Stocks climb but price action still choppy

Morning Note

Choppy: Stocks are firmer in early trade following yesterday’s losses. For all the movement we have seen, the FTSE 100 is tracking slap in the middle of its 6-month range. But now it’s facing near-term resistance from its 50-day and 100-day averages at 7,092/7,078, which seem to be capping any rallies at the moment, whilst the 200-day support at 6,913 is looking good for a retest. The DAX moved up more than 1%, or about 170pts, to around 15,150 as it looks to recover its 200-day moving average at 15,037. You are in ranges now where you feel it could break either way – as noted earlier this week you need to feel that the repricing for risk from a different macro outlook and rate environment (higher yields) has bottomed, that the valuations are looking healthier, earnings can deliver beats not misses and that we’ve passed peak inflation/stagflation ‘fear’ (if not the actual environment, which could last for many months).

Wall Street reversed early losses to rally on signs of progress on the US debt ceiling. The Dow Jones industrial average erased a drop of 400pts to end the day up 100pts. The S&P 500 rallied 0.4% as mega-cap tech rallied as bond yields didn’t really push on and investors thought they’re close to being oversold. But it’s still all rather indecisive. The S&P 500 continues to chop around its 100-day SMA and the 4,300 area. Futures are indicating higher with 10yr yields back down to 1.52% from 1.57% hit yesterday, the highest since June.

Senate Minority Leader Mitch McConnell said Republicans would back a short-term motion to raise the debt ceiling. “To protect the American people from a near-term Democrat-created crisis, we will also allow Democrats to use normal procedures to pass an emergency debt limit extension at a fixed dollar amount to cover current spending levels into December,” he tweeted.

ADP reported that private payrolls increased by 568k jobs last month, easily topping expectations. Allowing for the usual ADP caveats, this is a positive signal ahead of the nonfarm payrolls report on Friday – remember a key release ahead of the Fed’s November meeting re tapering.

Natural gas was the big story as prices spiked out of control in Europe/UK. US Henry Hub prices did reach a new multi-year high before reversing, apparently on comments from Vladimir Putin who said Russia would seek to stabilise the market and pump more gas. There is a lot going on there – political machinations aplenty and questions over whether much of the problems in the market have been Russia’s doing in the first place (weaponization of gas), but it did seem to cool the market. Prices are down 15% from yesterday’s $6.46 peak and now testing lowest in a week around $5.50 and possible bearish MACD crossover in the offing could signal a top.

Oil was weaker too as it also seemed to consolidate after extending the rally into overbought conditions – as highlighted on Tuesday. Inventories were mildly bearish too, rising 2.3 million barrels last week. The US said it was considering releasing oil reserves to cool prices – always a political hot potato in the US as much as in Europe. WTI is close to 5% below yesterday’s high at $76, possible test of near-term Fib and trend support around the $75.60 area.

Crude Oil Futures 07.10.2021

Talking of rising fuel costs, these are feeding into rising inflation expectations. UK inflation expectations topped 4% for the first time since 2008. A gauge of US inflation expectations has moved to its highest since June.

In FX, the euro made fresh YTD lows yesterday but is steadier this morning, with EURUSD back to 1.1560. Looking a tad oversold but the fresh low needs to mark a bottom soon or further selling can take off on another leg lower.

EURUSD Chart 07.10.2021

Stocks look to end week on a high as travel stocks catch tailwind

Morning Note

European markets on a firmer footing on Friday – FTSE 100 made a bold move at the open to recapture the week’s intraday high at 7,093 struck on Monday before pulling back, still trades up roughly half of one percent in early trade. This comes after a lacklustre session on Wall Street – Nasdaq up a touch, S&P 500 down a touch after the textbook bounce off the 50-day SMA on Thursday. Cyclicals were higher along with real estate, while basic materials and energy declined as oil pulled back from its highs and precious and some other metals took a hit. Stock markets on either side of the pond now just in the green for the week, Nasdaq just a tad lagging at the moment. Better session for the Hang Seng but still down 5% for the week.

 

Airlines and associated travel stocks are among the top performers this morning on hopes for the relaxation of international travel rules. Ministers are looking to scrap the need for the double-jabbed returning to the UK to take PCR tests, whilst the traffic light system would be scrapped. This would remove a huge blockage for the industry, though what hoops you need to go through once you get to your destination is another matter… ‘your papers please’…’I just wanted a sandwich!’. Anyway, shares in the likes of TUI and IAG rose around 4%. SSP – which does the sandwiches – up 3%. WH Smith +2%.  Informa – which does conferences – also benefitted as it ought to make business travel less of a headache for those HR teams. Not all travel shares were up – EasyJet fell another 1%. HSBC rallied on two upgrades. IHG also got a boost as Berenberg upgraded to buy. Wickes rose 5% after Deutsche Bank raised the stock to buy. 

