Bank of England lays ground for negative rates

Morning Note

The Bank of England is laying the groundwork for a descent into negative interest rates. This should worry us all. In a letter to banks today, deputy governor Sam Woods asked firms to detail their “current readiness to deal with a zero Bank Rate, a negative Bank Rate, or a tiered system of reserves remuneration – and the steps that you would need to take to prepare for the implementation of these”.

The letter notes that “the financial sector … would need to be operationally ready to implement it in a way that does not adversely affect the safety and soundness of firms”, and explains that “the MPC may see fit to choose various options based on the situation at the time”.

It comes after details from the last policy meeting showed that the BoE is actively considering negative rates, whilst Andrew Bailey has been at pains to stress that this does not necessarily mean they will take that route.

Indeed there is clearly a debate within the MPC going on right now that we are seeing play out in public. Last month deputy governor Dave Ramsden issued a note of caution only a day after Silvana Tenreyro pointedly backed negative rates.

It looks as though there are some clear ideological disputes among rate setters that needs to be worked out over the autumn, implying as Andrew Bailey suggested last week that negative rates are not likely on the near horizon, albeit they are being considered actively.

The problem for the Bank would be an unemployment crisis into Christmas that could put pressure on the MPC to act.

Sterling doesn’t mind too much, with GBPUSD making its highest in almost 5 weeks before paring gains a little. Bank shares also didn’t take fright, with Natwest and Lloyds higher at the open.

Money markets have already priced in negative rates next year – today’s update does not materially alter the perception that the Bank is thinking seriously about negative rates but is in no rush to wheel them out. US bond and money markets are closed today for the Columbus Day holiday.

The idea that negative rates boost lending doesn’t wash – banks are not worried about the marginal impact on net interest margins as they are about whether the principal is repaid or not. And this in the current economic downturn and threat of rising unemployment, this will weigh on banks’ willingness to lend.

Indeed, I refer you again to the San Francisco Fed study from last month that shows the ECB made a big mistake by going negative.

This noted “banks expand lending only temporarily under negative rates” and “as negative rates persist, they drag on bank profitability even more”. It concluded that while lending initially increases under negative rates. “…gains are more than reversed as negative rates persist”. And under extended periods of negative rates, the evidence shows that “both bank profitability and bank lending activity decline”.

Negative rates are meant to increase loan growth, not depress it.

Chart showing how negative interest rates will affect UK monetary policy.

 

 

 

 

 

 

 

Equities were mildly higher in European trade early on Monday. The FTSE 100 enjoyed a solid week and managed to close on Friday above the 6,000 level that has proved so tricky to hold onto.

The FTSE weakened a little in early trade back to this round number support, with energy and consumer cyclicals dragging.

The S&P 500 rose Friday and closed at its best level since the start of September when it made the all-time high. Stimulus hopes remain in the forefront but the market, as a result, remains on the hook to rumours and headlines.

Donald Trump upped his offer to $1.8tn but Nancy Pelosi said it wasn’t enough. A stimulus package is coming sooner or later, although as stressed last week, there is a risk that a disputed election result delays this until 2021.

On the slate this week: IMF and World Bank meetings kick off today, whilst we have three days until the UK’s self-imposed Brexit deadline.

Nevertheless, even if there no breakthrough comprehensive trade deal agreed this week, the two sides are pledged to continue talking right up to the last moment.

Emmanuel Macron, who faces elections in the not-too-distant future, may seek too many concessions over fishing rights, which may scupper a deal. However, with the coronavirus causing havoc with the economy, neither side has a particularly strong hand and both sides need a deal.

Wall Street banks kick off earnings season across pond – read our preview here.

Election Watch

Biden leads by 9.8pts nationally and by 4.5pts in the battlegrounds. The Democrats lead by 4.9pts in the battleground states four years ago – Trump has been over this ground before and won against the odds – don’t write him off just yet. Trump has pulled ads in Ohio and Iowa leaving him off air in those states for a third week in a row. According to our friends over at BlondeMoney are the two most winnable swing states for Trump.

They say: “Either Trump is supremely confident he’s got these in the bag, despite polling neck-and-neck with Biden. Or he realises that he’s got to double down and go for the tougher states, and hope to sweep up those that are easier to win in the process. If he doesn’t get Florida or Wisconsin, Ohio or Iowa barely matter.”

My sense is that there is do-or-die attitude in the White House and he needs to shore up support elsewhere, such as Florida as his campaign finances, rather like his business empire, are not all they appear to be.

The dollar appeared to roll over last week. On DXY we had a MACD bearish crossover and 14-day RSI trendline break that indicated (as we flagged) that there could be downside.

What’s harder to say is whether this is yet more of a chop sideways for the dollar or renewal of the downtrend.

The close under the 50-day SMA could be taken as bearish signal and we may yet see the 91 handle tested again. The near-term support at the mid-Sep swing low sits around 92.70.

 

The Dollar index on the morning of12.10.2020

UK growth cools, British Land resumes dividend

Morning Note

UK growth unexpectedly cooled  in August, signalling a slower pace of recovery into the back-end of the year. GDP rose by 2.1% in August, which was below the 4.6% expected, despite the eat out to help out scheme boosting the hospitality sector significantly. The food and beverage service activities industry grew almost 70% over July thanks to the easing of lockdown restrictions and the government support scheme. 

