Stocks choppy after sharp risk reversal, gilt yields strike fresh lows

Morning Note

Stocks continue to chop around their June-July ranges after risk sentiment rolled over at the start of yesterday’s US session. Surging Covid cases, hospitalizations and deaths in several US states continues to weigh on risk sentiment, Donald Trump was dealt a blow by the Supreme Court, and Joe Biden – who may well become the next president – said he would end the era of ‘shareholder capitalism’.

Around 3pm yesterday we saw a sharp reversal in risk appetite as stocks, bond yields and oil fell and the dollar rallied. California, Texas and Florida reported their biggest one-day increase in Covid-19 related deaths. Stocks hit the lows after Florida reported a spike in Covid-related hospitalizations, but recovered somewhat after Dr Fauci, director of the National Institute of Allergy and Infectious Diseases, revealed Moderna’s coronavirus vaccine candidate would enter phase 3 trials soon.

Supreme Court rules on Trump tax returns, Biden announces economic plan

The Supreme Court ruled Donald Trump’s tax returns should be seen by the Grand Jury, but it threw out rulings that allowed Democrat-led Congressional committees to obtain Trump’s financial records. Although this means further litigation, it should mean the documents are not a factor in the election.

Meanwhile, Joe Biden launched his $700bn economic plan by taking aim at Wall Street a threat to ‘end to the era of shareholder capitalism – the idea that the only responsibility a corporation has is to its shareholder’. Whilst no Bernie Sanders, there is little doubt that Biden will raise taxes and regulation risk – equity markets need to start to price in the risk better and there are signs that some investors already are.

Investors need to be wary of a Democrat clean sweep of the House, Senate and White House, which could greenlight some pretty aggressive redistributive policies. ‘During this crisis, Donald Trump has been almost singularly focused on the stock market, the Dow and the Nasdaq. Not you. Not your families,’ Biden added. After 2008 it was fashionable to bash the banks, now all corporate America is fair game if they are not woke enough. ‘Wall Street bankers and CEOs didn’t build America,’ Mr Biden said.

Europe opens weak, turns green

European shares were choppy after Asian markets fell and China’s equity rally finally ran out of steam. The FTSE 100 fell under 6,000 this morning before paring losses, returning to the low end of its June range. After a weak open, European indices were turning green after the first hour of trade.

The S&P 500 struck a low at 3,115 yesterday before closing down 0.5% at 3,152, flat for the week. Energy stocks led the drop, declining 4% as oil prices sank. Futures are lower and indicate a weaker open at the 61.8% retracement of the June-July range. The Nasdaq rose 0.6% to a fresh record as the tech sector continued to be the only real area of safety.

US unemployment numbers were a little better than expected but continue to show just how long the road is ahead. Weekly initial jobless claims fell to 1.314m, better than the 1.375m expected and representing a decline of 99k from a week ago. Continuing claims fell to 18.06m, a drop of almost 700k and much better than the 18.9m expected. The previous week’s number was also revised down over half a million.

Treasury yields fell, with US 10s back to 0.58% having notched a record low yield on an auction. UK 2- and 5-year gilt yields have hit a record low this morning, following Eurozone and US yields lower. Investors are showing no fears that massive issuance is going to force up borrowing costs as long as central banks remain in full support mode.

WTI through trend support as risk appetite cools

Crude oil fell sharply with stocks as risk rolled over. WTI (Aug) broke down through the trend support and may push lower. From a technical perspective we can start to consider completion of the head and shoulders reversal pattern and look for the move to head towards the neckline around $35. The IEA’s July report this morning suggested oil demand will pick up in the second half and that the worst of the demand destruction is behind us.

The IEA said oil demand this year will average 92.1m bpd, down by 7.9m bpd versus 2019, which is a slightly smaller decline than forecast in the April report, mainly because the decline in the second quarter was less severe than expected. But at this point it remains very hard to say how demand will recover longer-term given we do not know how the virus will progress nor how governments and citizens will respond – at least it seems negative prices were only a blip.

Fresh shutdowns in the populous Sun Belt states remains the worry, albeit we did see a decent draw on gasoline stocks last week, according to the EIA. Nevertheless the IEA noted that the accelerating number of Covid-19 cases is ‘a disturbing reminder that the pandemic is not under control and the risk to our market outlook is almost certainly to the downside’.

Elsewhere, gold fell with risk assets, with the near-term pullback finding support at $1796 and should look for consolidation around the $1800 level. The outlook for gold remains constructive and we should expect lots of pullbacks along the way – nothing goes up in a straight line, and gold is particularly prone to these tactical retreats. In FX, the dollar rallied on the broad drop in risk sentiment. GBPUSD moved down to test near term trend support formed by the bullish channel. EURUSD pulled back from highs at 1.1370 to chop around the 1.1270 region.