 

UK retail sales missed expectations in August, but people are spending more on doing things than they are stuff. We had 18 months locked up to order patio sets and games consoles. Now is the time to get out and go the pubs, restaurants or whatever it is you like to do. 

 

After bemoaning the lack of FX volatility earlier this week, yesterday saw it reappear. The main story was a stronger dollar, which rose to its highest in three weeks after some surprisingly good US data. US retail sales rose +0.7% vs –0.8% decline expected, which signalled resilience among consumers as delta fears start to ebb and perhaps indicates spending will start to improve as US households unwind savings again after a period of caution. JPMorgan’s latest spending data report showed consumer spending well above July/August levels. More good news for the US economy emerged as the Philly Fed manufacturing index jumped as price pressures eased. 

 

And now an FT report claiming the European Central Bank is far closer to raising rates than official communiques indicate has the market guessing. The report cites an internal memo saying the ECB is on track to hike rates in about two years’ time, a year earlier than forecast. EURUSD has caught some bid after hitting its weakest since late August but this could just as well be about a paring of dollar gains after an outsize move yesterday. I would not be surprised if the ECB were to keep schtum over a possible earlier rate hike, as it won’t want the euro to rally, however such a hawkishness would go against everything we have come to learn about the ECB over the last decade. It maybe reflects internal concerns that inflation will be stickier than central banks admit right now and that they will be forced into adopting a less accommodative stance presently. On that note, markets are keen to see what the Bank of England does next week to get a grip on inflation.

 

EURUSD: potential inverted head and shoulders but near-term momentum with bears – note bearish MACD crossover. Current price action is tracking a well-worn channel. If a test of 1.6660 fails then we look to recover 1.19. If this gets taken out first and confirmed, looking for 1.22.

Gold was hammered yesterday as the dollar rose and Treasury yields spiked on the better US data. Whilst neither of the data sets should materially alter the Fed’s decision next week, they do nudge things in favour of the USD and spikier yields. The MACD indicator again provided us with a good signal last week for a short. Could be a shakeout of the weaker hands before resumption of attack on $1,830.

UK growth cools and is there still more downside to this market pullback?

Morning Note

Reopening can’t come soon enough: UK GDP expanded by a meagre 0.8% in May, led by indoor hospitality, but held back by a global chip shortage hitting car production. The monthly growth rate was below the 1.5% forecast and leaves the economy 3.1% below its February 2020 pre-pandemic size.

Stocks sold off on Thursday. The kind of worries that have seen narrowing breadth and overbought conditions for the major indices broke over the broader market. Concern about China regulatory pressure on big tech, and concerns about antitrust stuff in the US have gnawed away at the margins. Worries about the rise of the Delta variant globally are also a factor – Tokyo’s decision to ban spectators was taken as a warning that Covid the pandemic is far from over. The biggest worry it seems it this sense that we have hit peak growth – and hit peak expectations a couple months back as evidenced by the top in the commodity market. The last one-two months has seen mega cap growth do all the lifting as the reflation trade unwinds but even with lower rates we saw the market come off yesterday, so there is just this broad sense of being overblown after a 5% rally for the S&P 500 in the last fortnight, while the Treasury market is not making much sense at all and the recent plunge in yields is apparently without any justification and being explained away as a technical thing. This is true but it is not entirely the whole story, and we now face the risk of the 10yr being at 1% at year end and not 2%. Or at least that is what the market seems to be saying – in fact I’d expect once this flushing out of the market (painfully), normal service will resume with the Fed beginning to signal the taper in Aug/Sep.

The US 10yr note yield rallied off a low at 1.25% to reach 1.33% this morning. US equity indices finished Thursday down but well off the lows. The S&P 500 fell 0.86% to 4,320 after hitting a session low of 4,289. The Dow Jones declined 260pts but was about that much off the low of the day by the close. The S&P 500 could still drop another 100 pts to the 4215 area to perform the tap on the 50-day SMA that has been a feature of recent pullbacks. After running up 5% in just two weeks it was ripe for a pause, if not a deeper pullback – the 50day line looks appealing. Current trailing PE of 30 for the S&P 500 suggests it’s heavily overbought – earnings season kicks off next week and with high expectations and the broad market +15% YTD it could be a sell the news affair.

