Todays podcast

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Overview Walking on Sunshine

• Positivity to end the week with equities up, yields down and USD down
• Better than expected retail data and Citigroup earnings the main drivers
• Lower inflation expectations also sees pricing fall for a 100bps Fed hike
• Fed’s Bullard still hawkish, ups desired rate to 3.75-4.00% from 3.50%
• All eyes on Nord Stream this week to see if gas flows again; ECB too
• Coming up today: NZ Q2 CPI, RBA’s Lowe on crypto, BoE Saunders

“Hey, alright now; And don’t it feel good!!; Yeah, oh yeah; And don’t it feel good!!; Walking on sunshine” Katrina & The Waves 1983

Risk sentiment rallied on Friday with a better than expected US retail sales print and positive earnings from Citigroup lifting equities, all likely exacerbated by positioning . A fall in 5-10yr inflation expectations out of the University of Michigan Survey to 2.8% from 3.1% also saw markets further reduce their pricing for a 100bp hike from the Fed, which was reinforced by the Fed’s Bostic who backed a 75bp hike after having been open to it. The S&P500 rose 1.9%, though for the week it is still down -0.9% and is around -19% away from its early January peak. Yields fell with the US 10yr -4.4bps to 2.92%, and with 2yr yields little changed the 2s10s curve inverted further to -21.3bps. Despite the positivity recession risk is very much alive with the Atlanta Fed GDP Now at -1.5% annualised for Q2, while markets continue to price the Fed overdoing the hiking cycle with 56bps of cuts price in 2023 after a peak of 3.54% in February 2023. The USD fell amidst the risk positive environment with the DXY -0.4%, but is +1.0% for the week.

The catalyst for the spike in equities appeared to be Citigroup with its shares up 13.2%. Citigroup beat expectations with earnings per share of $2.19 vs. 1.68 expected, though note profit is still lower than last year’s $2.85. Revenue rose a bigger-than-expected 11% in the quarter to $19.64 billion, more than $1 billion over estimates, driven by interest income and strong results for trading and institutional services. Overall Citigroup noted it saw little evidence so far that a recession is imminent, with the CEO noting: “while sentiment has shifted, little of the data I see tells me the U.S. is on the cusp of a recession. ” Overall though the profit reporting season has been lacklustre with FactSet noting that 7% of companies had reported so far for Q2 with 60% beating on EPS, below the usual beat of 77%. Earnings for non-financials in particularly highlight cost pressures as seen in reports by Delta and Fastenal.

The other factor driving positivity was a better than expected US Retail Sales print with core control at 0.8% m/m vs. 0.3% expected. The prior month though was revised lower to -0.3% m/m against 0.0% initially reported. A lower than expected inflation expectations read out of the University of Michigan Survey also added.  The 5-10yr expectation fell to 2.8% from 3.1%, just below the 2.9-3.1% range seen in the preceding 11 months. The Fed’s Daly said the inflation expectations print was a “a good thing ” combined with comments by Bostic (see below) saw pricing for a 100bp hike in July fall to 19%. As for overall consumer confidence this was little changed at 51.1 from 51.0 and remains near all-time lows and at levels consistent with a recession. Also inflation related, import prices excluding petroleum fell ‑0.4% m/m, perhaps showing signs of the stronger USD flowing through.

It wasn’t all rosy in terms of data though, and recession risks are still alive. Manufacturing Production was weaker than expected at -0.5% m/m against -0.1% expected, and the prior month was also revised lower to -0.5%. Following the data the Atlanta Fed GDP Now tracker was updated with Q2 GDP still expected to be well negative at -1.5% annualised (see Atlanta Fed GDP Now for details). A technical recession thus still seems a high possibility, but it is a strange one with the profit reporting season so far showing that while firms are preparing for a slowdown, there is little hard evidence outside of housing and consumer/business confidence so far. Also out on the data front was the NY Empire Fed Manufacturing Survey. While current conditions were positive, forward expectations were disastrous and at levels worse than at the height of the pandemic.

Fed commentary reinforced expectations of a 75bp hike in July. The Fed’s Bostic noted he supported a 75bp hike, after having said “everything is in play for future policy decisions” after the CPI figures, noting that “moving too dramatically I think would undermine a lot of the other things that are working well.”. The Fed’s Daly also said her “most likely posture” was a 75bps hike later this month. Closely watched Fed whisperer Nick Timiraos also penned a weekend piece that seemed to suggest a 75bp hike was all but certain (WSJ: Fed Officials Preparing to Lift Interest Rates by Another 0.75 Percentage Point). Market pricing for a 100bp hike fell to 19% on Friday from as high as 63% on Wednesday.

More important Fed commentary in your scribe’s opinion was Bullard’s hawkish comments. Bullard noted the Fed may need to raise interest rates to higher levels this year than previously anticipated given the broadening out of inflation (“inflation is proving to be broader and more persistent than we would have thought even 60 or 90 days ago ” and that based on rents core PCE probably hasn’t peaked at this point), nominating a rate of between 3.75-4% by the end of the year, from his comments around 3.5% previously. That would imply around 225bps of hiking at the next four Fed meetings, meaning the Fed after hiking by 75bps in July, would continue to hike 50bps a meeting to the end of the year. Markets continue to price the Fed overdoing the hike cycle with 56bps of cuts priced for 2023 after peaking in February 2023 at 3.5%. Meanwhile the latest WSJ survey of economists 46% of economists surveys said the Fed would overtighten (see WSJ: As Fed Tightens, Economists Worry It Will Go Too Far).