Stocks tread water, US jobs numbers on tap

Morning Note

Caution is the order of the day. European stocks are mixed after falling for the second session in a row on Wednesday. Asian share ticked up overnight, with China continuing to charge. Wall Street rose on Wednesday but overall the major indices are still well within their June trading ranges.

Nine-year high for gold, Fed cautious on economic outlook

Gold broke out to its highest level in nine years, breaking free from the $1,800 psychological resistance to clear $1818 at one point. The path is open to further gains, albeit we have just seen real interest rates come back in a touch. Nevertheless, the outlook for gold remains constructive – lower real yields, worries about inflation emerging down the line, and broader economic uncertainty all combine for a perfect environment for gold bugs.

Fed officials are increasingly sounding cautious. Richmond Fed President Thomas Barkin said whilst businesses might have had decent order books and pipelines of work to keep them going, new orders are not coming on stream fast enough. Fiscal payments are coming to an end and it is not clear what will replace them. The US may well need to extend and pretend.

Boston Fed president Eric Rosengren said: ‘I do expect unfortunately that the economy is going to remain weaker than many had hoped through the summer and fall.’ US cases continue to soar, with the country again reporting its biggest one-day jump in cases, choking the reopening and recovery process at birth.

US jobless claims on tap

The US weekly unemployment claims data will be closely watched following the big nonfarm payrolls report last week. Initial claims are seen at 1.375m, with key continuing claims down to 1.875m. Whilst these numbers have been coming down, they haven’t been contracting at a rate fast enough to warrant great optimism.

Data from Japan at first looked encouraging but masked some nasty surprises. Core machinery orders, a volatile leading indicator of activity, rose 1.7% in May after a 12% drop in April, and ahead of the 5% decline expected. However, the 17.7% rise in orders for non-manufacturers was offset by a 15.5% decline in manufacturers’ orders and 18.5% drop in overseas orders.

Dollar weakens, WTI oil eases back after breaching $41

In FX, the dollar is being offered. GBPUSD cleared resistance and moved above 1.26. Resistance 1.2690, the Jun 16th swing high, is the next target for bulls. EURUSD has cleared 1.13 but pulled back sharply after running into resistance at 1.1370. Eurogroup members to vote on a new president today ahead of the key summit next week at which the EU needs to hammer out agreement on the €750bn rescue fund.

Crude oil pushed higher before pulling back. WTI (Aug) moved above $41 but pared gains and traded around $40.70 at send time. The EIA said US crude inventories rose by 5.7m barrels vs expectations for a draw of around 3m barrels. But the data was not as bearish as it appeared at first glance – stockpiles were up largely on higher imports, whilst gasoline inventories fell by almost 5m barrels, a good sign Americans are back on the road. Refining activity rose to a 14-week high.

Investors eye UK mini budget, gold heads to $1800 as stocks slip again

Morning Note

Stock markets remain in choppy trading ranges. The optimism that fuelled the rally at the start of week has fizzled out, leaving indices back towards the middle of the June range and back close to where they finished up at the end of last week. Investors continue to look at soaring case numbers on the one hand and on the other the pace of recovery and massive stimulus which has already been administered.

Asian markets slipped, albeit China stood out as it continued to rally on some good stoking by the state-run press. The ASX fell 1.5% as investors reacted to the lockdown in Victoria. European stocks followed suit and were softer on the open on Wednesday. The FTSE 100 pulled back further below 6200 where it has found some degree of support at 6153 on the 38.2% retrace of the pullback in the second week of June that has formed that range of the last month and a half.

Gold climbs towards $1800, US yields hit fresh lows

Treasury yields slipped on a broad risk-off mood. US 10s went to 0.655% which left 10yr TIPS – our favourite gold indicator – at fresh seven-year lows at –0.78%. This gave further succour to the gold bulls and lifted prices to fresh seven-year peaks above $1797 and it looks like $1800 can be taken out. The gold bull thesis rests not only on the requirement for safe assets given the economic uncertainty, but also longer term on fears of a surge in inflation caused by the massive increase in the money supply caused by central banks. In large part due to the corresponding fiscal actions, unlike the QE that occurred after the financial crisis, this time the excess cash is not going to get lost in the banking sector.

While yields dipped and gold is at multi-year highs, the prospect of more stimulus may keep markets relatively buoyant for the time being. The worry is that as the support packages roll off, particularly the kind of financial aid for employees from the likes of the UK’s furlough scheme, the pace of recovery slows drastically. The economic data could really start to crunch as temporary layoffs become permanent and the pressure for governments to continue to ‘do whatever it takes’ will increase.