Still a bull market: corrections like these are seen as ‘healthy’, rotation is about positioning for growth not running for cover. Bank of America’s closely followed Flow Show notes that ‘poor level of yields and Wall St dependent Fed remain key reasons why stocks and credit investors still believe in TINA’. Futures this morning indicate a higher open on Wall Street.

The Dow transports index slipped 3% with Biden taking aim at rail and sea shipping with an executive order addressing competition in the US economy. Pain for meme stocks continued with AMC, GME falling sharply in early trade before ending the day higher in an impressive turnaround. Meanwhile, the US is to place more Chinese companies on its blacklist. San Francisco Fed president Mary Daly warned on prematurely declaring victory over the pandemic.

Signs of inflation cooling? China’s factory gate price growth cooled in June, as the rollover in the commodity market following the May peak eased cost pressures. China’s producer price index still rose 8.8% in June, but this was down from the 9% growth in May.

The FTSE 100 is higher in early trade Friday to recover some of the ground lost on Thursday when it declined 1.7%. Continues to tread a 3-month range as the 78.6% Fib level at 7.155 continues to prove a tough nut to crack.

FTSE 100 performance as indicated on multi-symbol chart.

S&P 500: Looking for the 50-day tap on the S&P 500 before the weakest hands are flushed out?

S&P 500 performance indicated on a chart.

EURUSD: looking for a breakout of the trendline, potential bullish crossover on the daily MACD coming?

EURUSD chart showing currency pairing performance.

Stocks firm ahead of jobs report, waiting on OPEC

Morning Note

European stocks rallied again in early trade after yet another record high for Wall Street as investors look ahead to today’s big jobs report from the US. The FTSE 100 rose above 7,150 for its best since Jun 18th and close to the post-pandemic peak set a few days before at 7,189.63. The DAX was up 0.4% in early trade to 15,666. Travel & leisure, basic resources and tech lead the way higher on the Euro Stoxx 600 this morning, whilst banks and retail are down. Earlier saw the S&P 500 notch a 6th straight record close, finishing above 4,300 for the first time at 4,319.94 with all sectors in the green, led by a 1.6% pop for energy stocks on higher oil prices.

All eyes today turn to the US jobs report, the monthly nonfarm payrolls. Initial jobless claims declined to 364,000 last week, data yesterday showed, the lowest level since the pandemic started, but there are still more than 11m Americans receiving pandemic-related benefits. Today’s NFP is expected to print around 700k, but as ever the range of estimates is quite wide. That would imply an improvement from May’s 559,000, while the unemployment rate is expected to decline to 5.6% from 5.8%. Whilst we know the Fed has signalled it’s not ignorant to inflation risks, we also know that the labour market is a key factor in determining the likely timing and pace of tightening when it does happen. Since the Fed’s last meeting, which the market took as a sign of more hawkishness (from a very dovish base), the equation for markets has changed slightly. US 10-year yields trade around 1.46% ahead of the report, whilst US equity index futures are mildly higher.

OPEC failed to agree on an increase in production yesterday, as the UAE emerged as a dissenter against plans to gradually raise production by an additional 400k bpd each month through to December until the baseline for its own output is raised. The agreement in principle would also have led to the production deal being extended through to the end of 2022. The failure of OPEC members to agree to the deal means the planned OPEC+ meeting has been pushed back to today and could go on into the weekend. If OPEC cannot agree a deal, it could mean there is no agreement to gradually raise output, leaving production at current levels and forcing prices higher in what’s already seen as a very tight market.

WTI (continuous) remains well supported above $74.20 after spiking on yesterday’s news before paring gains a touch. The market seems to still expect a deal to be struck – failure could see another leg up.

Chart indicating movement of oil spot contracts.

Elsewhere, the bid for the dollar we have seen all week continues, with GBPUSD trading at the lowest since mid-April at 1,3750, which yet take it back to the double bottom at 1.3660.

GBPUSD performance indicated on a chart.

EURUSD also dropping to weakest since early April, bear flag playing out still, possible extension to the March low at 1.170. But in both cases the dollar is starting to look a little stretched.

Performance of the EURUSD currency pair.

Bitcoin futures around $33k, still trades under 200-day SMA.

Performance of Bitcoin contracts.