 

Nevertheless, the outlook is not particularly encouraging. August 2020 GDP was now 21.7% higher than its April 2020 low, but the UK economy is still 9.2% below pre-pandemic levels. Sticking plasters like eat out to help out act only as a mild salve. Moreover, as the government considers more restrictions on people’s liberties to combat the virus, it is clear the path of recovery to pre-pandemic levels of activity will be slow and difficult. The pace of recovery has peaked, and things may get worse as we head into the winter before they improve again. The UK Chancellor Rishi Sunak will announce the next phase of the job support programme later today, which is set to include support for workers in industries forced to close under local lockdowns, such as bars and pubs. Sterling was unfazed by the loss of momentum in the economy with GBPUSD nudging up to 1.2970, yesterday’s high and close to the top of the range at 1.30.

 

Markets of course rather decoupled from the realities of the economy thanks to vast amounts of central bank stimulus and liquidity. The FTSE 100 rose above 6,000 for the first time in three weeks but this level continues to act as a very difficult barrier for bulls to clear. The S&P 500 closed up 0.8% at the highs of the day at 3,446. The Dow added 0.43% for its third positive session of the week and the Nasdaq added 0.5%. House speaker Nancy Pelosi said Democrats would reject any standalone stimulus packages. But we know stimulus of some sort is coming either before or after the election – the problem emerges if there is a contested election. 

 

Dallas Fed president Robert Kaplan underscored his more hawkish credentials, saying there is no need for additional QE on top of the Fed’s $120bn-a-month programme. A Fed paper this week suggested it could increase asset purchases by $3.5tn to boost the economy. Kaplan said that “the bond-buying needs to curtail, the Fed balance sheet growth needs to curtail”. The Fed’s position however remains that it will continue to purchase assets at least at the current clip.  

 

Election Watch 

 

With 25 days to go to the US election, Joe Biden leads Donald Trump by 9.7pts at a national level but his lead in the top battlegrounds has come down to 4.6pts. Trump trailed Hilary Clinton by 5.1pts in the key battleground states at this stage in 2016, but we should note there are fewer undecided voters this time. Latest betting odds imply 65% chance of a Biden win. 

 

Equities 

 

The pandemic has wrought damage on the commercial property sector as businesses have found it difficult to meet rent payments on time and the value of assets has been written down. Land Securities advised today that of £110m rent due Sep 29th, just 62% was paid within 5 working days, vs 95% for the same period a year before. Businesses renting office space (82% on time) were timelier than retailers (33% on time). For the earlier part of the year, the company has received 84% of rent due on 25 March (up from 75% at 2 July) and 81% of rent due on 24 June. Nevertheless, shares rose 3.5% in early trade as these numbers are perhaps not as bad as feared. 

 

British Land gave a very robust update though, noting all retail assets and 86% of stores are open. Footfall is 21% ahead of benchmark, retailer sales 90% of the same period last year. Collection rates for June have improved to 74%; 98% offices, 57% retail. Meanwhile 69% of September rents have been collected (91% offices, 50% retail). Management was also keen to talk up balance sheet strength – £1bn in undrawn facilities and cash, with no need to refinance until 2024. So robust in fact it’s resuming dividend payments – another little boost for the bedraggled income investor. Divis will be paid at 80% of underlying EPS. Those income investors cheered as shares rose 5%. 

 

London Stock Exchange confirmed plans to offload Borsa Italiana to Euronext. The €4.325bn is perhaps a little behind what had been touted, but it’s a necessary step to clear the decks for their Refinitiv acquisitions.  

 

Charts 

 

Gold still within the falling channel but making higher lows and now pushing up to the top of the channel – 50-day SMA above but the horizontal resistance at $1.920 needs to be cleared first.

Euro Stoxx 50 – still within the long-term range but after moving above 21-day SMA now is looking to clear a cluster of moving averages including the 50-day SMA and 200-day EMA.

European equities bounce, dollar fights back

Morning Note

What is the right multiple when the Fed is stoking inflation and says it will not withdraw accommodation? What price should stocks carry in a world of ZIRP and QE-4-ever? It’s very hard to say: the usual model for forming a judgment on how richly or poorly valued stocks should be – using interest rates and earnings – is becoming out of step with the reality of unlimited central bank support. How do you derive the right discount rate?

We have always assumed that central banks will withdraw accommodation as the economy gets hot and inflation picks up. Or in other words, it’s always been there to take away the punch bowl whenever the party got a little rowdy. Indeed, often it was too quick to turn the music off just as people started to dance.

Now the Fed says it won’t do that and the ECB and others are set to follow – where the Fed goes usually the rest of the world needs to follow. If it’s unlimited Fed support, who cares if the forward multiple on the S&P 500 is x25? If there is no hiking cycle on the horizon, then stocks could continue to rally from these already very stretched levels.

