Markets Today: Markets tossed back and forth in a sea of uncertainty

The biggest news overnight is commodities, oil prices are up, which threatens to prolong the inflation narrative.

By Tapas Strickland

Todays podcast

https://soundcloud.com/user-291029717/markets-tossed-back-and-forth-in-a-sea-of-uncertainty?in=user-291029717/sets/the-morning-call&utm_source=clipboard&utm_medium=text&utm_campaign=social_sharing

Overview Weather With You

Weak China data set the theme last night, though sentiment improved a little overnight
US equities modestly lower along with the us 10yr yield and US dollar
Commodities surge, oil up some 3-4% and wheat up an astounding 12%
Coming up today: RBA Minutes, UK Jobs, US Retail Sales, Fed’s Powell

“Well, there’s a small boat made of china; It’s going nowhere on the mantlepiece; Well, do I lie like a loungeroom lizard; Or do I sing like a bird released?” Crowded House 1991

Weak China data largely set the tone, with this continuing overnight. Major equity indexes finished in the red with the S&P500 -0.4%, after having been down by -1.0% earlier in the session. Yields also fell with the US 10yr -3.6bps to 2.88%. The USD fell alongside the small fall in yields with the DXY -0.3% with most pairs higher by the same magnitude (AUD +0.4%, NZD +0.5%, EUR +0.2%, GBP +0.5%). Big moves were seen in commodities, threatening to prolong the inflation surge. Brent oil was +2.4% to $114.23 with the focus on refined products given a shortage of refining capacity. Wheat was also up +12.1% after weekend news of India restricting wheat exports. There was little Fed speak with only Williams re-iterating similar points to Powell recently.

First to the China activity numbers which sharply disappointed across the board. Retail Sales in April were -11.1% y/y against -6.6% expected, while Industrial Production was -2.9% y/y from 0.5% expected. In seasonally adjusted terms, retail sales are 14% below their February peak and Industrial Production is 7% below the February peak. Fixed Asset Investment in contrast was more steady at 6.8% y/y against 7.0% expected. With Shanghai’s virus situation improving, restrictions are set to ease which should enable some resumption of normalcy. However, is unclear when China can pivot to living with COVID and further virus outbreaks (likely given the Omicron variant) will weigh on the economy.

Second-tier US data also showed signs of weakness in May with the US Empire Fed Manufacturing Survey falling to -11.6 against +15.0 expected and 24.6 previously. The monthly decline of thirty-six points is the largest since the peak of the pandemic. Sharp falls were particularly prevalent for the new orders index which was down a sharp thirty-four points to -8.8 along with the shipments index which plunged fifty points to -15.4. It is unclear how much signal should be taken from this survey given its volatility, but it does place more of a premium on the other regional manufacturing indexes – the Philly Fed is out on Thursday, and perhaps hints of spillovers from China.

Fed talk was on message with the Fed’s Williams singing from the same hymn sheet as recent FOMC speakers. Williams the Fed’s “job number one is bring inflation down” and endorsed the prospect of two further 50bp hikes, stating such a plan “makes sense” as the Fed moves rates “expeditiously over this year back to more normal levels.” Williams also noted the FOMC is uncertain on how long inflation will remain high, a point emphasised by Mester in an MNI interview: “ With inflation as high as it is, and with expectations for inflation above 2%, you need to take into account that — at least on the short end — we’re still at an accommodative stance of policy. And even if we get up to 2.5%, depending on what’s happening on the inflation and expected inflation, we may still be accommodative,” (see MNI: Fed’s Mester sees upside risks to inflation).

On recent volatility in bonds, Williams notes volatility is in line with other markets and reflects: “there’s a lot of uncertainty, and a lot of events happening. We’re also seeing our actions moving monetary policy, I think, in a very strong direction, to more normal rates, and so some of that volatility, again, I think is — in say, the Treasury market — is really the markets digesting that information, ”. As for yield moves overnight the US 10yr yield fell -3.6bps to 2.88%, with the consolidation in yields around these levels continuing. Meanwhile across the pond the ECB’s Villeroy expected the ECB’s June’s meeting to be “decisive” for normalising policy and 2022. Markets currently price around 94bps worth of hikes from the ECB in 2022. Also in Europe the European Commission downgraded growth forecasts to 2.7% in 2022 from 4.0%. Inflation is projected to hit 6.1% in 2022, before falling to 2.7% in 2023.

The biggest news overnight perhaps is commodities, which threatens to prolong the inflation narrative. Oil prices are up 3-4%, with Brent at $114.23. A shortage of refinery capacity has also seen refined products surge by more than what the oil price would imply with US gasoline futures above $4 a gallon for the first time ever. Since the beginning of the year US gasoline futures are up 80.2% compared to WTI of 51.6%. Record US gasoline prices ahead of the summer driving season will add to the squeeze on the consumer as well as adding to transport costs. Expectations that Chinese demand is set to recover as restrictions ease is also likely a factor. Germany also noted it plans to stop importing Russian crude by the end of the year even if the EU fails to agree on coordinated action.

The other commodity worth watching closely is Wheat which surged 12% last night in Chicago continue to surge, with another gain of 5.9% after India moved to restrict exports. Prices are now up 61.9% since the beginning of the year can only add to the pressures on global food inflation for the rest of the year and into next year. The impact on emerging markets is likely to be more acute given many are food importers, a point illustrated by the BoE Governor Bailley overnight who said “that’s not just a major worry for this country, but a worry for the developing world. I’m sorry for being apocalyptic, but it is a worry.” . How central banks deal with inflation that is clearly not under their control is uncertain, the current wisdom is to normalise policy to ensure inflation expectations do not become inconsistent with the inflation target.

Coming up today:

The RBA Minutes is the focal point this morning. Offshore the focus will be on UK Employment and US Retail Sales to see what impact recent tightening and the real income squeeze is having on activity. There are also six US Fed speakers, including Chair Powell. Details below:

AU: RBA Minutes: The main interest of the Minutes is whether they give any insight into the appetite of the RBA to do a supersized 40-50bp hike. Governor Lowe in his post-Meeting press conference indicated a preference for 25bp increments, described as “business as usual”. The pace of the hike cycle is also under focus, but it is unclear whether there will be any further information on top of what Governor Lowe has said about 2.50% being reasonable.
EZ: Employment and a second read on GDP: No consensus available for employment, a while a second read on Q1 GDP is expected to be unrevised at 0.2% q/q. ECB President Lagarde also speaks.
UK: Employment & BoE’s Cunliffe: Focus is on both employment and earnings amid the sizeable real income squeeze. For wages the consensus is 4.1% y/y for earnings excluding bonus, along with a 51k gain in payroll jobs. The BoE’s Cunliffe speaks, but this is likely to be more on regulation given he is speaking to the Future of Everything Festival on ‘Money, markets and regulation’.
US: Retail Sales/Industrial Production & Fed Speak: Core retail sales control group is expected to rise 0.8% m/m after last month’s -0.1%. Any downside miss would heightened concerns of the economy slowing more than expected amid the real income squeeze and a tightening in financial conditions. Earnings for retailers will also be watched closely with Walmart and Home Depot reporting. There is lots of Fed speak with six Fed speakers, including Chair Powell who is being interviewed by the WSJ journal. Powell is likely to re-iterate similar wording to his interview of last week where he took a hawkish line, taking some sugar coating off a soft landing: “whether we can execute a soft landing or not, it may actually depend on factors that we don’t control” (see Powell: interview transcript with Marketplace ).