European stocks kick off July with strength, eyes on OPEC+

Morning Note

European stock markets have made a solid start to the second half of the year, making up for yesterday’s losses, whilst Asian shares got the session off to a soft start. Equity indices are looking positive this morning as the FTSE 100 rose 1% and popped above 7,100 again, with the Euro Stoxx 50 and DAX also both +1%, but continue to tread over well-worn ranges.

European and global stock markets have enjoyed a strong run-up in the last six months as a combination of ultra-loose monetary policy, fiscal largesse and a vaccine-enabled reopening of economies allowed investors to look ahead to a brighter future for earnings and growth. Now there are risks on the horizon, but the market remains biased to the upside. That’s been evidenced by fresh record highs on Wall Street as the S&P 500 notched its fifth-straight record closing high. The broad index has risen more than 14% this year, while both the Nasdaq Composite and Dow Jones are up by more than 12%. As bond yields remain subdued, US markets have benefitted from a rotation out of the reflation/reopening trade back into the mega cap growth/tech/growth area of the market, which is propelling the market to new records. The lack of such companies in European indices is perhaps a factor in why they have failed to keep pace.

Data from Asia overnight showed China’s Caixin Manufacturing PMI slipped to 51.3 from 52.0, amid concerns about cases in Guangdong. Meanwhile Japan’s Tankan survey showed a bounce for large manufacturers, with the index up to +14 from +5, its highest level in two and a half years. Services was less positive at +1 from -1.

Eyes on the NFP report tomorrow – still expected at around +700k for June. Yesterday’s ADP report printed 692k vs 600k expected, though the headline beat was offset by revisions to the previous report. Anyway no one cares about ADP – the key labour market tomorrow will be a market mover. Still in the US, pending home sales jumped 8% in May compared with April, the highest level of activity for the month since 2005. Today sees the release of the US ISM manufacturing PMI (exp. 61) and initial jobless claims (exp. +388k).

The focus today is on the oil market as OPEC and its allies convene to decide on production for the month of August and potentially beyond. As we explained in our preview, whilst the market is increasing tight there are one or two concerns about the rise of the Delta variant and what that could do to demand in the second half of the year. OPEC thinks demand should rise 6m bpd in 2021, with 5bpd of that figure due to arrive in H2. This presents a risk as oil demand recovery is weighted to the second half of the year and may not emerge due to new restrictions on mobility in response to new waves of the virus. This could leave OPEC+ cautious about raising output now. Moreover, it does not have the spectre of US oil dominance hanging over it in the same way as it has had in the years preceding the pandemic. US oil production remains about 2m bpd short of pre-pandemic levels and the whole paradigm of US energy has pivoted since the election. The US is not the swing producer anymore and can’t just open the spigots at will, which leaves OPEC holding all the cards.

EURUSD bear flag: Solid US data helped lift the dollar, with EURUSD hitting its lowest since April. That bear flag highlighted earlier this week proving reliable and seems to confirm a breakout from the bullish channel of the last year or so. With the new low consider possible extension to the 1.1705 March low, also the 38.2% retracement of the 2016-2018 rally.

Chart indicating EURUSD currency pair performance on 01.07.2021.

Dollar index highest since early April, extending gains after rebounding from the double tap on the 200-day SMA.

Dollar Index performance displayed on chart.

USDJPY: Eyeing breakout from the channel as it keeps above 111 and looks tests the trendline resistance around 111.250. Break of the trendline calls for test of March 2020 highs around 111.70.

Performance of the USDJPY currency pair.

 

Markets look for direction from ECB, US CPI inflation

Morning Note

European stock markets were again lacking direction ahead of today’s closely awaited ECB meeting and a hotly anticipated inflation reading from the US. The FTSE 100 trades a little higher, the DAX a little lower. Wall Street closed lower with the major indices holding to well-worn ranges. The S&P 500 down 0.4% to 4,219.55 but remains just a few points below its all-time high of 4,238.04 set on May 7th.  

Meme stocks attracted the most interest as Clean Energy Fuels – the fourth most talked about stock on the /Wallstreetbets thread yesterday – rallied 31%. AMC fell 10% and Clover Health dropped 23% after a monster rally in the previous session. Today’s most-discussed stocks include WISH, CLF, WKHS, AMC and TLRY. 