Vix points to uncertainty as US Presidential Election nears

Of course, as repeated nearly every day, near term I worry that this extended rally is ripe for a pullback as the US election approaches, and I am not alone. Whilst retail investors rich on stimulus cheques still think ‘stonks only go up’, there are signs investors are worried about how far this has gone.

Vix futures keep moving in an upwards trajectory that suggests investors are paying more for downside protection on the S&P 500. Vix futures settled above 28 and contracts expiring in Oct are north of 33, signalling a lot of uncertainty around the election. The race will be far closer than polls show. Our election tracker shows Trump narrowing the gap.

FTSE lags global stocks

Such concerns about stretched valuations and ever-higher multiples are not a concern for UK investors. The FTSE 100 has rather majestically shrugged off the rally in global stocks and serenely plunged to its weakest since May. A stronger pound undoubtedly took the wind out of the sails and a bit of a catchup trade was in play after the market was closed for the bank holiday on Monday, meaning it didn’t take part in the mild sell-off across Europe yesterday.

But the FTSE’s troubles are not a new phenomenon – a complete absence of tech and growth is a major problem. Dividend cuts have also vanquished income investors, albeit the yield of almost 4% doesn’t seem too bad today. Last night the FTSE 100 settled on the 38.2% retracement of the March to June rally which has offered near-term support for today’s bounce – dollar strength this morning is helping too.

Record closes for SPX and Nasdaq fuel rally in Europe

European stocks rallied in early trade on Wednesday, including the FTSE 100, after the S&P 500 and Nasdaq both hit fresh records. Apple rallied another 4%, seemingly unstoppable. Tesla declined 5% after it announced a $5bn stock sale, which though a bit of a surprise is not a complete shock given Tesla’s vast capex requirements and share price accretion – as it did in February, Tesla is taking advantage of favourable market conditions to raise fresh cash early on in the cycle.

Meanwhile, we are not getting much further on stimulus – US Treasury Secretary Steve Mnuchin rejected the Democrats’ latest $2.2tn coronavirus relief package, but we are set for more spending, more printing until inflation becomes a problem.

The dollar came back fighting with DXY back above 92.50 as both GBP and EUR retreated off key resistance levels. Could be a dead cat bounce for USD. GBPUSD made a run to 1.35 but failed this test and backed off further this morning to take a 1.33 handle.

Watch for the Bank of England’s Andrew Bailey, who will be giving oral evidence to the Treasury Committee in Parliament on the economic impact of coronavirus. Obviously it’s bad, but house prices have hit a record high so that is good if you own one, not so good if you don’t. Messrs Haldane (he of the V) and Broadbent are speaking later, too.

Euro struggles after strong US manufacturing data, US ADP jobs report in focus

The euro – has a line in the sand been drawn? EURUSD pushed up to have a run at 1.20 but got knocked back as the US ISM manufacturing came in better than expected at 56. This could be a line in the sand for the euro bears defending the roaring 20s? Eurozone inflation turned negative in August – a clear signal of the disinflationary pressures wrought by the pandemic.

Inflation fell to –0.2% from +0.4% in July. It lays bare the mountain the ECB needs to climb and simply tells us that the central bank will need to keep monetary policy exceptionally loose for a very long time. It’s worth noting that the much-hyped EU rescue deal has yet to be delivered. EURUSD pulled back under 1.19 in early trade on Wednesday as the dollar caught a bid.

Today, we are looking ahead to the ADP nonfarm employment report ahead of Thursday’s weekly claims count and Friday’s main nonfarm payrolls print. The ADP number is expected to show a gain of 1m jobs from a paltry 167k in July.

US factory orders and crude oil inventories on tap this afternoon, expected to show a draw of –2m barrels. Later we also have the Fed’s Beige Book, while the Fed’s Williams and Mester are speaking.

FTSE lags as dollar continues to drop

Morning Note

Back to school: the unruly mob are back. But that is enough about MPs going back to work – children start the autumn term this week and the furlough scheme starts to unwind with the government reducing its contribution to employees’ wages to 70% in September.

Furlough forever is simply not an option – zombie staff, zombie businesses. But it means unemployment is surely set to rise – and consumer confidence always follows. The chancellor is floating a tax raid – better to monetize the debt surely?

Stocks soft after strong August

Stocks were a tad weaker on Monday, but August was a great month. The MSCI World index rose 6.6% and the S&P rallied over 7% to record their best August since 1986. The Nasdaq rose 10%. August is usually a poor month for stocks.

Tuesday morning saw a firm bounce for the major European bourses, though the FTSE 100 lagged as it played catchup following the bank holiday. A stronger sterling is also dragging on the big dollar earners. AstraZeneca has started large-scale human trials of its coronavirus candidate vaccine in the US.

The Federal Reserve has put a floor under markets and a ceiling on rates, delivering conditions where stocks can only float higher. We call this TINA – There Is No Alternative. It’s not sustainable of course, but it won’t stop the Fed and other central banks continuing to inflate the bubble. The Fed’s policy shift on inflation has marked a important change for the central bank and it may be followed by the ECB and others.

