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US equities saw a modest pullback from record high levels yesterday, with the S&P 500 dropping about 0.3% on the session and the Nasdaq 100 dropping about 0.7%. Market commentators cited the usual reasons as to why stocks were down on the day; Covid-19 delta variant concerns, inflation concerns (or the worry it might trigger a further hawkish shift from the likes of the Fed) and US/China tension concerns. Given that in pre-market trade on Friday, major US equity index futures are still trading within about a percent of record highs, that all might be overthinking it. US 2-year yields continue to trade around the middle of this week’s roughly 0.21-0.26% range, which implies that bond markets at the very least are not too concerned right now about the Fed bringing their rate hike timeline any further forward due to inflation – this makes sense given that Fed Chair Powell stuck to his guns at the semi-annual testimony this week, reiterating that the current spike being observed in inflation is transitory and that it remains too early to start QE tapering (though the Fed is discussing it). Powell’s appearance this week has largely been interpreted as dovish, which ought to keep risk appetite (stocks at the very least) underpinned for now, despite rising Covid-19 delta variant risks (infection rates are rising globally and in G7 nations).
A dovish Fed Chair Powell despite this week’s hotter than expected CPI and PPI reports combined with Covid-19 risks seems to have been a perfect storm for bonds; US yields are down on the week, with 10-year yields reversing their brief post-CPI spike above 1.40% to fall back towards multi-month lows in the low 1.30s% and 30-year yields dropping under 2.0% again. Yields are also down in Europe, with a heavier emphasis there being placed on safe-haven demand for bonds, as the resurgence of the pandemic triggers a broad move back towards a tightening of international travel restrictions across Europe. Looking ahead, the main driver of global stocks and bonds today will be a data dump from the US, where the June Retail Sales report and the preliminary version of the July University of Michigan Consumer Sentiment survey are both set for release.
Turning to commodities; crude oil prices look are broadly flat on the session and look set to post their worst weekly performance since May. Front month WTI futures are currently consolidating just to the south of the $72.00 level, having fallen just under 4.0% from week open levels around $74.50. Reports that the recent impasse regarding OPEC+ policy are close to being solved has raised the prospect that the cartel will be able to reach a deal on near-term crude oil output hike, to potentially start from September. Moreover, given that the Saudi’s have seemingly caved into UAE demands to increase the baseline from which the latter’s production cuts are calculated when the cartel extends its overarching deal next April, there are concerns those other countries (like Iraq) will also want their baseline production levels lifted from then, raising the risk of crude oil oversupply from Q2 2022. All of the above has been cited as weighing on crude prices, as well as the above mentioned growing Covid-19 delta variant fears, as the pandemic continues to cripple the outlook for international travel (and hence jet fuel demand). But commodity strategists continue to emphasise that, until the end of the year at least, crude oil markets are set to remain heavily undersupplied, as demand recovers faster than production (given OPEC+ activism), which should keep a floor under prices, they argue.
Turning now to FX markets, the US dollar trades subdued with the DXY roughly flat on the day, with mixed performance being seen across the G10 majors. At present, the DXY trades just to the north of the 92.50 mark and looks set for gains of around half a percent on the week. Market commentators note that the buck has remained perhaps surprisingly well supported, despite the somewhat more dovish than expected tone from Fed Chair Jerome Powell earlier in the week and the downside this seemingly triggered in nominal and real US bond yields (which is in itself a negative for USD). Strategists have noted that this may be down to a continued sense of “reluctance” to short the dollar after the FOMC’s hawkish shift last month, as well as the scope for a further short squeeze given CFTC data continuing to highlight a market that is still very much short the US dollar. Others have noted that this week’s USD strength might be a reflection that, following this week’s much higher than expected US CPI and PPI readings, FX market participants are becoming more concerned that the Fed’s “transitory” inflation story might be incorrect, which could result in a further hawkish shift from the bank. Hence the USD buying to hedge against this risk. Looking ahead, US data is likely to be the main driver of the buck today, with the possibility that much stronger than expected Retail Sales and Consumer Sentiment numbers might trigger dollar upside given its potential “hawkish” implications for Fed policy.
Elsewhere in the G10, the New Zealand Dollar is the best performer, up about 0.4% on the day versus the buck, which has been enough to push NZDUSD back to the north of the 0.7000 level. Outperformance follows a much hotter than expected New Zealand CPI report for Q2 that was released overnight; CPI rose at a YoY rate of 3.3% in the quarter, well above expectations for growth rate of 2.8% and above the upper limit of the RBNZ’s 2-3% inflation target. As a result, markets have increased their bet for imminent RBNZ rate hikes, with OIS (Overnight Indexed Swap) money markets now pricing two 25bps rate hikes by the end of this year. Recount that prior to overnight CPI data and this week’s much more hawkish than expected RBNZ policy meeting, markets had only been expecting one 25bps rate hike by the end of the year and not even with full certainty. For this reason, NZD sits atop the G10 FX weekly performance table, just ahead of the US dollar.
Elsewhere in FX markets, the yen is the worst performing currency so far on the day, down about 0.3% versus the dollar, pushing USDJPY back above 110.00. But that only means that the yen is now flat on the week versus the dollar, so ought not be read into too much. Traders have cited growing global concerns about 1) the Covid-19 delta variant and 2) the growing risk of a slowdown in Chinese economic growth in the coming quarters as a reason why JPY has remained well supported this week. Last night saw the BoJ’s latest rate decision, which was a non-event (as usual) and delivered no surprises; the bank held policy settings and downgraded its economic forecasts for the current fiscal year, all as expected. CAD, AUD, GBP, EUR and CHF are all pretty much flat on the day versus the buck, amid a lack of any major catalysts for any of these currencies and as FX markets await the next round of important US data releases. EURUSD is sat on the 1.1800 level, GBPUSD is holding just above 1.3800, USDCAD is holding just below 1.2600 and AUDUSD is holding just above multi-month lows around 0.7400.
The Day Ahead
As noted, US data is the main theme today. The June US Retail Sales report is out at 1330BST, followed by the July preliminary University of Michigan Consumer Sentiment survey at 1500BST. US Business Inventories at 1500BST and Canadian Wholesale Sales at 1330BST won’t get much attention. Otherwise, watch out for a speech from NY Fed President and important FOMC member John Williams in the afternoon; he likely will not add much to what he said on Monday, however, nor deviate much from Fed Chair Powell’s script from the semi-annual testimony earlier in the week.