 US inflation reading key risk event

If there is a worry about inflation – today’s US CPI print will tell us a lot – then the bond market is not showing it. US 10yr yields fell under 1.49% to the lowest level in 3 months. This is not just a Fed thing – the yield on longer dated paper such as the 30yr is also well off its 2021 highs. Today’s inflation reading still poses a risk to the market. The annual rate is forecast to climb to 4.7% in May, from 4.2% in April, whilst the core reading is seen at 3.4%, with the month-on-month at +0.4%. With the Federal Reserve anchoring its policy goals to employment, another hot reading won’t be too much to worry about. Nevertheless, the print will still lead to some volatility at 13:30 (BST) in index futures, numerous FX crosses and gold. An above forecast inflation reading would reignite market taper fears, albeit this is likely to be short-lived and one to fade as the Fed still has control of this, at least to the extent that the market believes it does.

ECB set to hold steady for now

The European Central Bank (ECB) convenes today amid a much rosier economic outlook than at the start of the year. But with the central bank having communicated its plans to front-load asset purchases, there is not expected to be any material change in policy or communication. It will be hard to avoid taper talk so how the ECB responds to questions around tapering will be of central importance to the market’s expectations and the euro. At the March meeting the ECB said it would pick up the pace of asset purchases, front-loading the PEPP scheme, but that it could still use less than the full envelope of €1.85tn if favourable financial conditions can be maintained without spending it all. The outcome of the March meeting was very much that the PEPP programme is more likely to end by March 2022 than be extended, albeit policy will remain very accommodative well beyond that point. Today it’s likely the ECB will support continuing running PEPP at around €80bn a month before starting to taper in September. 

Yields have been pressing higher but have retreated from the May peaks. The increased pace of asset purchases that was agreed in March came as a response to rising yields at the time. But the economic outlook – chiefly driven by a strong vaccine rollout that was slow to start but is now firing on all cylinders – has improved greatly since then. The ECB has been taking the line that inflation is temporary and rising bond yields reflect better fundamentals, so I don’t think it will be unduly concerned by a higher rate environment now due to the better economic picture. This will make talk of a taper very difficult to ignore. The language around the speed of asset purchases may change somewhat, and this could drive EZ yields + EUR higher. It will be very interesting to see what the ECB says about the state of financing conditions, and it is sure to continue to tie PEPP purchases to maintaining these as ‘favourable’.  

The big risk for EUR crosses around this meeting is: does the ECB silence taper talk with enough vigour to keep yields in check, or does it allow the market to think the more hawkish voices are winning the argument about when the central bank eventually exits emergency mode? With the ECB seen in a holding pattern, there is quite a low bar for a hawkish surprise.

Inflation has picked up since the last meeting, which could see the forecast for 2021 and 2022 revised upwards from the March level. EZ inflation rose to 2% in May from 1.6% in April, the first time it’s been on target in over two years. With growth in Q1 a little light, the rebound in the summer should mean GDP projections remain broadly unchanged. 

ECB speakers have been offering a few titbits since the last meeting. Of particular importance to the speed at which the ECB will exit emergency mode, Christine Lagarde stressed that inflationary pressures will be temporary – sticking to the global central banker script. At the April meeting she said tapering talk was premature. But she remains caught between the hawks and doves. Kazaks and Lane made it clear policymakers will look at the asset purchase programme again in June, which could involve scaling back the programme if the economic situation is better.  There were dovish comments from Panetta in late May, noting that it was too early to taper bond purchases. Banque de France Governor, Villeroy de Galhau, stressed that the ECB is going to be at least as slow to tighten as the Federal Reserve. 

Finally, London’s IPO market is showing signs of fatigue. Broker Marex has pulled its planned listing, while fuel cell company Elcogen and miner Tungsten have both delayed planned floats. Whilst there may be more to the Marex decision than simply ‘challenging IPO market conditions’, it does rather seem there is some amount of investor fatigue after a deluge of new issuance in the first quarter. Wise to pause. In the case of Marex, it may be wise to steer clear. 

ECB preview: no big changes ahead of Jun 10th meeting

Forex
  • No material changes expected 
  • More hawkish (EUR positive) more likely than more dovish 
  • Brighter economic outlook since March 

The European Central Bank (ECB) convenes on Thursday (Jun 10th) amid a much rosier economic outlook than at the start of the year. But with the central bank having communicated its plans to front-load asset purchases, there is not expected to be any material change in policy or communication. It will be hard to avoid taper talk so how the ECB responds to questions around tapering will be of central importance to the market’s expectations and the euro. 

At the March meeting the ECB said it would pick up the pace of asset purchases, front-loading the PEPP scheme, but that it could still use less than the full envelope of €1.85tn if favourable financial conditions can be maintained without spending it all. The outcome of the March meeting was very much that the PEPP programme is more likely to end by March 2022 than be extended, albeit policy will remain very accommodative well beyond that point.  

