- Risk off start to the week see stocks tumble and dollar rally
- European Central Bank likely to maintain dovish rhetoric
- Earnings: Focus turns to technology from banks
- Macro data highlights include ECB and PMIs
Risk aversion has remained the dominant theme so far in the day. After Friday’s mid-session reversal, we have seen further falls for global stocks and US index futures in the first half of Monday’s session, while safe-haven assets like benchmark government bond prices have rallied, along with the Japanese yen and the US dollar. But despite the lower yields, gold and bitcoin have not been able to find any love, held back by the rallying dollar and lack of appetite for risk taking. Crude oil has unsurprisingly sold off on the back of the weekend news from the OPEC+ group. Although their new agreement means short-term uncertainty has been lifted, the fact that baseline production levels were raised means more oil supply will be coming back than expected, and at a time when rising Delta variant of covid is raising question markets about the sustainability of demand.
Source: ThinkMarkets and TradingView.com
What is going on?
The sell-off has been quite brutal for stocks, but it is difficult to say whether this is just a retracement ahead of more gains at some later point in time or whether this is the start of something really major.
The bears would argue that it was becoming quite obvious we would get a sell off like this given that only a handful of companies were holding up the S&P 500 at record highs. There was a big divergence in breadth as a growing number of stocks broke down as the rally for the S&P index slowed down. This has been in part because of investor concerns over sky-high valuations. Although the global economy is expected to grow strongly in the second half of the year, the markets have already priced this into stock prices.
Many investors are wondering whether they can justify holding equities when valuations are so stretched and at a time when they are forced to re-price some of the optimism they had baked in with the grand opening of major economies. The Delta threat has also forced many governments into providing new travel restrictions, which has raised serious questions over travel and tourism. It looks like Asian countries have been hit the worst. Indonesia’s daily case count has now surpassed India. Other countries in the far east such as Thailand are reporting the highest number since the pandemic began. US virus cases surged last week, and hospitalizations are rising rapidly although remain significantly lower than the peak of the crisis thanks to a successful vaccinations programme. There is also the unknown threat posed to vaccinated people by future strains of the virus, as lockdown measures continue to ease, and people return to office life.
Another worry for investors is the potential withdrawal of monetary support from central banks. Dovish rhetoric from the Fed has fallen to death ears. The dollar has rallied sharply in recent weeks even though the Fed keeps reminding investors that it thinks inflation is going to be transitory. But some of the other major central banks have turned hawkish in light of rapidly rising inflation across the globe.
Will US Federal Reserve Surprise markets?
The uncertainty surrounding central bank policy has started to hurt some stocks and sectors, while causing the major currencies to weaken with the US dollar coming back amid rising inflationary pressures in the US and despite the Fed’s continued dovish rhetoric.
Last week, we twice heard from Fed Chair Jay Powell, who was characteristically dovish at
his testimony, causing yields to dip he continued to defend the central bank’s stance to keep providing support to the U.S. economy despite rising inflationary pressures. However, while adamant that inflation is going to be transitory, Powell did warn that the Fed is ready to act if needed, particularly because there’s still a lot of unknowns. He acknowledged that no one knows for sure how much longer price pressures in categories like used cars, which has been one of the main drivers behind CPI, will remain elevated. “We also don’t know whether there are other things that will come forward and take their place,” Powell added.
We won’t be hearing from Fed officials given that the next policy decision is less than two weeks away now. And with the economic calendar being fairly quiet in the week ahead, we won’t have many macro indicators to provide us strong clues as to what the FOMC might decide at its next meeting on 28 July. But given the stronger-than-expected rise in inflation, will the Fed surprise the market at that meeting? Time will tell. It could be a long wait.
European Central Bank likely to maintain dovish rhetoric
The European Central Bank meeting on Thursday will likely be the week’s main macro event. Last week, the ECB announced a change in its strategy, allowing the central bank to tolerate inflation higher than its 2% goal when rates are near rock bottom. That is the case right now, but this does not mean the Governing Council will agree on the economic and inflation outlook – and thus on how much more bond buying stimulus is needed. ECB President Christine Lagarde has also said that “forward guidance will certainly be revisited." At the moment, the guidance says the ECB will purchase bonds for as long as necessary and will keep interest rates at current levels until the inflation outlook "robustly” converges to its goal. With the cases of the delta variant of Covid-19 rising sharply across Europe and elsewhere, you can rest assured that the centra bank will not even entertain the idea of dialling back stimulus. Indeed, Lagarde has already said that her sense is that the ECB will be “maintaining favourable financing conditions in our economy," and that the ECB's Pandemic Emergency Purchase Programme (PEPP) could "transition into a new format" after March 2022, which is the earliest the programme can end.
In short, expect the ECB to remain dovish, especially if we see further sharp rises in Covid cases until the central bank’s meeting. This should keep the euro under pressure.
A few central banks have turned hawkish
As mentioned, some of the major central banks have turned hawkish and this is providing additional pressure on the markets. The Reserve Bank of New Zealand has announced it will end QE and we have seen further gains in NZ inflation data on Friday. Meanwhile, the Bank of Canada has already been tapering its asset purchases programmes. Elsewhere, a couple of policymakers from the Bank of England
also spoke last week, calling for the reduction of monetary stimulus, which helped to keep the pound stable and caused the FTSE to once again struggle. The next BoE meeting is scheduled for 5 August.
Earnings: Focus turns to technology from banks
The earnings season will kick into a higher gear and the focus will turn to the US technology sector after banks posted mostly above-forecast results thanks to strong deal making in the last quarter. Morgan Stanley posted its second-most profitable quarter on record thanks to $2.38 billion in revenue from its investment banking division. This helped to offset a big drop fixed-income trading revenue. Other US banks such as JPMorgan and Goldman Sachs have posted similar results.
In the week ahead, we will hear from the likes of Netflix, Intel and Twitter, among others.
- After its meteoric rise, Tesla will be in focus afters its shares pulled back about 25% from record highs in recent months. Its shares have fallen in part due to valuation concerns with other carmakers such as GM, Ford and Daimler all ramping up their own electric vehicle offerings.
- Netflix has managed to regain its poise after the big miss on Q1 user growth in April saw its shares tumble. Investors will be wondering how many new subscribers the streaming services has been able to add after its explosive growth during the pandemic. With lockdown restrictions having been eased further in the recent quarter, the risk is that we may see another miss.
Macro data and earnings highlights
The economic calendar for the week ahead is fairly quiet with only a handful of potentially market moving data to look forward to in the second half of the week. These include the European Central Bank meeting, retail sales from Australia, Canada and the UK, and global services and manufacturing PMIs.
- No major data
- Earnings: IBM
- RBA meeting minutes, and US building permits and housing starts
- US Earnings: Netflix
- European Earnings: Volvo, EasyJet
- Aussie retail sales
- Earnings: Texas Instruments, Verizon, Coca-Cola and Johnson & Johnson
- ECB policy decision and press conference
- US jobless claims and existing home sales
- US Earnings: Intel, Twitter, AT&T and Snap
- European Earnings: Unilever, SSE
- Retail sales from UK and Canada
- Global flash manufacturing and services PMIs, including from Eurozone
- Earnings: Honeywell International (US) and Vodafone (UK)
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