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US equity market’s put in a good shift on Tuesday, with the S&P 500 rising 0.8% to post a record closing high in the 4420s, the Dow also gaining 0.8% to close comfortably above 35K and the Nasdaq 100 gaining 0.7% to close above 15K for the first time since last Thursday. This morning, index futures are a touch lower as traders await key incoming US data releases (ADP and ISM Services today, followed by NFP on Friday). Equity analysts continue to cite broadly strong earnings over the last few weeks as supportive for the equity complex; indeed, as earnings season draws to a close, analysis from Refinitiv suggests that close to 90% of companies listed on the S&P 500 have reported positive earnings surprises for the second quarter so far. Moreover, subdued conditions in US (and global) bond markets are also offering support to equities. US 10-year yields are under 1.20% this morning, close to multi-month lows having failed to recover back above 1.30% last week. Meanwhile, US 10-year TIPS yields (the inflation-expectation adjusted 10-year yield) are currently sat barely above record lows just above -1.20%. Low yields from investing in government bonds make investing stocks comparatively more attractive and boost stock valuations.
The move lower in global bond yields in recent weeks seem to be a reflection of concerns amongst bond market participants about the inevitable slowdown in global growth – after the global economy underwent a sharp, deep recession in 2020 due to the onset of the pandemic, it enjoyed a rapid rebound, with many economies posting record growth rates. Such growth rates of course cannot be sustained forever. The big question is how much global growth is going to slow? Is it going to slow back to “normal” trend levels (which could be annual GDP growth of between 2-3% in the US and 6% in China) or “sub-trend” levels (below 2% in the US and below 6% in China)? Evidence from the Chinese economy points to a growing risk of the latter, which could be why bond yields have been dropping. The very same growth concerns are yet to hurt equities, likely given expectations that slower growth will equate to more accommodative global central bank policy.
European equities also benefitting from strong earnings and low yields and the Stoxx 600 hit a record high for a third consecutive day on Wednesday, rising above 468 for the first time for a gain of more than 0.5% on the day at the time of writing. Analysts now expect Stoxx 600 companies to post a record 139.6% YoY jump in second-quarter profits, according to Refinitiv IBES data, a jump from expectations of YoY profit growth of closer to 100% at the start of the earnings season. Head of strategy at TS Lombard Andrea Cicione said that “earnings are coming out really strong and that is giving (European) equity investors some comfort” but added that “the other thing that could give investors a rush of bullishness could be the fact that, if you look at the UK, new cases of COVID-19 are falling quite sharply. That gives you a hope that the same should happen in rest of Europe as well.” Note that positive sentiment in Chinese equity markets overnight may also be offering some support; the Hang Seng and Shanghai Composite indices both rose nearly 1% amid better-than-expected Chinese Caixin Services PMI, which rallied to 54.9 in July from 50.3 the month prior, much larger than the expected rise to 50.6, though the report did note rising inflationary pressures in the sector.
Turning now to crude oil markets; prices are in the red for a third consecutive session, with front-month WTI futures looking heavy above the $70.00 handle. A drop below here could open the door to a move back to mid-July lows in the low-$65.00s. Having opened the week close to $74.00, WTI has now lost nearly $4.00 so far on the week (nearly 5.0%) amid rising concerns about the impact that the worsening state of the Covid-19 outbreaks in key markets such as the US and China may have on demand. Analysts reason that the relatively high vaccination rate in the US out to protect the country from seeing the kind of death rates witnessed earlier in the pandemic, thus removing the need for equally strict lockdown measures. But China operates a zero Covid-19 policy, and a number of inland cities are currently under various degrees of lockdown. According to Capital Economics, “the Delta variant is the biggest test of China’s zero-COVID strategy since the initial outbreak last year… but given the country’s track record in dealing with the virus so far, our assumption is that they will quash the outbreak before it gets out of control. Of course, doing so will come at some economic cost”. This will be a key theme for crude going forward. Oil prices were somewhat supported overnight following last night’s bullish weekly Private API inventory report, which saw crude oil stocks drawing 0.88M barrels (less than expected) but showed a much bigger than expected draw in gasoline stocks of nearly 6M barrels (a positive indicator of US fuel demand). The latest API report also indicated that US inventories are now at their lowest since January 2020. Most commodity analysts expect this the drawdown, which is a direct result of the fact that US and global demand is exceeding supply (thanks to output cuts from OPEC+), to continue for the rest of the year. Oil traders await today’s official EIA inventory report for confirmation. Middle Eastern Geopolitical tensions between Western powers and Iran are also worth watching after Middle Eastern security sources claimed on Tuesday that Iranian forces seized an oil product tanker, the second such attack since Friday.