To taper? 

Yields have been pressing higher but have retreated from the May peaks. The increased pace of asset purchases that was agreed in March came as a response to rising yields at the time. But the economic outlook – chiefly driven by a strong vaccine rollout that was slow to start but is now firing on all cylinders – has improved greatly since then. The ECB has been taking the line that inflation is temporary and rising bond yields reflect better fundamentals, so I don’t think it will be unduly concerned by a higher rate environment now due to the better economic picture. This will make talk of a taper very difficult to ignore. The language around the speed of asset purchases may change somewhat, and this could drive EZ yields + EUR higher. It will be very interesting to see what the ECB says about the state of financing conditions and it is sure to continue to tie PEPP purchases to maintaining these as ‘favourable’.  

The big risk for EUR crosses around this meeting is: does the ECB silence taper talk with enough vigour to keep yields in check, or does it allow the market to think the more hawkish voices are winning the argument about when the central bank eventually exits emergency mode. 

New projections 

Inflation has picked up since the last meeting, which could see the forecast for 2021 and 2022 revised upwards from the March level. EZ inflation rose to 2% in May from 1.6% in April, the first time it’s been on target in over two years. With growth in Q1 a little light, the rebound in the summer should mean GDP projections remain broadly unchanged. 

What has the ECB been saying lately? 

ECB speakers have been offering a few titbits since the last meeting. Of particular importance to the speed at which the ECB will exit emergency mode, Christine Lagarde stressed that inflationary pressures will be temporary – sticking to the global central banker script. At the April meeting she said tapering talk was premature. 

Kazaks and Lane made it clear policymakers will look at the asset purchase programme again in June, which could involve scaling back the programme if the economic situation is better.  There were dovish comments from the Panetta in late May, noting that it was too early to taper bond purchases. Banque de France Governor, Villeroy de Galhau, stressed that the ECB is going to be at least as slow to tighten as the Federal Reserve. 

But we’ve also had warnings about financial stability risks stemming from rising levels of sovereign debt. Vice president de Guindos warned of a “legacy of higher debt and weaker balance sheets which … could prompt sharp market corrections and financial stress”. 

Technical outlook 

Right now, the price action has flipped above the 5-day moving average (RHS), so we look for a confirmation of this move (close above today and a green candle again tomorrow) for a bullish signal. On the LHS, the longer-term view of the daily MACD divergence is raising a warning flag. 

EZ economic activity picks up, UK retail sales soar

Morning Note

European markets are tentatively higher in early trade on Friday, solidifying gains from Thursday’s upbeat session as global stocks made gains. DAX traded not far off recent intra-day all-time high at 15,440, but 15,500 continues to act as headwind for bulls and early gains were largely pared after one hour of trading, whilst the FTSE 100 dropped more than half of one per cent in early trade to drop under the key 7,000 level. Tech shares led a rebound on Wall Street as stocks in the US snapped a three-day losing streak. The S&P 500 rallied over 1% to 4,159, with the Nasdaq up 1.8% to 13,535. NDX rallied almost 2% as the big tech names that have the biggest impact on the index put in a strong day with Apple and Netflix both up 2%, with other FAANGs rising 1% and Tesla +4% and ARKK rose 3.5%. Futures indicate the major US indices will open higher later.

On the FTSE, tech and energy are leaders, whilst healthcare and industrials (yesterday’s gainers) are lower as the market continues to really chop around these 6,850-7,150 ranges. Until we see a breach in either way, this is our stomping ground for the time being. The big rejection of the 6800 handle on May 13th indicates little appetite for the lower end, but many factors are at work here. Not least, as discussed yesterday, the exposure of basic resources and energy stocks to the growth in emerging markets that could be affected by covid.

Chart showing FTSE 100 price movements.

UK retail sales beat expectations as all that pent-up demand was unleashed in April as non-essential shops were allowed to reopen on the 12th of the month. Sales rose 9.2% from March, versus forecasts of +4.5%. GBPUSD was bid up to 1.42 ahead of the release before peeling back to the 1.4180 area.

PMI numbers show progress in Europe, with the composite index for the Eurozone at 56.9 vs 55.1 expected, helping to keep EURUSD close to a 3-month high, however it keeps hitting a brick wall at 1.2240 and has retreated a touch from here this morning to sit at the 78.6% retracement of the Jan-Mar drop. With a potential topping patter at this area we could look to a retreat to 1.2170 area should the dollar catch any yield-related bid. Upside breach of 1.2240/5 area, the Feb swing high, calls for return to the Jan highs. Of course it all depends on markets’ analysis of the relative pace of change in expectations for the ECB and Fed tapering actions.

