up and take notice. The VIX Index of S&P 500 options volatility rising sharply to a five-week high reflects the growing concern about what the prospect of higher for longer rates might mean for portfolios. Friday’s tepid payrolls allowed the VIX to unwind slightly, and whilst an increase of +19% might sound like a lot, a move from 13 to 15 suggests this is just a small shot across the bows. This minor move is reflected in the decline in the e-mini S&P 500 futures from 4498 to 4420. However, unless there is a loss of the support at 4368, there is little really that technical traders will be getting overly concerned by, even if there is a negative divergence in the RSI momentum indicator. The e-mini NASDAQ 100 futures suggest a similar warning to the bulls but without being too worrying. A pullback from 15432 to 15111 barely scratches the surface of the bull run. Only a move below 14853 would see alarm bells start sounding.

What’s next? US CPI inflation will be a massive release this week. Unless inflation plummets, it is almost nailed on that the Fed will resume hiking at the end of the month. If inflation comes in even remotely hot, then expectations of another hike in September/November will soar. The USD will be positive on any upside surprises to the CPI data but moreover, it will be the broad market reaction for risk appetite.

Europe.

• Bank of England rate hike expectations rise ever higher

• European indices breach key support levels

Expectations of Bank of England interest rates have soared. Hawkish signals are emanating from central bankers throughout major economies and bond yields are pulling higher. The yield on the UK 2-year Gilt has soared to 5.5%, whilst the UK Government has been forced to auction 2-year bonds at a record 5.668%, the highest of any auction since 2007. Traders are subsequently looking at the central bank that needs to be the most hawkish and pricing for much higher interest rates. According to the UK’s SONIA interest rate futures, markets are now positioned for a peak rate for the Bank of England at a whopping 6.5%. With the BoE Base Rate currently at 5.00%, this does have the feel of being massively over-priced. The UK PPI is falling decisively and anecdotal evidence suggests that companies are experiencing lower input costs, even if they are yet to pass them through to customers. Whilst this may still take a few months to feed into consumer inflation, thinking that the Bank of England will get as far as 6.50% seems pretty far-fetched.

Falling European equities. With these higher yields and US index futures dropping back, the European markets are not doing much better. A sharp pull lower on DAX futures and FTSE 100 futures has seen markets falling to their lowest levels since March. There is a feeling following the payrolls report that the moves may be stretched a little near-term, which could induce a little unwinding technical rally near-term. DAX futures have rebounded off 15559, but traders will be looking at the reaction between 15883/15900 this week. A quick and decisive rally back through the overhead supply of these previous lows and the outlook can begin to improve again. As for the FTSE 100, the technical rally from the RSI being below 30 is yet to really get going. Traders will be keeping a close watch on the key March low at 7198 but if stability can begin to form, then a rebound back towards 7408/7442 resistance can develop.

What’s next? As part of the UK employment data, average weekly earnings will be crucial. The Bank of England will be concerned by the prospect of a wage/price spiral. So if wages continue to move higher, then markets will become ever more nervous about prospective BoE tightening (if that is even possible). In the Eurozone, the German ZEW Economic Sentiment gives a good look at German economic activity.

Asia.

• Hints of intervention as USD/JPY backs away from 145

• RBNZ on hold

Is 145 the line in the sand on Dollar/Yen? With Japanese officials now openly talking about intervening, traders are suddenly very wary of 145 on USD/JPY. This was supposedly the point at which Japan began to intervene in October/November last year. Perhaps it comes as no coincidence that the peak in USD/JPY came a hair’s breadth above 145 in the past week. Notably, despite strong rate hike leanings from the Fed and US yields pulling sharply higher, USD/JPY barely budged. Then on Friday, when the US jobs data came in fairly tepid, there was a rush to sell the USD against the newly supported yen. Technical analysis shows that initial support is at 140.90/141.20, but it seems that 145 is very much a line in the sand once more and will be an area of key resistance now.

Chinese inflation remains subdued. Chinese inflation is on Monday and is expected to remain around zero. In the coming months, it is expected to pick up, but this is mainly at the behest of base effects. The important PPI is expected to remain deeply negative and fall further to -5.0% this month. This is a lead indicator for the falling input costs seen in economies around the world as the supply chain feeds through.

What’s next? The RBNZ is expected to hold rates steady at 5.50%. However, watch for the language surrounding the hold as other central banks have tended to be hawkish in their messaging when holding recently.

Commodities.

• Upbeat OPEC oil demand ushers oil futures back to test key resistance

• Gold futures show recovery signs

Upbeat OPEC support oil futures. According to Reuters, OPEC sources suggest that the cartel will maintain an “upbeat view on oil demand growth” for 2024 in the outlook to be published later in July. Despite risk appetite diving, this may now be ready to stoke the fires of a rally in oil futures. NYMEX Oil futures have been picking up over the past week and are once more now testing the key resistance band between $72.72/$75.06, which has restricted rallies over the past two months. Technical analysis shows the RSI now decisively above 50 and at a 10-week high, suggesting that momentum is finally improving. A close above $75.06 would open upside towards the medium-term range highs above $82.60.

Gold futures jump after payrolls. There has been a notable pickup in Gold futures in the wake of the tepid payrolls data. Could this be the start of gold forming support? The decline in the USD and pullback in yields plays into support for gold, but it is too early to call an end to the correction of the past two months. It would likely need a decisive negative surprise in the CPI data to justify a decisive turn in outlook. On the chart, there is key resistance around $1931/$1940, whilst the 50% Fibonacci retracement is also a basis of resistance. The first key lower high to note is $1963. A move above here would begin to look like a decisive shift in technicals too.

On the calendar.

• US inflation is a dominant theme of the week. Eyes will be on Core CPI on Tuesday with the expectation of a continued but gradual decline to 5.0% YoY (from 5.3% in May). However, it will also be worth watching out for the US core PPI on Thursday too, with a drop a shade to 2.7% (from 2.8% in May). The PPI has been leading CPI inflation lower but just began to show signs of slowing this reduction last month.

• Elsewhere, the question is once more one of rate hikes. The RBNZ is expected to be on pause at 5.5%, whilst the Bank of Canada is expected to hike once more by 25bps. The Bank of England will also be mindful of UK wage growth amid signs of a wage-price spiral fuelling inflation.

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