Riding a sea of green; Oil in focus +G7 makes gold official; Forex focuses on Sintra
Equities ended the week on a strong note as the return to lower yields created significant tailwinds for growth stocks. And given the body language of the market lately, I suspect long-term investors were more than happy to surf a sea of green for a change.
Indeed, it was an epic bear market bounce, especially as catastrophic prophecies have recessionary storm clouds billowing vertically on the horizon.
We calculate that the lack of selling was sufficient to explain part of the rebound, as there was minimal buying flow from retail or to otherwise fund this rotational rally.
On bonds, we think the street will wait until we are closer to the next CPI release to re-enter shorts, as seasonal factors are supporting the rally in duration, so there could be more leeway for equities amid this fragile easing.
The final version from the University of Michigan revised the 5-10 year inflation expectation to 3.1% from 3.3%. And the 1-year inflation expectation was adjusted to 5.3% from 5.4%.
At first glance, this suggests that it was unreasonable for the Fed to decide monetary policy with a retrospective approach. With 5yr and 5yr breakouts still in control, many now believe there was no need to raise 75bps based on survey data. Thus, Friday’s softer Fed Funds curve was due to the weaker inflation reprint.
I would ignore it for one simple reason. Rising oil prices are the number one enemy of inflation for the Fed. And lower gas prices top the Biden administration’s election plan ahead of November’s midterm elections. As the Fed focuses on the headlines rather than the heart, US monetary policy is increasingly captive to oil prices. This observation implies greater volatility around the Fed’s reaction function. Therefore, with oil and gasoline prices remaining high, the Fed will keep the rate hike pedal on the metal.
Additionally, any hot data printing will provide room for higher repricing in front meetings, especially with a narrow window for the Fed to sprint to the finish line and hit the terminal rate target. the end of the year. From this perspective, the risk-reward of further acceleration in the upside is attractive.
We believe that the next multiple declines in the S&P 500 will come from an earnings write-down. Last week I suggested that there was no need to risk a career mistake by selling blocks from SPX 3700 to +30 VIX. Indeed, institutional sellers will need much more confidence that the deterioration in earnings is happening now and the consumer has stopped spending. The two go hand in hand; Declining consumer spending poses the biggest threat to big-ticket revenue – especially in the event of a recession.
And, of course, with the largest month-end and quarter-end rebalancing buy estimate since March 2020, people are less inclined to face a month-end bounce.
Energy stocks were under huge pressure until Friday’s reversal, consistent with the broad pullback across the commodity complex driven by the deepening recession and demand concerns. And that should remain a pressure point.
Therefore, I suspect that commodity markets will remain in focus, particularly oil, given the extent to which energy inflation fears have fueled risk this year.
Will price action soon tell us if the latest plunge was a function of demand destruction or overcrowded positioning? But one thing is certain: the oil complex is not as tight as many thought.
After being hammered most of last week due to the recession and fuel demand destruction issues, oil prices rallied over the weekend on the back of physical demand. These global economic concerns have apparently been offset by increased demand from China for “real world barrels”.
Indeed, power demand in northern, central and northwest China has hit record highs as millions of people have turned on AC power to escape the sweltering heat wave, which likely has created the Domino effect. The record level of electricity not only impacts fuel-intensive industrial production, but also oil prices.
There could have been an element of the tail (time gaps) wagging the dog (spot) but the curve in heavy receding for a while but when word started to spread that China is a bounty for barrels fast is more than enough to scare shorts.
Although oil is a spot asset typically driven by supply and demand fundamentals, it is not uncommon for the complex to trade as a timing asset (equities and currencies) driven by the rate of Broader economic demand growth, which is slowing if the PMI data is sure.
Our point of view has been unwavering; with no fresh supply, it will be difficult to see Brent trading below 100 as the escalating war between Ukraine and Russia will continue to cause energy price fears.
On the other hand, it is a mistake to think that Brent Crude l could stay at +$120 given the magnitude of the central bank-induced slowdown likely to be seen later in the year. The Fed and other inflation-fighting central banks want lower commodities, which they are explicitly trying to engineer.
The G-7 countries will officially announce that they have stopped buying Russian gold. Given that the Russian Bars were seen as politically tainted in the West following the country’s invasion of Ukraine, I doubt making it official would have much impact on the gold market, as it was assumed that Russia would keep domestic production at home to absorb the excess USD and prevent excessive appreciation of the rouble. But there could be a rebound in headlines at the open.
Last week’s Eurozone PMI indices added to a long list of reasons to be wary of the euro’s continued rise. From the war in Ukraine to lockdowns in China, economic activity looks lackluster. At the same time, it would usually be enough to send the EURUSD towards parity on the back of a hawkish Fed. However, the street is in conflict with the ECB on the brink of a momentous political pivot while establishing the springboard out of negative rates.
I don’t think the street wanted to be short of the euro ahead of this week’s Sintra meeting, which could cement expectations of an imminent exit from negative rates and possibly deploy a functional anti-fragmentation “backstop.”
On another countertrend trade, we still believe the yen offers an attractive bias given the growing risks of recession in the US and the prospect of a change in monetary policy in Japan itself. And with the intervention rhetoric picking up again, Tokyo might be cautious about buying dollars here.
As usual, the Ringgit continues to be driven by external factors while underperforming the improving terms of trade due to its high beta against CNH weakness, domestic investor outflows and exporters unwilling to convert USD due to hawkish Fed.
However, with global risk sentiment improving and the yuan rallying, we could see a follow-up below 4.40 early in the week if US yields continue to trade lower.