EURUSD currency pairing performance on May 21st.

Gold remains steady around the 50% retracement of the Aug-Mar decline. Treasury yields are steady, with 10s around the 1.64% level – so far not seeing much direction from the bond market but I’d expect this to shift up a gear soon.

Chart displaying gold price as of May 21st 2021.

WTI is testing nearly one-month lows at the $62 handle following the last couple of sessions’ weakness. Fears about tapering maybe, fears about demand in Asia rolling over and fears about Iranian crude coming back on the market certainly. Potential triple top could herald breakdown to the $60.60 area after downside breakout of the longer term trend line. But if bears can’t get it here then look for rebound to the $64 area.

WTI price movements.

ECB preview: Keep it simple

The European Central Bank (ECB) convenes today for its latest policy meeting. After last month’s word puke from Lagarde (“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.”), we have spent several weeks trying to accurately assess where the ECB is really at in terms of responding to the changing economic outlook with regards the recovery from the pandemic, rising bond yields and higher inflation expectations. There is greater clarity now – it looks like the ECB is happy to let inflation run higher and only let bond yields move up if due to better growth: it’s now all about real yields. At the last meeting the ECB said it would pick up the pace of asset purchases, front-loading the PEPP scheme, but it could still use less than the full envelope of €1.85tn if favourable financial conditions can be maintained without spending it all. The outcome of the March meeting was very much that the PEPP programme is more likely to end by March 2022 than be extended, albeit policy will remain very accommodative well beyond that point. The question about tapering PEPP should wait until June, and ending the programme may need to be discussed in September, but for now the ECB should be looking to keep it simple.

This ought to be a quiet one for the ECB, but the propensity for miscommunication is strong. Since the March 11th meeting, the selloff in sovereign debt and rally in yields cooled, before picking up some steam again. While German 10-year bunds are north of where they were at the time of the March meeting and close to the February highs, real rates remain at historic lows. This is what matters to the ECB more than nominal rates. Moreover, the economic data has not materially changed since the last meeting and there signs the largest economies are adapting to lockdown restrictions better than before and are more resilient. The latest Zew survey about the German economy shows investor sentiment at its highest in over a year. The head of the French central bank recently noted that economic activity is declining less than feared in April. Vaccinations, slow to start, are picking up pace and the EU should be on course to catch up the UK and US before too long.

So we look rather to the risk that a hawkishness creeps in. The ECB will need to be careful about getting itself tied in knots about when and how it will exit PEPP just yet, and whether a PEPP taper coincides with raising traditional asset purchases, and just what the reaction function is given it’s spent several weeks trying to clarify this since the last meeting. Now is not the time for such debates, however markets will look towards hawks becoming louder as inflation starts to pick up. Hawks are going to get more vocal if inflation starts runs higher over the next few months – the mandate is clear on this one. Lagarde will need to not sound overly confident about the recovery (why should she anyway?), or else risk letting markets latch on a timeframe for winding down PEPP.

And we should note that chatter about when is the right time to exit emergency mode is coming just as the ECB is looking at a potential change to the inflation mandate. Not content with a more symmetric target a la the Fed, it also wants to introduce inequality and climate change mandates…This only makes guessing the future path of monetary policy and the ECB’s reaction function even more muddy, which in turn may lead to some form of spike in yields and widening of spreads, which exactly what the ECB is seeking to avoid. Another reason to keep it simple tomorrow.

Tighter financial conditions ahead?

The ECB will also have to wrestle with the expectation of tightening financial conditions in the Euro area later this year. Banks and Eurozone banks expect to tighten access to credit in the second quarter, having already tightened in the first quarter. “This reflects banks’ uncertainty regarding the severity of the economic impact of the third wave of the pandemic and the progress in the vaccination campaign,” the ECB said, adding that loan demand is also faltering as companies postpone investments.

The ECB’s job is to make sure it doesn’t get dragged into a conversation about tapering PEPP and keep the markets happy until June when it will have much more data at its disposal and news on vaccinations will hopefully be much better. For this meeting, keep it simple is the order of the day.

EURUSD: Rejection of the 100-day SMA sets up today’s retest of the 1.20 round number support. Ultimately the ECB may not be the main driver of the pair right now and more exposed to broader risk sentiment and Treasury yields impacting the USD momentum.