UK coronavirus ‘mini budget’ on tap

Today, Britain’s chancellor Rishi Sunak will respond with a ‘mini budget’, to be delivered at 12:30 BST after PMQs. This will aim to shift the support on offer from the emergency to the more lasting with measures such as cash for training young people to prevent the risk of mass youth unemployment, a stamp duty holiday to goose the housing market, a maybe a VAT cut to help the hospitality sector. Housebuilders ought to be among the main beneficiaries of the budget, but shares in Barratt and Taylor Wimpey slipped this morning after rallying this week ahead of the statement. Meanwhile Marston’s and Mitchells & Butlers shares plunged around 5% this morning ahead of the statement which may not have as much for the hospitality industry as some had hoped.

Sterling held gains above 1.2540 ahead of the statement, having gained sharply yesterday arguably on some hopes that the budget will get the economy moving a bit quicker. GBPUSD remains well within the recent range and shows little signs right now of mounting a serious ascent to 1.30, however having created a bottom at 1.2250 the recent move higher can continue and the bullish bias persists – the Jun high at 1.28 is the key.

A huge part of the problem facing investors in this market is figuring out what the data is telling us. As noted many times in recent weeks, the economic data is noisy and difficult to interpret because the speed and magnitude of the collapse was like nothing we have ever seen. For example, France’s statistics body, Insee, says the French economy will rebound 19% in Q3, but still be down 9% in 2020. This points to the difficulty in reading too much into the easy part of the recovery process as lockdowns end. The longer-term recovery to activity levels comparable with 2019 will take a lot longer.

Key Eurogroup vote on new president tomorrow

Eurogroup members to vote on a new president tomorrow. The vote comes at an important moment for the Eurozone as it tries to agree on financial aid package as part of budget talks. The summit of July 17th and 18th is the date for your diaries.  Christine Lagarde said the ECB may hit the pause button on its easing programme, telling the FT that the ECB has ‘done so much that we have quite a bit of time to assess [the incoming economic data] carefully’. This should put to rest any thoughts the central bank would announce fresh easing measures at its meeting next week. Ms Lagarde wants to stress that it’s time for the EZ member states to step up and sort out the fiscal support rather than leaning ever more on the ECB and lower rates.

Meanwhile, the White House is said to be looking at ways to undermine the Hong Kong dollar peg to the US dollar as a potential way to hit China. If such a tactic were to be deployed, it could raise risks for Hong Kong banks to access dollars and we could feasibly see ripple effects across the FX space – albeit I don’t see the US embarking on any kind of outright manipulation to weaken or strengthen the dollar. It’s probably not a tactic that will be considered seriously or pursued by the administration, but it’s one to watch.

Oil steady after API data shows oil storage build, gasoline draw

Crude oil (WTI for August) was steady still around the $40 handle. API data showed a build in US crude stocks of 2m barrels, whilst gasoline stockpiles fell by 1.8m barrels. Crude at the Cushing, Oklahoma, hub rose 2.2m barrels. Meanwhile the U.S. Energy Information Administration presented a more bullish fundamental case and raised its WTI price forecast for 2020 to $37.55 a barrel, up almost 7% from the June forecast.  2021 prices are forecast to average $45.70 in 2021, a gain of 4% from before. The EIA said changes in supply and demand have shifted global oil markets from an estimated 21 million barrels per day of oversupply in April to inventory draws in June. EIA crude oil inventories later today are forecast to see a draw of 3.2m barrels, but the consensus estimate has been wide of the mark for several weeks now.

Stocks steady after Q2 boom, gold breaks higher, economic data uncertain

Morning Note

The S&P rallied 1.5% to finish the quarter up 20%, its best quarter since 1998 and keeping its YTD losses at –4%. The Dow Jones industrial average closed up 200pts as it continued its bounce off the 50-day simple moving average to notch its best quarter since 1987. Things were a little more mixed in Europe but again we saw the major bourses finish their best quarter in years.

Stocks rallied so sharply in Q2 for a number of reasons – chiefly stimulus, both fiscal and monetary, as well as the reopening of economies and better virus rates in most countries, though this trend has somewhat come undone in the US in the last couple of weeks. The aggressive pullback in February and March also left stocks rather oversold on a short-term basis, when considering the stimulus and relative yields to government bonds.

Meanwhile hopes of a vaccine are central if we are to see 2021 look more like 2019 than this year. For gains to be sustained in Q3 stocks require the continued support of stimulus, which remains on tap, as well as a better outlook on the virus spread and for the hard economic data to show a strong bounce from Q2, both of which could be more tricky.

