Market Briefing - Risk Appetite Recovers on Falling Rate Expectations

In the topsy-turvy logic of today’s policy-driven financial markets, bad news can be good news. A one-two punch from weak manufacturing data and hawkish central bank rhetoric drove interest rates down and defensive equities up during yesterday’s session - a combination that triggered a modest sell-off in the dollar. 

More evidence of a slowdown in the US economy was provided when S&P said its manufacturing purchasing manager index fell to 52.4 from 57 in May, saying, “Declines in production and new sales were driven by weak client demand, as inflation, material shortages and delivery delays led some customers to pause or lower their purchases of goods”. 

And Federal Reserve officials kept threatening to tighten into a slowdown: Chair Jerome Powell adopted a more aggressive stance when testifying before the House, reiterating the central bank’s “unconditional” commitment to fighting inflation, before Michelle Bowman, a voting member of the Fed’s rate-setting committee, cued up another jumbo-sized hike at the central bank’s July meeting. In a speech delivered to a business group in Massachusetts, Bowman said, “Based on current inflation readings, I expect that an additional rate increase of 75 basis points will be appropriate at our next meeting as well as increases of at least 50 basis points in the next few subsequent meetings, as long as the incoming data support them”. 

Weaker growth prospects drove long-term interest rates lower, encouraging investors to buy defensive stocks. The S&P 500 was up almost 1 percent and the Nasdaq climbed 1.6 percent during yesterday’s session, and both are looking at a stronger open this morning. Ten-year Treasury yields are floating near 3.10 percent after topping 3.48 percent only a week ago. 

The interest differentials that supported the dollar’s gains over the last year are beginning to narrow, suggesting the currency could be headed for a period of underperformance. 

Oil prices remain under pressure. Barrels of West Texas Intermediate are changing hands for $104, down almost 10 percent on the week, while the global Brent benchmark trades at $111, completing an 1.5 percent drop in the last five days. 

Statistics Canada will release its April Survey of Employment, Payrolls and Hours - a more detailed jobs report - at 8:30 am. The country is assumed to be running close to full employment and the lagged nature of the data means markets are unlikely to get excited about it. 

The Canadian dollar keeps trying to stage a rebound, but deeper gravitational forces around the 1.30 mark are keeping it restrained. The currency’s gains have been capped by the Bank of Canada’s tendency to follow in the Fed’s footsteps, high household leverage is raising the risk of a slowdown as rates rise, and commodity prices are clearly turning down. 

No major data releases or obvious volatility catalysts loom ahead on today’s calendar, but a final read on the University of Michigan’s consumer sentiment survey could prove interesting. Revisions in the 5-to-10 year inflation expectations number - which was repeatedly cited by Jerome Powell as a factor in compelling June’s bigger-than-expected rate hike - could see markets react. 

In a piece published yesterday, analysts at Goldman Sachs said “the coming barrage of political ads pointing to high inflation ahead of the midterm elections… heightens the risk that the Fed could continue to tighten aggressively even as economic activity slows sharply”. We think that is right. Because media narratives can influence consumer expectations, the world’s most powerful central bank is now caught in a political vice, and the risk of a miscalculation is growing. Markets could face another series of violent adjustments in the run-up to the November election. 

Upcoming Events

FRIDAY

CAD    Survey of Employment, Payrolls and Hours, April

USD    University of Michigan Consumer Confidence Survey, 

USD    Baker Hughes Weekly Rig Count

MONDAY

USD Durable Goods Orders, May

TUESDAY

USD Advance Goods Trade Balance, May

USD    Conference Board Consumer Confidence, June

WEDNESDAY

USD Department of Energy Weekly Inventories

CNY    Purchasing Manager Indices, June

THURSDAY

EUR    Unemployment Rate, May

USD    Personal Consumption Expenditure, May

CAD    Gross Domestic Product, April

USD   Weekly Jobless Claims

CNY    Caixin China Manufacturing Purchasing Manager Index

USD    OPEC+ Meeting

FRIDAY

EUR Consumer Price Indices, June

USD    ISM Prices Paid

USD    Baker Hughes Weekly Rig Count