Stocks pick up, bonds remain bid ahead of Fed minutes

Morning Note

European stocks edged higher early Wednesday after taking a sharp tumble in yesterday’s afternoon session. Bonds and the dollar rallied, leaving benchmark yields at their lowest in some months, knocking the wind out of the cyclical recovery trade. The FTSE 100 ended the day down 0.9% at 7100 but has regained some poise in the early part of today’s session to trade at 7,130. European markets remain very much stuck in month-long ranges. Shell shares rose more than 2% on a promise if higher shareholder returns.

Mega cap growth helped the US market keep a more level head as the S&P 500 declined 0.2%, easing away from a record high set last week, whilst the Nasdaq rallied by almost the same amount. The Dow Jones fell 0.6% as economically sensitive names like Caterpillar, Chevron, Home Depot and JPMorgan slipped. US 10yr yields are under 1.34% this morning, a five-month low. Similar story for gilts, with the yield on 10yr paper at 0.627%, the lowest since Feb.

Yesterday’s pullback and the sharp drop in bond yields reflected doubts about the pace of growth, and the extent to which costs are going up for businesses. The talk is that peak growth is behind us and The ISM services PMI reflected the trouble for growth is not on the demand side; quite the reverse. Businesses anecdotally reported ‘supply chain outages, logistics delays and employee- and management-staffing constraints’ and that ‘business conditions continue to rebound; however, like everywhere, the challenges in the supply chain are numerous. We continue to see cost increases, delayed shipments, pushed-out lead times, and no clarity as to when predictive balance returns to this market’. I fail to see how this implies inflation will be transitory.

A run-up in the S&P 500 of 5% in the last two weeks looks to be unsustainable and at the very least I’d anticipate we see a pause and trading sideways, if not a deeper correction over the summer. For now, though, Tuesday’s dip is not a sign of reversal. The market is narrowing, too. The S&P 500 would have had a much sharper drop (~1%) had it not been for the 14 index points added by Apple and Amazon. Shares in Amazon rallied almost 5% as the US Defense department cancelled its $10bn JEDI contract with Microsoft, with the Pentagon saying it will seek a new multi-vendor contract. It will seek proposals from both Microsoft and Amazon.

The narrative and the ‘macro picture’ seem a little less understood – has growth peaked, will inflation wipe out economic gains, has the Fed really got inflation angst? We get to find out a lot more about that with today’s release of the minutes from the last FOMC meeting. Earnings season is coming up but it’s well known we are going to see some monster numbers and it is less obvious how Q2 reporting will drive the market higher – if anything it could lead to a round of profit taking and recalibration. Expectations are already so high. But we can’t ignore the bond market and equity market concentration in growth stocks – if bonds find more bid and the 10yr pushes yet lower to 1%, then the stock market can keep gliding higher.

The dollar is holding higher against peers ahead of the minutes from the June meeting. The meeting revealed a couple of things we had pretty well expected: a) Fed officials are talking about tapering, b) dots are coming in due to the rapid economic rebound and, less well anticipated, c) the Fed is a little bit concerned about letting inflation off the leash. The minutes should provide some further clarity/explanation about the Fed’s likely position but ultimately we don’t see any change until Jackson Hole in late August or the September meeting. The trouble for the market is dealing with the Fed’s reaction function in terms of yields: a hawkish Fed and quicker taper/hike ought to drive yields higher, but the reaction to the June meeting saw the reverse as the statement and projections implied the Fed wouldn’t let inflation get out of control. So now we know this, we are likely to see a more considered market reaction that, all else equal, should see rates move higher this year as the Fed lays down the tapering agenda and inflation remains more persistent than central banks think.

EURUSD made a fresh 3-month low in a further extension from the bear flag downside breakout.

EURUSD price action on July 7th 2021.

GBPUSD: firm rejection of 1.39 yesterday and continues to stick to the downtrend. For now, continues to scrap around the 1.38 area, felling just below this morning and eyeing a break to 1.3660 area, the 200-day SMA and Mar/Apr double bottom.

GBPUSD price action on July 7th 2021.

Crude oil futures catching a little bid in early trade this morning after yesterday’s reversal. Concerns remain that the failure by OPEC to agree to gently increase production could lead to the output agreement unravelling, which could lead to more crude coming on the market. But there is a lot of uncertainty – if OPEC+ stick to the current quotas global inventories will draw down further and the market will further tighten, squeezing prices higher.

Chart showing crude oil price action.

Gold is getting a filip from lower yields, though the stronger greenback is checking its advance. 10yr TIPS have slipped to –0.94%, the lowest since the middle of February as nominal rates fell. Price action remains above $1,800 with the bullish crossover on the MACD confirmed.

Gold chart showing price action 07.07.2021

NFP miss: does it mean anything?

Indices

US jobs growth cooled with just 226k created in April, well below the 1m+ expected. The blowout number from March was also revised lower by 146k to 770k. Wages rose more than expected.

What does it tell us, if anything?

1) Don’t read too much into this print – the US economy is by most measures booming. Payrolls are a lagging indicator and at the mercy of a huge number of factors. Payrolls can sometimes produce a monthly print way off the reservation. Moreover, +266k is a good number in normal circumstances and the country is still in the throes of the pandemic – expectations might have gotten a little elevated for this number (guilty). Too much hype maybe a factor here in some of these market moves on the announcement – the narrative doesn’t really change IMHO.

2) If slower employment growth is something to consider, then it will simply keep the Fed easier for longer. This was reflected in the surge in tech/growth and a reversal of the reflation trade (ie Dow lower, NDX higher) in the futures market. Overall, this ought to be a net positive for risk assets like stocks, albeit it may create yet more churn and rotation, which makes it messier. As per point one, however, this print does not mean that suddenly WFH stocks are about to suddenly get out of their funk, or FAANGS are more attractive than they were yesterday. Similarly, it does mean that the reflation trades are less appealing. If anything, it simply has created a more useful entry point for some – as can be seen by the fading of the initial kneejerk on the Dow and elsewhere.