Boeing declined by more than 5% as Norwegian Air cancelled an order for almost one hundred jets and competitor Airbus announced it would cut its workforce by 15,000, whilst Tesla shot 7% higher to a new record that takes its market capitalisation to $200bn for the first time. Shares in Facebook, which has come under fire lately by showboating big brands who are pulling advertising temporarily, rallied 3%.

Protests in Hong Kong signal geopolitical stress – Western powers have expressed dismay at China’s decision to pass the new national security law. The first arrests under the new law have been made – only a few hours after its imposition. The potential for this to create further unrest in Hong Kong and stoke US-China tensions will need to be monitored.

European equities traded cautiously on the first day of July and the third quarter after a mixed bag from Asia as Tokyo fell and Chinese bourses rallied. Australia was also higher as Hong Kong was shut for a holiday. The major indices remain in a broad zone between the 38.2% and 61.8% retracement of the drawdown in the second week of June.

Despite the sharp rise in cases in the US, which Dr Fauci says is out of control, Americans’ confidence is returning. The Conference Board’s index jumped by 12.2 points to 98.1, the best one-month rise in nine years. Chinese data was a little better than expected as the Caixin manufacturing PMI hit 51.2, but the Japanese Tankan survey disappointed at –34. Data points will remain mixed and noisy as we exit the crisis.

PMIs, which are diffusion indices, are particularly challenged by the speed and magnitude of the economic contraction. I would prefer to look at the hard data as it comes out over the third quarter. Economically things have rarely been this uncertain – we could be running way hotter than we think, but equally the long-term consequences could be deeper and longer-lasting than the V-shaped recovery camp would have it.

Looking ahead to today’s session, the ADP nonfarm employment report will provide a taster for Thursday’s BLS nonfarms report, while we will also be looking to the FOMC meeting minutes later for clues as to what else the Fed might be up to – there is unlikely to be anything other than ‘do whatever it takes’ mode on offer.

Gold prices rallied to fresh 8-year highs near $1790 on a technical breakout from the bullish flag formation. Real US rates remain at 7-year lows, while benchmark 3yr, 5yr and 7yr Treasury yields notched record low closes. As expressed in recent notes, gold looks to be a long-term winner from the pandemic as social and economic uncertainty favours the safe haven, whilst the vast increase in M1 and M2 money means there is a high chance – though not a certainty – of an inflation surge. Fading momentum on the CCI with a bearish divergence to the price action suggests a near-term pullback may be required – perhaps at the $1800 round number resistance – before the next significant leg higher can be made.

The rally on Wall Street upset the emerging downtrend and reasserted the range trade for the time being, with the S&P 500 finishing at 3100 in the 50% area of the June pullback.

In FX, cable bounced sharply off the 1.2250 support on the second look but remains constrained by the upper end of the channel.

Equities in retreat as Covid-19 cases advance, oil drops

Morning Note

Equity markets have come under pressure again as a spike in new Covid cases across the US has investors worried, whilst the IMF drastically cut its growth forecasts for the year. Major equity indices have retreated towards the lower end of the range traded in June but have yet to make fresh lows for the month – when they do it will get very interesting and could call for another leg lower.

Stocks in Europe were down 3% on Wednesday, whilst Wall Street dropped 2.6%. European markets opened lower again Thursday, with a risk-off trade seeing all sectors in the red and telcos, healthcare and utilities declining the least.

Investors are pulling their heads in a little as the surge in cases raises concerns about how quickly the US economy can emerge from the ashes. There are also clusters in Germany of course but the focus is on the divergence between the European and US experience.  The FTSE 100 retreated close to 6,000 round number but found support around the 23.6% retracement at 6,066.

The S&P 500 closed at 3,050, on the 38.2% retracement. With softness on the open in Europe and futures indicating a lower open, we may see SPX test its 23.6% level on the 3,000 round number. A retest of the June lows looks increasingly likely.

IMF cuts global outlook, US-EU trade tensions simmer

Meanwhile the IMF lowered its 2020 outlook, warning the global economy would shrink a lot more this year than it had forecast in April. Global output is forecast at –4.9%, vs –3% in April. The UK and EU will decline 10%, whilst the US economy will shrink 8%. Tellingly, the IMF also lowered its 2021 bounce-back forecast – growth globally is expected to rally 5.4%, vs the 5.8% forecast in April.

In other words, the decline will be deeper and the recovery slower; that is, no V-shaped recovery. We can also add US-EU trade tensions into the mix hitting stock market sentiment, as the White House has threatened fresh tariffs. I’d also suggest that the closer we get to the election and the more polls show Biden leading Trump, the greater the risk of a Democrat clean sweep, which will need to be priced into equity markets.