Finishing with a quick look at FX markets; EURUSD has been pretty boring this week as traders await key US jobs data on Friday, the pair undulating between 1.1850 (just above which it currently trades this morning) and the 1.1900 handle. Likewise, GBPUSD also hasn’t seen much volatility, with GBPUSD spending most of the week within about 50 pips of 1.3900, with sterling traders tentative ahead of Thursday’s BoE policy meeting. USDJPY and USDCHF have been a little more interesting in recent days; the former is down about 1.25% since the start of last week to close to 109.00, while the latter is down about 1.5% to number 0.9050. Yield differentials seem to be playing a role here; both nominal and real 10-year government bond yields are down about 10bps since the start of last week to under 1.20% and just above to -1.20% respectively, as bond markets seemingly signal concerns about long-term US economic growth and inflation prospects. Such concerns naturally favour haven (like the yen and Swissie). The US July ADP National Employment Change estimate (out at 1315BST) and the US July ISM Services PMI survey (out at 1500BST) has the potential to inject some volatility into markets today given 1) the ability of the former plus the employment subcomponent of the latter have the ability to shift expectations for Friday’s crucial jobs data and 2) the latter has the ability to inform expectations regard US economic growth in the coming months. But traders are likely to hold off any making any big bets prior to the release of Friday’s key US jobs data.
Elsewhere, NZD was supported by strong jobs data overnight, where unemployment dropped to 4.0% in Q2 from 4.7% in Q1, much larger than the expected drop to 4.5%. That pushed NZDUSD from just above 0.7000 to the 0.7075 area, a daily gain of 0.9% and leaving the pair up more than 1.5% so far on the week. The red-hot jobs data appears to have solidified expectations that the RBNZ will definitely be hiking interest rates by 25bps later this month, adding further fuel to the move higher in NZD. These expectations had already been elevated heading into last night’s jobs data given an announcement from the RBNZ on Tuesday that it will be looking at ways to tighten mortgage lending standards in a bid to get house price inflation under wraps (which was interpreted as a hawkish indicator for monetary policy), and given recent hawkish actions/rhetoric from the bank, which axed its QE programme and signalled that a shift in policy towards normalisation was on the horizon at its July meeting. A number of local NZ banks are now calling for the RBNZ to have lifted its Official Cash Rate (OCR), the bank’s key lending benchmark, to 1.0% by the end of the year, which equates to 75bps of hikes from current 0.25% levels. The Aussie is a little higher in sympathy, shrugging off a large MoM contraction in domestic retail sales in the month of June (which to be fair was in line with expectations).
The Day Ahead
As noted, the main data today will be ADP’s estimate of US employment change in the month of July, which will be released at 1315BST, followed by the release of the US ISM Services PMI survey at 1500BST. There will also be a lot of attention on remarks from influential FOMC Vice Chairman Richard Clarida, speaking from 1500BST, with traders keen to see if he agrees with the more cautious (dovish) approach towards QE tapering being argued by the likes of Fed’s Brainard, or the more aggressive (hawkish) approach towards QE tapering being argued for by Fed’s Waller. It seems likely he will agree more with the former, given this stance seems closer to where Fed Chair Jerome Powell sits. If he sounds as hawkish as Waller, this would be a big surprise and may result in a hawkish market reaction (dollar, US yields up, stocks and commodities like gold down). Oil traders will be watching official EIA inventory data at 1530BST.