Chart showing USA 30 index response to NFP release May 7th 2021.

3) There has been some evidence that poorer folks are better off than they were thanks to stimulus cheques. These won’t last forever, but there is an argument that ongoing government support create a moral hazard around incentivising people back into work post-pandemic. A question that does need to be asked by the Fed and Treasury is how their policies are going to improve productivity and generate real employment gains.

4) Even if yields and the value/cyclical equity market plays recover – as they seem to be doing in the first half hour of trading on Wall Street today – the print does not do an awful lot for USD. Bonds were bid, and yields moved sharply lower, with the 10yr down under 1.5% in short order. The sharp move lower in yields lifted gold and sent the US dollar lower to breach the late April low and snap the rising trendline. If we can use this print as anything to go by, then it means the Fed is inching further away from a taper than the ECB which ought to be supportive for a long-awaited EURUSD rally to 1.25.

Yields response to NFP release May 7th 2021.

5) Rising wages underscore a sense that employers are struggling to find workers. Lower paid jobs that were lost in the pandemic are coming back, but they may not be as low paid as they used to be. This suggests further upside pressure on inflation over the coming months as businesses seek to attract staff. The problem for the Fed becomes this: if inflation picks up and employment does not recover quickly enough, its’ current policy stance will be questioned and the bond market will start to flex its muscles.

Let’s just call it the weekend

Morning Note

Britain’s economy contracted less than expected in January, but nevertheless showed the dire impact of lockdown on economic activity. The European Central Bank said it would speed up the pace of bond buying to lean against the rise in yields but didn’t provide an awful of clarity overall. Wall Street rose to a fresh record and Bitcoin made a new all-time high as investors looked to the imminent arrival of stimulus cheques. European stocks move a little lower in early trade on Friday despite a new record high on Wall Street for the S&P 500. However, the main bourses are on track for a roughly 4% gain this week, while the FTSE 100 is up a little over 1%.

A 30-year bond auction in the US went off without too much trouble in the end. Nevertheless, US 10-year yields have popped back to 1.6% a level that has elicited some concern of late. Meanwhile, Britain’s chancellor, Rishi Sunak, warned that “the public finances are much more sensitive to changes in interest rates and inflation than they were previously”. Quite. The more you are in hock the more ‘sensitive’ you are to rates. But equally, if you have a central bank that will hoover up at auction, you don’t need to worry about the market rate…but that is a debate for another day. It seems the UK government is intent on making sure the public finances get ‘fixed’, whatever that means. (it means higher taxes for you and me, is what it means, so we can afford to pay people not to work).

“Financing conditions are defined by a holistic and multifaceted set of indicators, spanning the entire transmission chain of monetary policy from risk-free interest rates and sovereign yields to corporate bond yields and bank credit conditions.” Holistic and multifaceted…woooweee!! That sounds so clever. The ECB, well, did what the ECB does. Little clarity and a lot of complexity – flexibility – around its reaction function. Christine Lagarde spent a long time trying to explain what the ECB is trying do by saying it will increase the pace of bond purchases; partly because it’s a bit unclear about what it wants to achieve and partly because Lagarde is not a master of the press conference like Draghi. The ECB will speed up asset purchases, but it could still use less than the full envelope of €1.85tn if favourable financial conditions can be maintained without spending it all. Which sounds like it has no clue: flexibility is good, but it must be a little more in control of things than this.

The sensitivity to rates is extraordinary. Cue the headline: “European bonds rally after ECB pledges to step up asset purchases”. Get this – the yield on 10-year bunds slipped 0.02 percentage points – a whole two basis points! That is quite a reaction, I mean talk about bond vigilantes…I joke of course…

Gold failed at the $1,740 area and has retraced the last few days’ gains as yields climbed again.

Gold failed at the $1,740 area and has retraced the last few days’ gains as yields climbed again.

Eurozone bank shares slip further on weak yields, eyes on Fed speeches

Equities

Eurozone bank shares are amongst the worst performing today. The sector has fallen 1% overall, greatly outpacing the wider market dip.

The biggest movers include Sabadell, with losses in the region of 1.1%, Credit Agricole, off 1.5%, UBI Banca, down 1.7%, and ABN Amro, also down 1.7%.

The sector has been hit by weak Eurozone government bond yields, which are currently hovering just above record lows. The German 10-year bund currently yields -0.311%. That’s just above the -0.329% record low seen last Tuesday.

All eyes are back on the Federal Reserve ahead of a set of speeches, including one from chair Jerome Powell during the US session.

Federal Open Market Committee members signalled after last week’s policy meeting that a rate cut was on the way. This wasn’t enough for President Donald Trump, who responded that the Fed “blew it”. The President called a few months ago for 100 basis points of cuts and the reintroduction of quantitative easing.

Markets are waiting to see whether the Fed will bow to pressure and crank up the dovish rhetoric. President Jerome Powell has so far had little time for the President’s attempts to intervene. But with market expectations racing way ahead of what the data and policymakers themselves would suggest is necessary and a President intent on getting a weaker dollar to help him in his trade battle with China, can the Fed afford to go at its own pace?

Elsewhere stocks were holding near opening levels, with losses capped by the merger of two of the biggest business consultancies in Europe. The deal sees Capgemini purchasing Altran for €3.6 billion. Shares of Capgemini are up 7% to trade at a 2-month high, while Altran shares, reflecting the selling price, have shot up 21%.

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