Gilt Yields Jump, BoE Faces Stern Test

Make gilts boring again  

UK 2yr gilt yields jumped above 4.73%, the highest since September 28th when the mini-Budget was doing its wrecking ball job. This time is different – LDI has unleveraged, and it’s not about the fiscal or political risk premium. It’s all about strong wage numbers driving expectations for the Bank of England to need to press hike button again and again. We are now in wage-price spiral territory – private sector wage growth rose to 7.6% in the three months to April, whilst overall regular pay rose 7.2%. This only makes it harder for the BoE to cool inflation – a tougher stance is required but we know the dangers for the economy and notably the mortgage market if that happens. Andrew Bailey speaks later today. 

Greener Pastures 

Stocks in Europe drifted a bit higher after Wall Street notched its best close in a year. The S&P 500 rallied almost one percent to 4,338, its best since April, whilst the Nasdaq rose 1.4% for a 14-month high as Apple hit a fresh all-time high. The FTSE trades a tad firmer but still below 7,600 where resistance was felt yesterday. On Monday the blue chips closed 0.11% higher at 7,570, while the FTSE 250 rallied 0.52% at 19,190. Elsewhere – German CPI inflation ticked lower in May, down 0.1%, with the YoY figure down to 6.1% from 7.2% in April. China’s central bank cut a key short term lending rate for the first time in almost a year, giving a boost to Chinese and Asian equities overnight. 

Well, Fed 

The Fed meeting kicks off today with the US CPI data forming the key data point ahead of tomorrow’s statement. JPM: “The inflation news continues to evolve in a positive direction. The early reports on May CPI have largely come in below expectations … most forward-looking indicators ... line up nicely to point to a sustained downshift in inflation.” Credit Suisse: “Our work indicates that YoY inflation is likely to fall to 4.2% in May, 3.2% in June ... this would represent one of the greatest drops experienced in a 2-month period over the past 70 years.” The Cleveland Fed’s nowcast of inflation points to month-on-month inflation of 0.19% and core inflation of 0.45% = annualised inflation rate of 4.1% and 5.3% respectively.  

So, does the Fed hike? Mark McCormick, Global Head of FX and EM Strategy at TD Securities, says: “TD expects the Fed's final hike, offering Powell a moment to drop the mic. While a surprise hike might sound USD bullish, we demur. A Fed hike this week would likely to send a signal that the cycle is over, especially as data has been mixed recently”. Citi: "In our base case the Fed will simply raise rates 25bp this week. This is out-of-consensus but more logical than signalling more hikes will be necessary but then delaying the next hike until July.”  

SPX – What's next?  

Now 20% off its lows. So, is this a new bull, or an old bear? BofA says ‘bye, bye bear’, pointing out that 90% of the time the S&P 500 rises in the 12 months after it exits a bear market. Barclays notes that there have only been two comparable instances of such narrow stock leadership over the last three decades. “The leaders collapsed in 2000 ... whereas in 2020 the leaders delivered on earnings.” They reckon the current episode will resemble 2020.  

GS’s Kostin: “We raise our S&P 500 year-end price target to 4500 (from 4000), representing 5% upside from the current 4299 level… prior episodes of sharply narrowing breadth have been followed by a ‘catch-up’ from a broader valuation re-rating”  

Mike Wilson at Morgan Stanley remains doggedly bearish, but says: “the main piece of pushback we receive is that our base case earnings estimate of $185 is likely far too low ... it's worth pointing out that a 2023 earnings outcome of $185 does not even take us back to the historical trend … With the S&P 500 rally now crossing the 20% threshold, more are declaring the bear market officially over. We respectfully disagree due to our 2023 earnings forecast.”  

Remember, historically the S&P 500 doesn’t bottom until 6 months after the first rate cut.  

Elsewhere...  

GBPUSD traded higher on the UK employment and wages news along with gilt yields, pushing to 1.2560 to erase a chunk of yesterday’s losses as it ran into long-term trend resistance at 1.260. The dollar however is being roundly offered with DXY dropping to its weakest since May, testing the 100-day SMA. 

Crude oil – Spot WTI towards the lower end of the range, finding some near-term support at $67, the May 31st low. OPEC monthly report coming up.