Vix futures – the so-called ‘fear gauge’ are telling another story. These have started to grind higher despite stocks rallying, which raises a warning about the future path of the market. As previously mentioned, volatility should rise as the election approaches and the races proves far tighter than it currently looks. In summary, the options market is sending a signal that the stock market is not.

Strong China manufacturing PMI lifts sentiment, despite soft readings from France, Spain

Sentiment this morning is helped by data showing Chinese factory activity rose at the fastest pace since 2011. French and Spanish manufacturing PMIs softened, dropping under 50 to signal contraction, while Italy’s was a little better than expected at 53.1.

Some of the moves in US shares are striking. Apple rose over 3% to $129 after splitting, whilst Tesla shares rocketed 13% on its busiest day ever. Stock splits shouldn’t make a difference, except this time they have. Tesla is up 74% for the month.

Zoom races higher after smashing earnings forecasts

Zoom rose almost 23% in after-hours trade after it reported a 355% rise in revenues to $663.5m for the July quarter, smashing forecasts for around $500m. Zoom has proved to be a Covid winner of epic proportions – but shouldn’t we all be going back to the office by now? The UK significantly lags Europe and others in ‘getting back to work’ statistics – this has a huge implication for productivity and for the wider economy.

The dollar continues to soften and trying to guess the bottom is akin to catching a falling knife. The dollar index sank to fresh two-year lows in the wake of the Fed’s inflation shift. Perennial dollar bulls have been caught off guard with the unwind, however the Fed’s recent shift on inflation targeting only underlines that bears called this early.

More inflation and a central bank prepared to let it happen should reduce the purchasing power of the dollar and therefore it ought to weaken. However, with the buck usually a safe harbour, it shouldn’t soften too much more.

The pound was up, with GBPUSD pressing on the post-election euphoria high of last December a little above 1.34. There are Brexit risks ahead – talks recommence next week – but for the moment the major driver of this is the dollar’s weakness. Gold futures rose to $2,000/oz as the weaker dollar lifted commodity markets and US real rates – 10-year TIPS – have sunk again as inflation expectations rise.

FTSE comes under pressure ahead of Powell speech tomorrow

Morning Note

Stocks in Europe chopped sideways after fresh records were set on Wall Street and traders start to turn their attention to Federal Reserve chair Jerome Powell’s speech tomorrow.  Tuesday saw risk appetite go off the boil after a strong start to the European session – the FTSE 100 ended sharply lower while the DAX closed at the session low to end flat on the day.

The timid recovery across European bourses has left the rally in the US looking even more impressive. A pullback in Apple shares did hit the Dow – it won’t have such a big effect come Monday when its weighting will fall with the stock split (the Dow Jones is a price-weighted index). Shares in ExxonMobil, Pfizer and Raytheon all fell as they were given their marching orders from the index, while their replacements – Honeywell, Amgen and Salesforce.com – all rose sharply. The S&P 500 rose 0.36% to a new all-time high.

The FTSE 100 has endured a tough 24 hours – having hit a high yesterday morning near 6,180, this morning the blue-chip index is testing the 6,000 support. Last week’s low at 5,948 is yet to be tested again, however, and bulls will be hopeful that a base is forming and the near-term downtrend off the June highs is ending. If the dollar weakens further and sterling rallies, this support level could go.

Data today is light – US durable goods orders forecast at +4.4% and +1.9% core, which would be a sharp slowdown from last month’s +7.6% (+3.6% core). The weekly EIA crude oil inventories report is also coming later today.

Oil rises as API data reveals forecast-beating draw, Hurricane Laura approaches

WTI rose on a bigger than expected API draw as well as concerns about Hurricane Laura affecting supply. The American Petroleum Institute (API) reported crude oil inventories fell 4.5 million barrels for the week ending August 21st, after a 4.3m barrel draw the previous week. The forecast for the EIA figures today is for a draw of 3.4m. WTI (Oct) rallied for the best part of yesterday to test the $43.50 resistance where it immediately backed off.

Crude prices continue to grind higher as the economic data continues to indicate a slow recovery.

Central bank speeches in focus as markets eye virtual Jackson Hole symposium

Andy Haldane, the Bank of England’s chief economist and leading V-shaped recovery proponent, will speak later. His optimistic attitude the economic recovery is at odds with many.

The real focus on the central bank front this week though is the virtual Jackson Hole Symposium and Jay Powell’s speech tomorrow as US cash equity markets open. Expectations are running high: Powell is set to use this to deliver a shift in the way the Fed approaches inflation, sending a dovish message to the market that the central bank is in this for as long as it takes. The lack of fresh fiscal stimulus only makes the Fed likely to be more dovish.

Essentially, we think the Fed will signal explicitly it is prepared to allow inflation to run hot for longer with a new average inflation target. All this means is the Fed will be lower for longer. This should support risk and could weigh on the US dollar, but there is a risk that inflation expectations can start to become unanchored as they did in the 1970s.

If inflation spikes and the Fed lets it by continuing to keep yields down, stocks and gold should be the main beneficiaries. The vast increase in the supply of money combined with major supply chain readjustments and reshoring taking place against the backdrop of US-China trade tensions, suggests a bout of inflation is around the corner when a vaccine arrives and the real recovery takes hold, despite the initial disinflationary effects from the pandemic.

