The year so far

Stocks Up 

Today: Stocks are firmer this morning picking up a positive handover from Wall Street’s quarter-end rally on Friday and upbeat session in Asia overnight. Data later includes the US ISM manufacturing PMI. Treasury secretary Yellen is heading to Beijing July 6th-9th. US holiday tomorrow might keep it relatively quiet to start the week. RBA might hike tomorrow but looks like a coin toss after last week’s inflation slowdown. France riots situation seems to be not quite as bad as it has been. Tesla delivered 466,140 cars – a quarterly record and 83% ahead of last year…price cuts bearing fruit – shares up 5% in Frankfurt this morning. China’s top-selling BYD also set a quarterly record with more than 700k deliveries.  

2023 in a nutshell  

Economically nowhere near as bad as feared – recession seems to have been avoided for now but the risks of a policy mistake by central banks are higher than ever as we approach the final straight in tackling inflation – the last yards will be the hardest. As for markets, stocks have outperformed expectations but the breadth has been generally narrow and concentrated in megacap tech in the US.   

Central banks have maintained a hawkish stance and been tougher than markets have thought – in fact markets have consistently priced in too few hikes and seen CBs pivoting to cutting rates way too early. Disinflation has started to appear more pronounced, but core inflation remains too high and in some places we can see wage-price-spiral conditions.   

The banking sector went through a major wobble, with the failure of a series of mid-size US banks and Credit Suisse; regulators took an ad-hoc approach to solving the unfolding crisis and the Fed began shovelling liquidity in through the back door to shore things up. This positive liquidity flow is reversing into H2.  

Stocks have been doing well after big FOMO rally through to the middle of June. Debt ceiling unclenching, Fed pause, earnings resilience...and of course the AI curve ball. The emergence of AI as a thing in the earnings calls was one of the biggest changes in the first half. But towards the end of the half-year we saw some mean reversal - equal weight SPX has fared well relative to the NDX in June but across the year it was a handful of mega cap tech stocks that did all the lifting.  

Oil prices have trended lower without too much alarm, largely the China reopening story was less impressive than we’d maybe thought at the start of the year. Gold rallied but has been less impressive in the second quarter; silver down by the same amount as gold is up; copper is down fraction this year whilst platinum and palladium are both down heavily.  

The Bank of England tried to push back against market pricing for hikes and got schooled – the last 50bps in June was a moment when it realised it had to create a recession to cool inflation sufficiently. The Federal Reserve paused but has signalled more to come – and it might need to do even more than another 50bps. The ECB is arguably sounding more hawkish than any other major central bank. Pressure on the RBA and BoC to hike again has eased with inflation coming down. The BoJ seems scared to change course but there are signs that decade-long structural reforms (Abenomics) is paying off and inflation could become more sustainable. A slowing in export demand as rate hikes catch up with Europe and the US might be a reason to think Japan could slow in the second half. 

What to look out for the rest of the year  

It’s been a good start, but pride comes before a fall. Policy mistakes...CBs might overtighten and create recessions. These are called mistakes but in reality that is part and parcel of a hiking cycle – the Fed thinks it might get away with a soft landing...the ECB is turning a blind eye to recession risks, with Lagarde sounding very hawkish last week despite the soft economic data, whilst the BoE has basically admitted it’s in recession-creating mode because core inflation won’t die. The BoJ is a bit of a mystery still but they could surprise us still. 

Another big to watch for in the coming weeks is the liquidity drain. It comes down to the question of whether the reverse repo facility (RRP) can drain enough to absorb the new issuance or not. I think the story of H2 will be the rolling over of liquidity and markets will become a lot more volatile. The impact of the liquidity drain will depend on how much money market funds can absorb as they shift out of the Fed’s overnight reverse repo facility (RRP).