In FX the USD was broadly weaker on Friday amidst the improvement in risk appetite. The DXY fell -0.4%, but is still up 1% over the past week and close to 20-year highs. A day after falling below parity, the EUR rebounded 0.9% to 1.0080 while USD/JPY eased back from 24-year highs to 138.60. The AUD was stronger on Friday +1.1% amidst the weaker USD, but was still -0.9% over the week and ended around 0.6793. My FX colleagues lowered their AUD forecasts on Friday, seeing an extended period below 0.70 with a realistic range of 0.65-0.70 with the Aussie now not seen durably above 0.70 until September June 2023.

Elsewhere the focus continues to be on China where two headwinds are becoming more evident. China’s zero covid policy is taking much needed momentum out of the economy. Q2 GDP fell -2.6% in the quarter (-2% expected) with the annual growth rate slipping to just 0.4% y/y. The government’s 5.5% annual growth target is now widely considered to be out of reach and given the zero-covid policy stimulus is unlikely to gain much traction. According to the FT there are currently 31 cities in full or partial lockdown, equivalent to around 247.5m people. The other headwind is the property sector amid people boycotting mortgage repayments for partially completed dwellings. Financial markets are pricing in pain ahead with a bond sold by China’s second-largest builder falling to 82 cents in the dollar, while equity prices for Chinese developers are down 10% on the week. The likely weak growth trajectory for China is one reason we are pessimistic about the outlook for global growth and, by extension, the AUD and NZD this year.

Coming up this week:

Australia and NZ – RBA speeches, NZ CPI:

• Attention turns to the RBA following the much stronger than expected labour market figures with the unemployment rate having plummeted to 3.5%, a level the RBA did not forecast the economy to reach. Governor Lowe speaks Wednesday and Deputy Governor Bullock speaks on Tuesday, and both no doubt both will be asked whether the RBA is open to a 75bp hike in August, and whether policy now needs to go into restrictive territory and beyond the RBA’s self-assessed 2.50% neutral. Bullock’s speech is titled ‘How are Households Placed for Interest Rate Increases?’, an opportunity to see how much the RBA thinks the cash flow channel will limit how quickly and how high the cash rate can go. Also from the RBA is the Minutes from the July meeting. Across the ditch NZ has its Q2 CPI on Monday, which will be watched closely this side of the Tasman as well for any possible hints for Australia’s CPI figures the following week.

Offshore – Nord Stream Gas; ECB; US Earnings; Global PMIs:

• Europe dominates with focus on whether gas flows resume after the Nord Stream 1 gas pipeline finishes its maintenance period on Thursday 21 July. If gas flows do not resume meaningfully, European gas prices will surge, prompting Germany and others to enact gas and power rationing with a deep recession all but guaranteed. Our base case is that gas flows resume. The ECB also meets on Thursday where rates are expected to rise 25bps (though 50bps will be debated). A greater than expected rate hike would turn greater focus on the anti-fragmentation tool. Outside of gas flows, the other geopolitical event to note is the unfolding situation in Italian politics after PM Draghi offered to resign. He has a chance to find a new workable majority, otherwise Italy looks like it will go to the polls.
• In the US earnings the main focus after Fed officials on Friday favoured a 75bp hike at the upcoming 28 July FOMC meeting (Bullard and Bostic). Markets have significantly reduced their pricing of a 100bp hike to a 19% chance. The main earnings reports to look out for are BofA, Goldman’s & IBM (Monday), J&J and Netflix (Tuesday), and Tesla (Wednesday). On the data front are housing indicators, including Starts/Permits on Tuesday and Existing Home Sales on Wednesday. Jobless Claims will also be looked at closely and whether the lift seen recently is due to unfavourable seasonals, or a signal of some easing in the labour market. Business surveys may also give some guide to momentum in the economy amid elevated recession risks with the S&P PMIs on Friday and the Philly Fed on Thursday.
• China’s covid situation the main watchpoint with some reports suggesting 31 cities are under full or partial lockdown, which is impacting around 247.5m people. Shanghai is also seeing rising cases, with fears Shanghai and Guangdong may be lockdown down again.

Coming up today – NZ Q2 CPI:

• AU: RBA’s Lowe: speaking on Central Bank Digital Currency and Crypto-Assets and thus unlikely to be market moving. Note Governor Lowe is speaking on the macroeconomy on Wednesday.
• NZ: CPI-Q2: CPI on Monday and our expectation is +1.4% for the quarter and 7.0% y/y – exactly in line with the RBNZ’s (May MPS) forecasts. Just note that we have a relatively stronger view on non-tradables inflation. This could reflect in other core CPI inflation measures for Q2, including the sectoral-factor version the Bank computes.
• UK: BoE’s Saunders: MPC member Saunders is scheduled to speak.

Market Prices

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