Everyone’s suddenly talking about inflation, online retailers hit by sales tax report

Morning Note
  • Online retailers fall on sales tax report
  • Inflation in focus as yields climb
  • EURUSD outside candle

Shares in online retailers Asos, Boohoo Group and Ocado fell on reports the UK government is mulling a tax raid on companies that have profited from the pandemic. This may raise a question about opportunistic tax policy (the government is meant to be pro-business), however most people feel online retailers are not paying their fair share and the burden is falling too much on struggling high street stores. It’s never made sense that bricks-and-mortar businesses pay more in tax than the very rivals who are stripping away their market share. A possible tax hike aimed squarely at online sales presents a near-term overhang for these stocks, but they remain structurally well positioned to capture more sales as consumer habits continue to shift online. Boohoo and Asos both fell over 3% in early trade, whilst Ocado was down less at –1%. The news comes as Boohoo buys Dorothy Perkins, Wallis and Burton for £25.2m from Arcadia, following Asos snapping up Topshop etc last week. Boohoo’s purchase exposes the brand to a much broader consumer base but the online sales tax raid has somewhat overshadowed the move.

European stock markets were broadly higher at the open, extending a good run last week, whilst US futures are pointing higher today after hitting fresh record highs on Friday. The risk-on mood seems to be driven by a combination of falling case numbers in developed countries, whilst efforts by Congressional Democrats to pass Joe Biden’s $1.9tn stimulus without Republican support has delivered a fresh shot of confidence into equity markets. Vaccine setbacks – the AstraZeneca version is not so effective against the South African strain – are being largely shrugged off as cases fall. The risk-on mood is evident with Asian shares broadly higher, Brent crude taking a $60 handle and US 10-year yields are at a one-year high close to 1.2%.

Indeed, as long-end yields rise and curves steepen, inflation is shaping up to be the real test of market strength this year. Inflation is the big unknown as we don’t really know how central banks will respond – in fact I’m not sure if they know since none of the current crop of central bankers have the experience of needing to tame an inflation tiger. They are programmed to cut and ease, and tapering bond purchases has been as much as can be countenanced. The Fed did raises rates in the Trump period as the economy took off, but it was not due to rising inflation, simply to put the brakes on growth, prevent overheating and find some ammo for the next downturn.

Things have changed since then. Not least, the Fed will no longer act preemptively to cool the economy based on models of unemployment, wage growth and the Philips Curve. Instead, average inflation targeting explicitly calls for the Fed to stand pat even as inflation exceeds its 2% target. It will wait until the economy and jobs market are swinging again before hiking. Except, if inflation starts to shoot higher – and I think we have a perfect cocktail of demand and supply side forces to create inflation this year – then the Fed may need to act. Not just the Fed – the Bank of England last week said spare capacity in the economy will be eliminated this year.  I’ve consistently stressed that while the pandemic was initially deflationary, it would lead to inflation at the kind of levels that worry policymakers.

On inflation you have several forces at work. Supply side or ‘cost push’ – commodities are rising in price, supply chains are becoming more expensive and the recent manufacturing PMIs point to rising input prices. In fact, as detailed here last week, the last IHS Markit US manufacturing PMI reported that cost pressures worsened amid raw material shortages, and firms passed this on as selling prices rose at the fastest pace since July 2008. The ISM PMI noted inflationary pressures, too, as the Prices Index surged to 10-year high last month. On the demand side, higher costs are easily passed on as the fiscal and monetary stimulus has injected vast amounts of new money into the system and liquidity remains ample. US five-year breakeven inflation rates are at their highest in 8 years, whilst the 5s30s curve is at its steepest since 2015. 2s10s is at 1.10%, the steepest in almost 4 years.

All this matters in the end since if the US 10-year (risk-free) rate hits say 1.75%, it starts to lower the appeal of equities at current valuations. Tina – there is no alternative – starts to look less appealing. Bank of America says that while more than 60% of S&P 500 companies currently yield more than the 10-year does, should it hit 1.75% this percentage drops to 44%. Corporate debt markets are also at risk of a shakedown should Treasury rates move up.

In FX, the US dollar suffered a big reversal on Friday and backs my belief that the recent move higher was a bull trap. Sterling recovered $1.37 and a fresh stab at the 33-month high at 1.3760 looks to be in sight. This level held several times in late January and will a breach could see momentum follow through strongly to 1.40. Note on Friday’s outside candle on EURUSD, a possible bullish engulfing reversal as the trend support has been recovered.

Possible bullish engulfing reversal as the trend support has been recovered on EURUSD.

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