Will Powell speech hit the dollar?

The US dollar has marched lower since its March blowoff. But lately there have been signs of a base forming around the 92-93 level for the dollar index. An aggressively dovish message from Powell this week could see this support tested initially, but we should also bear in mind that average inflation targeting without, for example, yield curve control, could create a much steeper yield curve (i.e. higher long end yields) in tandem with higher inflation expectations, which could support USD in the longer term. US 10 year yields have already start to move higher, rising to 0.7%.

Ex-divis hit FTSE, US stocks near record high, trade comes back in focus

Morning Note

US stocks rallied to close near its all-time highs yesterday amid what some are saying are signs of greater confidence in the economic recovery in the US. Or perhaps it’s just even speedier decoupling between Wall St and Main St. Nevertheless, bond yields pushed higher amid a faster-than-expected rise in US inflation, whilst the market is starting to focus again on trade and tariffs.

The fact that the broad stock market is at all-time highs is a testament to unbelievable amounts of monetary and fiscal stimulus – the patient is hooked, and only more drugs will do. The disconnect between the stock market and the real economy is too stark, too unjust and too indicative of a system that continues to favour capital over labour that, sooner or later, a change is gonna come.

Europe soft despite strong close on Wall Street, TUI posts earnings wipe-out

Never mind all that for now though, stonks keep going up. The S&P 500 rose 1.4% to end at 3,380, just six points under its record closing high at 3,386.15, with the record intraday peak at 3,393.52. Asian stocks broadly followed through, with shares in Tokyo up almost 2%.

European stocks failed to take the cue and were a little soft on the open, with the FTSE 100 the laggard at -1%, though 22.3pts are due to BP, Shell, Diageo, AstraZeneca, GSK and Legal & General among others going ex-dividend.

For a taste of the real economy, we can look at TUI, which said group revenues in the June quarter were down 98% to €75m. It’s a total wipe-out of earnings, but it’s not a surprise – the business was at a virtual standstill for most of the period and was only able to resume some limited operations from mid-May. Just 15% of hotels reopened in the quarter, whilst all three cruise lines remain suspended.

TUI posted an EBIT loss of €1.1bn for the quarter, taking total losses over the last nine months to €2bn, with €1.3bn due to the pandemic forcing the business to be suspended. Summer bookings are down over 80% but it has got another €1.2bn lifeline from the German government. Shares fell over 6% in early trade.

Trade in focus as US-China weekend talks approach

US-China tensions are rearing their head again. Officials meet this Saturday to review progress of the phase one deal. White House economic adviser Larry Kudlow the deal was ‘fine right now’. Sticking with trade, the US is maintaining 15% tariffs on Airbus aircraft and 25% tariffs on an array of European goods, including food and wine, despite moves by the EU to end the trade dispute.

Crucially it did not follow through with a threat to hike tariffs, however it still leaves the risk of further escalation when the EU is likely to win WTO approval to strike back with its own tariffs.

Strong US CPI raises stagflation fears

Yesterday, despite the optimism in the market, there was – for me at least – some potential signs of bad news for the real economy (not the stock market, remember) with US inflation picking up faster than expected. You can read this as the economy doing better than fared as consumers return, but you can equally take a glass half empty view and see this as a major worry that prices of essentials are going to rise whilst economic growth stagnates – which can be a cocktail for a period of stagflation.

Given the enormous amount of money being pumped into the system, there is a better than evens chance we get an inflation surge even if the pandemic was initially very disinflationary. Unlike in the wake of the financial crisis, the cash is not being gobbled up in the banking system as increased capital buffers etc, but is going into the (real) economy. Moreover, it’s being done in tandem with a massive fiscal loosening.

Short-lived pullback for USD?

Year-over-year, headline inflation rose from 0.6% to 1%, whilst core CPI was up 1.6% in July vs the 1.2% expected. Food prices rose 4.6%, whilst the cost of a suit is down a lot. The risk is that inflation expectations can start to become unanchored as they did in the 1970s when the Fed had lost credibility, this led to a period of stagflation and was only tamed by Volcker’s aggressive hiking cycle.

Investor optimism is keeping the dollar in check. The dollar index moved back to the 93 mark, whilst the euro broke above 1.18 against the greenback for a fresh assault on 1.19, twice rejected lately. Sterling is making more steady progress but is well supported for now above 1.30, however the dollar’s pullback may be short-lived. Gold held onto gains to trade above $1930 after testing the near-term trend support around $1865 yesterday.

US EIA data, OPEC report boost oil

Oil prices held gains after bullish inventory data and OPEC’s latest monthly report. WTI (Sep) moved beyond $42 after the latest EIA report showed a draw of 4.5m barrels last week. Meanwhile, as noted yesterday, OPEC’s new report indicated the cartel will continue with production cuts for longer.

In its monthly report, OPEC lowered its 2020 world oil demand forecast, forecasting a drop of 9.06m bpd compared to a drop of 8.95m bpd in the previous monthly report. But the report also sought to calm fears that OPEC+ will be too quick to ramp up production again. Specifically, OPEC said its H2 2020 outlook points to the need for continued efforts to support market rebalancing. Compliance was down but broadly the message seems to be that OPEC is not about to walk away from the market.