Improved virus response, central bank stimulus lowers risk to equities

Although we see clear headline risk around spikes in Covid cases for equity markets, any second wave is not going to result in the same level of lockdown restrictions endured in the first wave: it’s just too costly economically and because we have learned a lot in how to cope with this virus, both in terms of treatment and prevention. This means any further pullback we see, whilst potentially quite sharp, is unlikely to see a retest of the lows in March.

Meanwhile central bank stimulus is still strong. The Fed has shifted materially – it now has a $7tn balance sheet, setting a floor under the bond market that pushes up equities. The risk to equities comes later in the year when we get a real insight into both the pace of economic recovery and, by extension, corporate earnings – does the S&P 500 still justify x23 forward PE, or should it start to trade at more like x19? The current forward PE of around x23 suggests hope of a bounce back in earnings next year that may not come to fruition.

US weekly jobless claims in focus

On the pace of economic recovery, today’s weekly jobless claims report will be of great significance. Last week’s underwhelmed. Following the surprisingly strong nonfarm payrolls report, the weekly numbers didn’t follow through with conviction – initial claims were down just 58k to 1.5m, whilst continuing claims only fell by 62k to 20.5m. The slowing in the rate of change was the main concern – hiring not really outpacing firing at a fast-enough pace to be confident of a decent recovery. I would like to see a greater improvement given the reopening of businesses, and it suggests more permanent scarring to the labour market.

Gold eases back as dollar recovers

Gold eased back off 8-year highs as the US dollar gained on the risk-off trade, but at $1765 in early European trade had bounced off lows around $1753 struck overnight. Short-term we see a stronger dollar exerting some pressure on gold prices; longer term the focus is on US real rates, which have just risen a touch off the lows. 10yr Treasury Inflation Protected Securities (TIPS) eased away from 7-year lows at –0.66 to –0.64, providing another little headwind to gold prices in the near term. 

Oil slides on rising stockpiles

Crude oil declined with the broader risk-off trade. Rising US stockpiles – which hit a record high for the straight week – have also started to spook traders. Crude inventories climbed 1.44m barrels in the week to June 19th, to 540.7 million barrels. Gasoline stocks were down 1.7m barrels, giving encouraging signals about driving demand. US crude oil refinery inputs rose 239,000 bpd to 13.8m bpd. Total US production rose 500,000 bpd to 11m bpd due to the return of Gulf of Mexico output following Tropical Storm Cristobal. 

WTI (Aug) retreated off the $40 level to trade just above $37 – as suggested whilst the fundamentals have started to build in favour of stronger pricing, the market will not be immune to a technical pullback on overbought conditions and/or a decline in sentiment among traders due to rising US cases. The emerging double top is less nascent than it was and increasingly calls for the $35 neckline to be touched. A breach here calls for $31.50, the swing lows touched in the second half of May.

In FX, we can see a downwards channel for GBPUSD. The cross has pulled back to 1.24 as the dollar found bid, before paring losses a little this morning. Bulls need to clear the swing high at 1.2540 to break the downtrend, but trend resistance appears around 1.25 first. Bears can eye a pullback to under the Jun 21st low around 1.2334, with the channel suggesting we may see a 1.22 handle should the bulls fail to break 1.25 next.

Gold makes fresh highs, equities retreat to middle of ranges

Morning Note

Gold broke out to fresh multi-year highs above $1770 as real Treasury yields continued to plunge. US 10-year Treasury Inflation Protected Securities (TIPS) dipped to new 7-year lows at –0.66% and have declined by 14bps in the last 6 days. The front end of the curve has also declined more sharply in the last couple of sessions, with 2-year real rates at –0.81%. Indeed, all along the curve real rates have come down with the 30-year at –0.14%.

Gold has also found some bid on a softening dollar in recent days, with the dollar index down 1% in the last two sessions. Fears that global central banks are fuelling a latent inflation boom with aggressive increases in the money supply continue to act as the longer-term bull thesis for gold.

Gold climbs on falling bond yields, fears of long-term inflation bubble

As previously discussed, gold is a clear winner from the pandemic. Gold was initially sold off in February and the first half of March as a result of the scramble for cash and dollar funding squeeze. Since then gold has made substantial progress in tandem with risk assets since the March lows because of central bank action to keep a lid on bond yields. The combination of negative real yields and the prospect of an inflation surge due to massively increased money supply is sending prices higher.

Whilst the Covid-19 outbreak is at first a deflationary shock to the economy, the aftermath of this crisis could be profoundly inflationary. Gold remains the best hedge against inflation which may be about to return, even if deflationary pressures are more pronounced right now.

