Unsurprisingly subdued start to FOMC week

Global equity markets are for the most part lower at the start of the new week. Concerns about the spread of the Covid-19 delta variant in Asia, particularly with China now reporting the second most Covid-19 cases since the January amid a new outbreak in the city of Nanjing. Meanwhile, concerns about tighter regulation from Chinese authorities are being cited as a possible factor weighing on sentiment this morning; authorities there are clamping down on the large private tutoring sector and the weekend also saw the announcement of further restrictions on the technology and property sectors in China. Separately, US/China rhetoric isn’t helping the situation for stocks in the region. High level meetings took place over the weekend between US and Chinese officials and are set to continue today, but Chinese media reported that a top Chinese diplomat had accused the US in the talks of making China an “imaginary enemy” to divert from domestic problems and to supress the country’s development. In the end, China’s main equity index the CSI 300 dropped 3.2% on the session and the major Hong Kong index, the Hang Seng was down 4.1%. However, losses in European equity markets and US pre-markets this morning are much more modest, with the Stoxx 600 down just 0.4% and E-mini S&P 500 futures down just 0.2%. Rising Covid-19 infections in Europe and the US are less of a concern for investors given that vaccine rollouts in these regions have been swift, breaking the link between rising cases and rising Covid-19 caused deaths and removing (or so investors hope) the need for the kinds of tight lockdowns seen earlier on in the pandemic. US and European investors seem instead to be focused on the multitude of key events coming up later in the week including 1) the next FOMC rate decision on Wednesday, 2) the first estimate of Q2 US GDP growth on Thursday and 3) US Core PCE (inflation) data for the month of June on Friday (the Fed’s favour gauge of inflation). At present, futures markets point to the S&P 500 index opening only just below record high levels around the 4400 mark and big moves are unlikely as traders await more information from the Fed and on the US economy.

In terms of other asset classes, the moves being observed in global bond markets are perhaps a little more interesting. German yields are down more than 1bps on the session and remain comfortably under the -0.4% mark, having managed to hit fresh five and a half month lows this morning. Selling in stocks, as well as a slightly weaker than expected German IFO survey of business sentiment in the month of July (released earlier this morning) are both being cited as factors that are weighing on yields. More broadly, the ECB’s dovish shift last week (the bank had to make its interest rate guidance more dovish to give credibility to its new 2.0% inflation target) is likely to at the very least keep European yields a sell on rallies for the time being, given that markets expect the ECB to extend its accelerated pace of bond purchases beyond the end of the PEPP in March 2022. Across the pond, the drop in US yields in pre-market trade is more significant; 10-year yields are down about 4.5bps and are back below the 1.25% mark, though remain well above last week’s lows close to 1.12%. The US yield curve is seeing further bull flattening this morning, a phenomenon typically seen late in the economic cycle and an indication that investors expect slower growth and lower inflation. Well, growth certainly does seem to have peaked in the US (this week’s GDP data should show a slowing in the pace of GDP growth in Q2 from Q1), but growth remains at historically elevated levels. The questions are how much growth will slow to in the coming years. Back to a steady state of 2-3% GDP growth per year? Or lower? Bond markets seem to be predicting the later, perhaps given the faster than expected slowdown seen in China (i.e. investors thinking the US is headed the same way). But the Fed should sound optimistic on the economy on Wednesday and there is expected to be further discussion at the bank about when to begin tapering the ongoing asset purchases programme.

Turning now to commodities; crude oil prices are a little lower this morning, (WTI -0.5%) though remain fairly rangebound as they take their cue from the more subdued tone to US and European equity trade. WTI prices are currently fluctuating mostly between the $71.00 and $72.00 levels, with the gains for now being capped by the 21DMA at $72.60 but the losses limited by the 50DMA at $70.40. Crude oil traders await further news on the spread of Covid-19 across the global and its impact on global oil demand growth, with focus having shifted back to the demand side after OPEC+ managed to forge a new supply management deal last week that likely secures the future cooperation of the cartel for the next 18 or so months. Gold, meanwhile, is a little higher on the session amid the drop in US yields but continues to trade broadly close to the $1800 mark, capped by the persistent bid being observed in the US dollar that sees the DXY continue to trade in the upper 92.00s, though the index is currently trading a little lower on the day (down about 0.2%) despite the market’s slightly more defensive bias.

FX markets are likely to trade indecisively ahead of the Fed on Wednesday and further key US data points thereafter, so small moves like the weakness being seen in USD this morning ought not be read too much into. In terms of the rest of the G10; the picture is mixed, with JPY, EUR and GBP each up between 0.2% to 0.3% on the day versus the US dollar but the Aussie and NOK both down close to 0.2%. The Aussie likely continues to feel the weight of lockdown concerns as Sydney continues to report rising Covid-19 infections despite the ongoing lockdown there, which is now rumoured to be extended yet again. Australian Q2 CPI data is out tomorrow night and will be closely watched. CAD and NZD meanwhile are pretty much flat on the session, with key Canadian data looming (CPI and monthly GDP) later in the week and keeping Loonie traders in wait-and-see mode.

The Day Ahead

There isn’t much for traders to sink their teeth into in the day ahead. US New Home Sales data for the month of June is out at 1500BST but won’t get much attention. Sentiment in US markets at least is likely to remain subdued today and as mentioned above, until after Wednesday’s FOMC meeting.