Equities hold ranges, gold jumps as US real yields sink

Morning Note

Equity markets are still looking for direction as they flit about the middle of recent ranges. Fear of a second wave of cases is denting the mood today, as the so-called R-number in Germany jumps to 2.88, US cases hit the highest level since early May, and Apple closes more stores in the US.

White House trade adviser Peter Navarro said the US is preparing for a second wave in the autumn – it’s debatable whether the current spike in cases in some states is still part of the first wave. Equity markets remain sensitive to headline risk around virus numbers, stimulus and economic data, but we are still awaiting signs of whether the strong uptrend reasserts itself or whether we see a more serious pullback.

Looking at the pullback over the second week of June, the major indices are still hovering either side of the 50% retracement of the move. Momentum may start to build to the downside should cases rise, and restrictions are re-imposed. For now, the indices are simply bouncing around these ranges. The question is whether markets finally catch up with the real economy – the disconnect between Wall Street and Main Street is a worry for those who think the market has rallied too far, too fast.

Economic data will continue to show a rebound, glossing over the fact that the numbers on the whole still indicate a severe recession. However, to make the bull case – the Fed and central bank peers are on hand and the old maxim still stands: don’t fight the Fed. Meanwhile there are record amounts of cash sitting on the side lines and bond yields on the floor – and will be for a long while – making equities (FTSE 100 dividend yield at 4% for example), more appealing.

The FTSE 100 opened down 1% and tested the 50% line at 6,223, whilst the DAX pulled away from its 50% level around 12,250 ahead of the open to fall through 12,200 before paring the losses. Asian markets were softer, whilst US futures indicated a lower open after falling on Friday – ex-tech.

Oil (WTI – Aug) ran out of gas as it tried to clear the Jun peak at $40.66 but remains reasonably well supported around the $39-40 level. We look at a potential double top formation that could suggest a pullback to the neckline support at $35. Imposing fresh restrictions on movement may affect sentiment ahead of any impact on demand itself, but OPEC+ cuts are starting to feed through to the market and we could be in a state of undersupply before long.

The risk-off tone helped lift gold to break free of the $1745 resistance, before pulling back to test this level again. The rally fizzled before the top of the recent range and recent multi-year highs were achieved at $1764. Whilst benchmark yields have not moved aggressively lower, with US 10s at 0.7%, real yields as indicated by the Treasury Inflation Protected Securities (TIPS) are weaker. 10yr TIPS moved sharply lower over the last two US sessions, from –0.52% to –0.6%, marking a new low for the year and taking these ‘real yields’ the lowest they’ve been since 2013.

Real yields are currently negative all the way out to 30 years.

In FX, GBPUSD started the week lower but has pulled away off the bottom a little. The momentum however remains to the downside after the failure to recover 1.2450. Bulls will need to clear the last swing high at this level to end the downtrend, though this morning the 1.24 round number is the first hurdle and is offering resistance.

CFTC data shows speculative positioning remains net short on GBP. Meanwhile net long positioning on the euro has jumped to over 117k contracts, from a steady 70-80k through May. Nevertheless, the current trend remains south though the 1.12 round number is acting support – the question is having seen the 1.1230 long-term Fib level broken, do we now and perhaps test the late March high at 1.1150.

Second wave fears weigh on risk

Morning Note

The dreaded second wave: Houston is weighing a new lockdown as it warns of a disaster in-waiting. Other states with large populations and economies like California and Florida are also worried about rising Covid case numbers. Across Europe the reopening continues with little to suggest of a disastrous second wave.

Stocks went into freefall yesterday as the untruths of the reopening trade got found and this particular bubble got pricked. As we discussed, fears of a second wave combined with the Fed well and truly killing off the V-shaped recovery idea.

The Dow tumbled nearly 7%, whilst the S&P 500 fell almost 6%. The forward PE multiple on the latter – which I like to track as a broad indicator of whether stocks are overbought – has retreated a touch but at 23+, it’s still rather pricey. The Vix shot above 40.

Futures indicated a little higher but I don’t fancy the chances heading into the weekend. You could say that Thursday’s tumble was basically just the Fed trade and has now played out so we need to look for new information to act as a catalyst, but the second wave fears persist.

European stocks volatile on the open

European stocks also got whacked and were extremely volatile in the first hour of trading on Friday as the bulls and bears pull either end of the rope.  The bears were winning at time of writing. We do seem to be at a key moment as the market makes up its mind – are we due a proper retracement of the recent rally or is this just a normal pullback before resumption of the trend higher. I would tend to favour the former.

The good news for the likes of the FTSE is that it’s underperformed since the March trough, versus its US counterparts. It’s also got an appealing dividend yield, despite some very noteworthy cuts and the prospect of BP likely needing to cut its pay-outs. From a technical point of view there seems to be strong support just a little below where it’s currently trading.