Covid-19 second wave fears keep stocks range bound

Stocks are a little shaky this morning after a strong bounce on Tuesday. European markets opened lower, with the FTSE 100 slotting back under 6,300 at the 61.8% retracement, which called for a further retreat to the 50% zone around 6220. The DAX is weaker this morning and broke down through support at 12,400, the 61.8% level.

The Dow is holding around 26,100 and the 50% level of the pullback in the second week of June, while the S&P 500 is finding support on the 61.8% level around 3,118. Equity markets continue to trade the ranges as investors search for direction on how quickly the economy will recover and whether second waves threats are real.

On the second wave, the US looks clearly to have suffered a new, and in the words of Dr Fauci, ‘disturbing surge’ in cases. Virus hotspots like Texas, Florida, California and Arizona are seeing cases soar. Such is the worry the EU may ban Americans from travelling to its member states. Tokyo has also reported a spike in cases, whilst Germany is locking down two districts in North Rhine-Westphalia and there has been an outbreak in Lower Saxony.

On stimulus, Treasury Sec Steve Mnuchin said the administration is looking at extending the tax deadline beyond July 15th and is seriously looking at additional fiscal support to build on the $2.2tn Cares Act.

Dollar retreats, RBNZ decision hits NZD

In FX, the dollar has been offered this week, allowing major peers to peel back off their lows. GBPUSD has regained 1.25, while EURUSD has recovered 1.13. The kiwi was offered today after the Reserve Bank of New Zealand left rates on hold but said monetary policy easing would need to continue. The RBNZ said it will continue with the Large Scale Asset Purchase programme of NZ$60b and keep rates at 0.25%. The central bank noted that the exchange rate ‘has placed further pressure on export earnings…[and] the balance of economic risks remains to the downside’.

Crude off multi-month highs, mixed on API data

WTI (Aug) pulled back having hit its best level since March, dropping beneath the $40.70 level that was the Jun 8th peak, but remained clinging to $40. Prices have slipped the near-term trend support. Again, I’m looking at a potential double top calling for a pull back to $35. However, the fundamentals are much more constructive, and indicate a stronger outlook for demand and supply than we had feared in May.

API data showed inventories rose 1.7m barrels last week, gasoline stocks declined by 3.9m barrels, while distillate inventories fell by 2.6m barrels. Crude stocks at the Cushing, Oklahoma, fell by 325,000 barrels for the week. EIA figures today are forecast to show a build of 1.2m barrels.

Chart: Gold up over 20% from its March low

A candlestick graph showing gold prices in 2020

Gold breaks out, European equities rally

Morning Note

Equities and oil are higher as investors cautiously welcome signs lockdowns are ending but markets remain in this tug-of-war pattern where we simply don’t know whether the damage will be a lot worse than feared or the recovery will be much swifter. Indices remain in broad ranges are still seeking direction.

On Sunday, Robert Chote of the UK budget watchdog warned a V-shaped recovery was unlikely. Fed chair Jerome Powell cautioned recovery in the US would likely be slow, and it could take a vaccine to see activity rebound to 2019 levels. This week in a testimony to Congress he will likely stress the ‘whatever it takes’ mantra and push for more on the fiscal side.

Absent buying equities and negative rates, the Fed has had its six. What’s going to be interesting is whether the policy response of different governments leads to different speed recoveries. This is most dangerous moment for people and the economy – the logic of lockdown made sense to prevent health system overload, but we are not anywhere near that now. We need to get moving a lot quicker than we are.

The Atlanta Fed forecasts GDP will contract 42.8% in the second quarter. Overnight data showed Japan has entered a recession already. The Bank of England’s assumptions for a V-shape recovery look rather naïve.

Gold has emerged as a clear winner from the economic turmoil created by the pandemic. Prices were slotted into a consolidation pattern since mid-April and a tentative upside breach was attempted on Friday, but the daily close was below the $1747 level that marked the multi-year high struck last month. There has been more energy about gold bulls today and prices have driven up to above $1760, the highest since Oct 2012. The peak in that month of $1795 is the next target for bulls.

As noted in Friday’s commodities note, although gold was sold off in February and the first half of March, this was prompted by a scramble for cash at all costs due in part to a dollar liquidity squeeze that has since eased considerably. Gold has made substantial gains in tandem with risk assets since the March lows.

Whilst sentiment and relative dollar values exert short-term pressure, the combination of negative real yields and the prospect of an inflation glut due to massively increased money supply is sending prices higher. Whilst the Covid-19 outbreak is at first a deflationary shock to the economy, the aftermath of this crisis could be profoundly inflationary.

Gold remains the best hedge against inflation which may be about to return, even if deflationary pressures are more pronounced right now.

