Risk appetite has experienced a sharp deterioration in the last few hours. Major US equity index futures are currently down more than 1.0% in pre-market trade, with E-mini S&P 500 futures falling back to but seemingly finding support at the 4300 level. European bourses trade with even steeper losses, with the Stoxx 600 index down about 1.6%, following on from what was an ugly session overnight for Asia Pacific equity markets. While the move in equities is likely to steal the headlines in the financial press, bond markets are in the driving seat with regards to macro sentiment right now. Global bond yields continue to drop sharply, with US 10-year yields on course for a fifth day of declines which has seen them drop from close to 1.50% to close to 1.25%. Up until only yesterday, this was being taken as a net positive for equities (tech stocks generally like lower yields). However, as the bond yield decline has extended, a fierce debate about what is driving the move has been ignited.
The narrative of “peak global growth” and the “end of the reflation trade” (i.e. bets on higher inflation ahead) seems to be gaining strength and driving the action today; recent further evidence of economic slowdown in China (June PMIs have fallen to their weakest since April 2020 and one of the countries’ leading growth indicators, credit growth, has been falling for months) seemingly has Chinese authorities and global markets concerned. The Chinese Cabinet announced overnight that there would soon be cuts to one of the country’s main interest rates, the RRR, in an effort to support the real economy. This announcement sent Chinese bond yields tumbling and has contributed to the global drop. It is important to understand that a slowdown in China typically heralds a slowdown elsewhere in the globe (it is the world’s second largest economy after all) and a slowdown in global growth strengthens the argument that developed countries are more likely to return to the pre-pandemic deflationary economic environment rather than onto a new inflationary environment. A deflationary environment reduces expectations as to how high developed market central banks will be able to eventually push interest rates in the coming economic cycle (hence the lower long-term yields). Other risk negative themes such as 1) concerns about the global spread of the Covid-19 delta variant, 2) ongoing OPEC+ impasse and 3) China’s crackdown on foreign listed tech companies are also being cited by analysts as reasons for the bond rally, with investors moving into bonds for their safe haven appeal.
Elsewhere, and taking more of a backseat as a driver of global risk appetite, there have been a few other notable central bank developments. We had the FOMC minutes last night, which seemed to lean dovish given that the board was in general agreement that “substantial further progress” towards its dual mandate goals was not deemed to have been met yet (remember the FOMC will only start tapering its pace of bond buying when “substantial further progress” is deemed to have been met). There were mixed views expressed as to when the conditions for tapering QE would be met, with some expecting them to be met sooner and some arguing for patience. We also just had the release of the ECB’s new strategy review; the bank set itself a new symmetric 2.0% inflation target, moving from its prior target that inflation should be close to but just below 2.0%. That brings it more in line with other central banks like the Fed and BoE, although to be fair, the Fed’s target is a little different, they seek to average 2.0% overtime with that average seemingly backdated to at least the start of the last economic cycle, meaning they will tolerate inflation above 2.0% for a time to make up for previously “lost” inflation. There is no indication of the ECB taking this back-dated average approach. The ECB’s new target should have dovish implications; the bank consistently failed to hit its old target, so it seems likely that it will continue to fail to hit its new target but by an even greater margin moving forward, which will strengthen the argument of the ECB doves (who will want more stimulus) going forward. The ECB minutes of last month’s meeting have now been delayed for release until tomorrow, given the release of the strategy review today.
Now taking a look at commodities; risk-sensitive commodities (energy and industrial metal) are generally weaker. Front-month WTI crude oil futures are down about 0.5% on the session and under $72.00, weighed by the drop in stocks. Copper is down nearly 2.0%, weighed by China growth concerns (China is the biggest global copper consumer). Meanwhile, the Bloomberg Industrial Metal Subindex is down about 1.5% also seemingly weighed amid the onset of “peak growth fears”. Returning to oil quickly; there are no developments to report on with regards to OPEC+, who remain at an impasse meaning no deal for an output hike in August. This is likely to remain in the driving seat of crude oil price action going forward and any signs of a further breakdown in cartel cooperation could trigger fresh selling. Turning now to precious metals; spot gold (XAUUSD) and spot silver (XAGUSD) prices are both doing pretty well, both aided by the sharp and ongoing drop in global bond yields – US real yields, with which precious metals have a strong negative correlation, have slumped on Thursday with 10-year TIPS probing the -1.0% mark for a second day running ahead of a potential drop back towards record lows around -1.1%. XAUUSD is currently supported above the $1800 level and XAGUSD remains supported above $26.00. Given the extent of the move lower in bond yield and strong demand for safe haven assets right now, one might expect precious metals to have seen stronger gains over recent days.
But the US dollar, due to its safe haven appeal, has remained fairly well supported in recent days, limiting the prospect for upside in the likes of gold and silver. Speaking of the US dollar; the DXY has seen a modest pullback from yesterday’s multi-month highs above 92.80 and currently trades just under 92.50. On the day, the index is down about 0.2% owing to the losses that USD is sustaining against its lower yielding, fellow safe haven peers JPY, CHF and (to a lesser extent a safe haven) EUR. CHF is up about 0.9% on the session versus the buck, pushing USDCHF below 0.9200 again and to fresh two-week
lows, while USDJPY has slumped from above 110.50 to under 110.00 amid a 0.8% rise in the yen versus the buck. Meanwhile, the euro is up about 0.4% versus the buck, bringing EURUSD back from multi-month lows under 1.1800 back to not far below 1.1850.
Meanwhile, unsurprisingly, we are seeing weakness in the more risk-sensitive currencies such as AUD, NZD, CAD and GBP, which are down 0.8%, 1.0%, 0.6% and 0.3% respectively versus the USD. AUDUSD has dropped to fresh multi-month lows under 0.7450 and NZDUSD is testing 0.6950, though remains above June lows. Both are exposed to the China economic slowdown. GBPUSD, meanwhile, has dropped under 1.3800 and not received much of a cheer from the fact that the England football team made it into the final of the European Cup last night. USDCAD is above 1.2550 now and also at multi-month highs ahead of tomorrow’s crucial Canadian jobs data. Analysts are citing an unwind of pro-risk carry trade positions (i.e. when you borrow in low interest rate currencies like EUR, JPY and CHF to lend in higher interest rate currencies like EMFX, AUD and NZD) as well as risk appetite as one of the main drivers in FX today (which explains the strength in the low yielders versus USD). Others are citing flows from currencies where the country has a current account deficit to the currencies of those with a current account surplus as being a driver today, which can also explain strength in EUR, JPY and CHF (the EU, Japan and Switzerland all export more than they import) over USD (the US has a big trade deficit).
The Day Ahead
US Weekly Jobless Claims data is out at 1330BST and could help to further inform expectations as to the path of the US economic recovery. The only other notable event on the calendar is the release of weekly US EIA crude oil inventory data at 1600BST (coming a day later than usual due to the US holiday on Monday). Last night saw a bigger than expected drop in inventories in the weekly Private API report and oil traders will look for confirmation of this today.