UK posts record GDP drop in April

ONS data shows the UK economy declined over 20% in April, the worst decline on record. It’s backward-looking of course, but it underlines how much of a recovery is required to get back to normal. The slow lifting of restrictions – pubs and cafes are still not open – means the UK may endure a wider bottom than many others, making recovery all the slower. All this before the jobs Armageddon this autumn when furlough support ends.

Chart: FTSE 100. The index has broken out of the channel on the downside. The three black crows candle pattern signal weakness and when combined with the bearish MACD crossover in overbought levels, suggest a pullback is not done yet. There is decent support around the previous Fib support level and the 50-day simple moving average in the 5800-5900 region.

Chart: S&P 500. The broad index closed at the lows, but bulls will be looking for the 200-day moving average around 3020 to hold. The area around 2975 at the bottom of the channel still looks appealing and if breached could act as a gateway to 2800. Another bearish MACD crossover in overbought levels signal weakness and a retrace of some of the recent rally.

Oil fell with other risk assets. WTI for August has moved back to test the $35 support level, with a potential retreat to the $31.50 area next if the trend continues. A bearish MACD crossover is again evident, signalling weakness.

Stocks off a little at month end, US-China tensions rise

Morning Note

What did they do just when everything looked so dark?
Man, they said “We’d better accentuate the positive
Eliminate the negative
And latch on to the affirmative”

Stocks are ending May on a slightly downbeat note, but investors have definitely been accentuating the positive this week and for the whole of May.

Thank goodness, Covid-19 is getting bumped off the headlines; trouble is it’s not for good news. At last though we are seeing some caution displayed in the markets over China’s decision to impose national security legislation on Hong Kong and the ensuing ramp up in US-China tensions.

US stock markets close in the red, Trump to give press conference on China

US stocks were positive for most of Thursday before sharply reversing in the last hour and closing in the red, after the White House announced that Donald Trump would hold a press conference on China on Friday. ‘We are not happy with China. We are not happy with what’s happened’, he said. The UK, which signed a joint statement condemning China for its actions with Australia, Canada and the US, is opening the door to citizenship for 300,000 Hong Kong residents.

Given how stretched valuations have become, worries about US-China tensions don’t seem fairly priced in. As previously noted, investors need to be prepared for things to get worse from here, particularly given the back drop of a looming election for a second term, the worst recession in memory and 100,000 deaths from Covid – blamed on China – and the trade war, which is still rumbling on.

The pressure on Donald Trump at home is high. The press conference today will likely see Trump increase the war of words with China but he could go further an announce further sanctions on individuals associated with law, or revoke Hong Kong’s special status with the US on trade.

The S&P 500 was up most of the session but closed 6 points lower at the death, whilst the Dow fell 0.6% to 25,400, crumbling 300 points in the last 45 minutes of trading on the news of the White House presser.

Overnight, shares in Hong Kong fell again. European equities followed suit on Friday, declining by around 1% after a decent run in the previous session. The FTSE 100 faded off the 6200 handle reclaimed on Thursday. Hong Kong and China focused HSBC was down another 2.5%. But the FTSE was still headed for a roughly 200-point gain this week. European equities are still firmly higher this week as investors rotated somewhat away from the Covid/tech/quality play and back into cyclicals as economies reopen without undue rises in cases.

The Nasdaq, which has notably outperformed on a year to date basis, has markedly underperformed benchmarks this week. Remember it’s the last day of the month of May – it’s been a solid week and month for equities so investors may seek to take a little risk off the table going into the weekend and into June. The Hong Kong/US/China situation is all the excuse needed.

Data continues to show the dire economic impact of Covid-19

The economic data still stinks. 1 in 4 Americans have lost their jobs since Covid hit. US initial jobless claims rose another 2m to top 40m. But it’s slowing, with the weekly count down again for the 8th straight week. Moreover, continuing claims fell 3.9m to 21.1m, which indicates the labour force is returning – hiring is beating firing again, but it will be a long slow process to recover the 40.8m jobs lost, far longer than it took to lose them. A portion will be lost forever.

The US economy slowed more than previously thought, with the second GDP print for Q1 at -5%, vs 4.8% on the initial print. The Atlanta Fed GDPNow model forecasts Q2 GDP down 40.8%.

French GDP in the first quarter was down just 5.3% vs the 5.8% initially printed. Retail sales and industrial production in Japan both declined by more than 9%. Retail sales in Germany dropped 5.3% in April, not as bad as the -12% forecast – spendthrifts! Meanwhile those frugal French consumers spent even less than forecast, with spending down more than 20% vs a 15% declined expected. France is though reopening its culturally vital bars, restaurants and cafes from next week, so that should get consumers parting with a few more sous.

Dollar offered despite risk-off trade in equities

Despite the risk-off to trade in equities the dollar was offered into the month end. The euro extended its rally after breaking the 200-day moving average yesterday, with EURUSD pushing up to 2-month highs at 1.11. The March peak at 1.1150 is the next target. Sterling was also firmer against the buck, with GBPUSD recovering the 1.23 handle, trying to hold the 50-day line as support.