Equities finished Friday on a more solid footing but were still lower for the week. On Monday, European equities charged out of the gate. Basic resources, oil & gas and autos led the way. The FTSE 100 rose over 2% reclaimed 5900 and was just about flat with where it opened last Monday. The DAX rallied 2% in early trade after declining 4% last week.

Global indices are still in their recent ranges, albeit moving back towards the top end. Today’s early bounce only wipes out last week’s losses. At 5940 the FTSE 100 is about 50% back to the Apr 30th peak.

Regulators across Italy, France, Spain and others have decided to end the ban on short selling, which was introduced in March to stem some of the bloodletting. This move signals greater confidence among regulators that the bottom is in for equities.

WTI oil (Jun) jumped $1.70 to above $31 and Brent futures also traded higher amid signs the market is rebalancing a little faster than had been expected. Easing of lockdown measures has been positive, whilst supply has come off due to shut-ins. OPEC has been talking up making deeper cuts for longer. The worry is that this rally simply prompts producers to carry on pumping.

WTI for August was only a little higher than the June contract as the contango spread tightens. Maybe things are not so bad as we thought in oil, but the issue of storage capacity remains as long as supply exceeds demand.

In FX, GBPUSD crashed through key support on Friday and closed at the lows of the day. The pair opened lower today but has pared losses. The tenor of Brexit talks is not supportive for sterling right now, after talks last week ended with no progress. Time is running out fast and we become less sure that either side has the political will and capital to expend on this when dealing with the economic catastrophe of the pandemic.

Chatter around the Bank of England looking at negative rates is another weight on sterling right now. It’s a huge moment as we deal with a massive increase in government debt, run huge twin deficits and exit the EU whilst in the midst of the worst global recession since the 1930s. What then happens to the pound if rates go negative?

After losing the 1.2160 support GBPUSD has now opened up a potential retreat to 1.18. Next Fib support at 1.2034.

Risk offered into the weekend

Commodities
Equities
Forex
Indices

A number of factors have conspired to create a more risk-off tone to the end the trading week than we saw at the start of the European session.

Although European indices are just about holding the line, US futures are indicated lower and we may see the S&P 500 retest the lows under the 50% retracement level at 2790. The Dow is indicated -200pts.

The FTSE 100 has retreated sharply from the morning highs of the day and may well stutter into the close should Wall Street drag sentiment down. The DAX is also well off the highs though still positive, the CAC is already weaker, and the Euro Stoxx 50 is flat. US indices are already set for their worst week since the middle of March. Key test at yesterday’s lows at 2,766 for SPX.

In FX, the Japanese yen was the strongest and kiwi was the weakest. Sterling sank to its weakest since late March. Gold has broken out above the Apr 24th peak and now has the $1747 region its sights. A breakout above $1750 could see the next leg higher to $1800.

US retail sales were even worse than forecast in April, sliding 16.4% vs 12% expected. Core retail sales fell 17.2% vs 8.6% expected. Trying to read too much into individual data points in the current environment is exceptionally tough, but the optics from these figures are hardly reassuring.

US-China relations sour by the hour, with the White House moving to block semi-conductor shipments to Huawei. Reports suggest China is looking at retaliation with measures against US companies like Apple, Qualcomm and Cisco. I think we can assume a ratcheting up of pressure on China by the Trump administration in the coming weeks.

UK-EU relations are also looking very risk-off. GBP is now in full RoRo mode and cable made fresh two-month lows as it breached the April 6th support at 1.2160 to test 1.2150. It looks like real stalemate.

The UK is refusing to countenance the EU’s level playing field demands. Britain also said it would refuse any offer to extend the transition period. Both Frost and Barnier sounded downbeat on the prospects of a deal. Barnier said the positions are extremely divergent, Frost said very little progress has been made.

A lot to do to avoid the dreaded no-deal – downside risks for GBP clearly evident. The pound is already beaten up pretty badly due to the wider macro outlook as a risk-on currency these days, and the Brexit risk has reared its head again to impart more pressure.

Advisory note – Trump as ever is the wildcard and we have Rose Garden update on a vaccine from the president at some point today.

Are gold prices about to stage a second wave rally?

Commodities

Gold prices have been very well supported due to a broad flight to safety amid the Covid-19 pandemic, whilst a slump in real yields has made the metal less unattractive despite the lack of inflation.

Although gold swung lower as risk assets were ditched in February and the first half of March, this was prompted by a scramble for cash at all costs due in part to a dollar liquidity squeeze that has since eased considerably.

As risk assets have rallied off the March lows, gold too has made substantial gains and is on the brink of notching fresh multi-year highs. Bitcoin has traded in a similar fashion.