Shares in Twitter declined by more than 4% as Donald Trump signed an executive order that paves the way for legislation to tighten rules for social media platforms around third party content liability. It’s probably all a lot of hot air and distraction as he pursues a personal vendetta following the fact check warning on a couple of his tweets. Nevertheless, we have consistently warned that social media companies will need to face up to more and more scrutiny and tighter regulation around content distribution and the use of personal data.

Oil first fell but since recovered after EIA figures showed a build in crude oil inventories. Crude stocks rose 7.9m barrels, though inventories at Cushing, Oklahoma, declined by 3.4m. WTI (Aug) was hovering around $33 at send time, just about slap in the middle of its consolidation range.

Equity indices clear big hurdles even as Hong Kong tensions simmer

Morning Note

Tensions between the US and China are worsening, with the two sides clashing at the UN over Hong Kong. China rejected a US proposal for the Security Council to meet over the issue, whilst US secretary of state Mike Pompeo declared that Hong Kong is no longer autonomous from Beijing. China’s ‘parliament’ this morning approved the controversial national security legislation for the territory.

We also note reports this morning that China escorted a US navy ship out of its waters. Meanwhile Taiwan is to buy Harpoon anti-ship missiles from the US, which is likely to further rile Beijing. Tensions are showing signs they could boil over – we cannot play down the importance of an embattled US president facing a national crisis at home in an election year – one he can blame on his chief geopolitical adversary. Expect more sabre rattling.

Shares in Hong Kong and Taiwan fell, whilst Japanese equities rose by more than 2% in a mixed session overnight in Asia. The FTSE 100 rallied towards 6200 on the open, but shares in Standard Chartered and HSBC fell, signalling investor concern about what’s going on in Hong Kong.

Nevertheless, equity markets continue to strengthen and move out of recent ranges and clear important technical resistance. Confidence in equity markets is strong thanks more stimulus and signs economies are reopening quicker.  A resurgence in cases in South Korea is a worry.

Yesterday, US stocks surged with the S&P 500 closing above 3,000 for its best finish since March 2nd, whilst the Dow added over 500 points to clear 25k at stumps. The S&P 500 cleared the 200-day moving average and is now trading with a forward PE multiple of about 24x – making it look decidedly pricey.

European followed Wall Street higher with broad-based gains. The DAX yesterday closed above the 61.8% retracement around 11,581 and extended gains through the 11,700 level. The FTSE 100 thrust towards 6200 this morning, hitting its highest intra-day level since March 10th. The 50% retracement around 6250 is the next target before bulls can seek to clear the gap to the March 6th close at 6,462.

EasyJet is planning to reduce its fleet by 51 and cut up to 30% of staff. This is the big fear playing out – temporary furlough becomes permanent firing once businesses figure out that demand has vanished. Whilst airlines will feel this more than just about any other sector, this trend will be seen in a wide range of industries, albeit to a lesser extent.

Shares in EZJ rose 8% – cost cuts are welcome of course for investors, but also the indication of running at 30% of capacity over the summer is better than had been feared. Efforts by the likes of Greece and Spain to salvage the summer season will help a lot. IAG and Ryanair shares rose 2-3%.

Twitter shares fell and were down more in after-hours trading after Donald Trump threatened to shut down social media sites that stifle conservative voices. Having been sanctioned by Twitter with fact-check warnings, the president is very unhappy. It hurts his ego and it blunts his most effective tool.

The White House said the president will sign an executive order on social media today. Facebook shares were also lower yesterday and extended losses in after-hours trade. Will Trump try to silence Twitter and Facebook? No, but he can put more of a regulatory squeeze on them and raise their costs.

Europe’s bailout proposals were greeted with optimism, but the frugal four countries of Austria, Denmark, Sweden and the Netherlands did not seem terribly impressed at plans that will raise their budget contributions. They will need to be brought round. Estonia has also said it won’t vote for the proposals. Work to be done – getting all countries on board with a complex budget takes a long time in the best of circumstances, let alone amid a dreadful recession.

The euro has largely held gains after rising on the EU’s budget plans. EURUSD firmed above 1.10 but is struggling to clear the 200-day moving average around 1.1010. Bulls need to see a confirmed push above this to unlock the path back to 1.1150, the March swing high. Failure calls for retest of recent swing lows at 1.0880.

Sterling was steady with GBPUSD around 1.2270 after yesterday giving up the 1.23 handle and testing support at 1.220 following Britain’s chief Brexit negotiator gave a pretty downbeat assessment of trade talks to MPs.

Today’s data focuses on the US weekly unemployment claims, which are forecast at +2.1m. As we enter the summer and states reopen, the hiring will gradually overtake the firing but we are not yet there. Durable goods orders – an important leading indicator of activity – are seen at –19% month-on-month with the core reading seen at –14.8%. A second print of the US Q1 GDP is seen steady at –4.8%.

Oil dived and took a look at last week’s lows as API figures showed a surprise build in crude inventories in the US. Stocks rose by 8.7m in the week ending May 22nd, vs expectations for a draw of 2.5m barrels. The build in stocks means the EIA data today will be more closely monitored than usual, given that expected drawing down of inventories has underpinned the resurgence in crude pricing. WTI (Aug) slipped back to $31.60, just a little short of the May 22nd swing low.

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