Whilst sentiment and relative dollar values exert short-term pressure, there is one key thing that drives gold prices: real yields. Central banks have been pushing down on yields aggressively with lower target rates and massively increasing their bond-buying programmes.

The Fed’s commitment to unlimited QE and the subsequent messaging from Jay Powell and colleagues means we cannot expect yields to pick up on the front end for some time. In fact we could see them drop further – fed fund futures markets recently priced in negative US interest rates.

Such is the pressure on yields right now that even with a dearth of inflation, real yields are at the bottom of long-term ranges.

Charts: US real yields (10yr TIPS) vs gold prices (inverse)

Moreover, the fiscal response from governments to the crisis could create a wave of inflation, particularly as we can see a pivot to Modern Monetary Theory in terms of a coordinated fiscal and monetary response to the crisis.

Whilst the Covid-19 outbreak is at first a deflationary shock to the economy, and therefore usually negative for gold – which tends to act as a store of value against inflation – the aftermath of this crisis could be profoundly inflationary, and therefore supports the bull thesis on gold.

Given the scale of the indebtedness and the dependency on it, the only option is to inflate it away, perhaps by monetizing the debt and overt monetary financing.

Veteran investor Paul Tudor Jones noted in his recent investor letter the increase in the supply of money (M1) could spur gold to fresh all-time highs.

A simple metric based on the ratio of the value of gold above ground to global M1 suggests gold could rally to $2,400 before it reaches valuations consistent with the lowest of the last three peaks in this valuation metric and $6,700 if we went back to the 1980 extremes,” he wrote.

On Friday gold tried to stage a break above the Apr 24th peak at $1738 but failed at this level and pared gains. A breach here would call for a retest of the Apr 14th multi-year high at $1747/8. Whilst long-term there is a bullish case to be made, the chart pattern indicates a battle at these levels and a potential triple top reversal pattern set against the bullish flag pattern.

Stocks stage fightback, Trump raises China stakes

Morning Note

US stocks staged a mighty comeback and closed at the highs as beaten-up financials managed to recover ground. The S&P 500 traded under the 50% retracement level at 2790, dipping as low as 2766 as US jobless claims rose by another 3m, before rallying to close up 1% at 2852. Financials, which have failed to really take part in the rally since March, led the way as Wells Fargo rose 6.8% and Bank of America and JPMorgan both rallied 4%. Energy stocks also firmed as oil prices rallied.

European indices were softer on Thursday but managed to recover a little ground in early trade on Friday. The FTSE 100 rose over 1% to clear 5,800, with the DAX up a similar amount and trying gamely to recover 10,500. Asian shares have largely drifted into the weekend with no clear direction.

The rally for Wall Street snapped a 3-day losing streak but the indices are still on for the worst weekly performance since mid-March. We’re still in this tug-of-war phase as the real-world impacts of Covid-19 run up against the stimulus and central bank support. Markets are still trying to figure it all out.  SPX needs to rally to 2915 today to finish the week flat, while the FTSE 100 requires 5,935.

The deterioration in US-China relations is another worry for investors, with Donald Trump saying he doesn’t even want to speak to President Xi and threated to ‘cut off’ China ties. He’s not angry, he just ‘very disappointed’. As I’ve pointed out in a past note, in an election year with the economy suffering from the worst recession in memory, Trump is likely to go very hard against China, particularly as this has bi-partisan support and polls indicate anti-China feeling running high. This will be partly a political game, partly what the US ought to be doing anyway, but either way it will likely provide yet another downside risk for investors.

Neckline support of the head and shoulders pattern is feeling pressure but yesterday’s rally is positive for bulls. Expect further push-and-pull around this region.

Overnight data showed Chinese factory output rise while consumer demand slowed. Retail sales declined 7.5% vs 7% expected in April. US retail sales today  are forecast at -12%, or -8.6% for the core reading.

Oil put on a good show with front month WTI rising above $28. The August WTI crude oil contract trades a little higher than $29, meaning the contango spread has narrowed by two-thirds in the last week. Price action suggests traders are far less worried about the underlying demand and storage constraints that have dogged prices for the last couple of months.

In FX, as flagged sterling tested the Apr 6th low, which has held for the time being and GBPUSD has recovered the 1.22 handle. Risks look to the downside, but short-term momentum looks like we could see a nudge up.

Gold has driven off the support and was last up a $1736. Whilst Covid-19 is initially a deflationary shock (negative for gold), the extent to which governments have fired up the printing presses and the fact that monetization of this debt seems the only way out, a significant period of inflation could be around the corner. Gold is still the best hedge against inflation. The Apr 23rd high at $1738 is first test before a retest of the previous top at $1747 and then $1750 to call for a breakout to $1800.

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