Market mood further darkened yesterday following another round of weak Treasury sales in the US. The 7-year note failed to attract enough demand on Wednesday. The 2 and 5-year auctions also saw weak demand earlier this week. The US treasuries remained under pressure. The 2-year yield – which best captures the Federal Reserve (Fed) rate expectations – shortly hit the 5% psychological mark, the 10-year yield spiked to 4.63% and the US dollar index advanced to the 50-DMA and is consolidating near that level this morning.
Things could get better or worse in the coming hours. The Fed’s Beige Book revealed yesterday that the US economy expanded at a ‘slight or modest’ pace since April, while consumers pushed back against higher prices. The latter would be ‘good news’ for the Fed – who desperately needs the US consumer demand to slow in order to progress in what they call the ‘last mile’ to hit their 2% inflation target. All eyes are on the US GDP update due today, and the Fed’s favourite gauge of inflation – the core PCE number – due tomorrow. The US GDP is expected to have slowed significantly in the Q1, with – however – a significant rise in price pressures (that’s already priced in), while the core PCE print for April could hint at some easing in the latest pickup in inflation. The best outcome would be a reasonably soft growth coupled with easing price pressures, but we could realistically get a slowing growth coupled with an insufficient easing in price pressures, instead. To the Fed, the inflation number will matter more than the growth update as regardless of the deteriorating economic growth, the progress in inflation will determine whether the Fed could remain on path to cut rates this year. Therefore, it will be hard to interpret today’s GDP data before seeing tomorrow’s PCE print. And even then, Citigroup thinks that this week’s data will trigger limited price action; the upcoming US jobs and CPI updates in the next weeks will matter more.
For now, the rising yields are taking a toll on stock valuations in the absence of other – and positive – catalysts. The S&P500 slipped below the 5300 level yesterday, and Nasdaq retreated. The US futures are in the red this morning, as Salesforce tumbled 16% in the afterhours trading after reporting a weaker-than-expected revenue growth in Q1 and after giving a softer-than-expected outlook.
Inflation is picking up beyond US
Released yesterday, the Australian inflation unexpectedly rose in April and the German inflation came in worse than expected. It appears that inflation in Germany rose from 2.4% to 2.8% in May, more than 2.7% penciled in by analysts. The German 10-year yield advanced to the highest levels since last November and the Stoxx 600 tanked more than 1% yesterday. Spain and Italy will release their inflation updates today, France tomorrow and we will have the aggregate CPI for the entire Eurozone tomorrow morning. Unless we see a big surprise – which I don’t think will happen, the European Central Bank (ECB) will probably announce a 25bp rate cut next Thursday. But an inconvenient rise in Eurozone inflation will likely vanish the expectation of a second rate cut in July.
If the Fed cut expectations vanish faster than the ECB cut expectations, the EURUSD should remain under pressure for further downside correction. The pair slipped below the 100-DMA yesterday, below the 1.08 this morning and is preparing to test the 200-DMA support at the time of writing. A sufficiently soft US growth and inflation figures could throw a floor under the EURUSD’s selloff but the divergence between the Fed and the ECB remains supportive of a deeper downside correction.
In precious metals, gold extends losses against a broad-based strength in the US dollar and the rising treasury yields. But the central bank uncertainties, geopolitical tensions and rising risk aversion could limit the gold selloff near the $2300 per ounce level.
Oil fails to clear key resistance
Happily, for everyone who doesn’t have a positive exposure to energy and energy stocks, oil prices don’t gather enough momentum above key resistance levels to further fuel the inflation worries. US crude for example sees decent resistance above the $80pb level as the waning rate cut expectations from major central banks weigh on global oil demand outlook and give the bears a good reason to remain in charge near the critical $80pb resistance. The ugly geopolitical situation in the Middle East does trigger short-term price spikes, but price rallies due to geopolitical tensions tend to remain short-lived.
Oil’s inability to gain a sustainable positive momentum is weighing heavily on energy stocks. Exxon retreated to the lowest level since March yesterday, as Chevron extended losses below the ytd bullish trend base. ConocoPhillips tumbled more than 3% on news that it will acquire Marathon Oil through a $17bn all-stock deal, while Marathon Oil jumped more than 8%. The ongoing consolidation in the Permian Bassin will help the US oil companies benefit from synergies and scale economies, and help them squeeze higher profits from their operations. At one point, the correction in energy companies’ share prices will become interesting for investors regardless of the economic and central bank prospects. If inflation eases, softer central bank expectations will boost the reflation trade, benefiting oil companies. If inflation doesn’t ease and central banks hold off on rate cuts, Big Oil’s juicy dividends and buybacks will attract investors seeking extra revenue to navigate the rising inflation tide.
 rate expectations – shortly hit the 5% psychological mark, the 10-year yield spiked to 4.63% and the US dollar index advanced to the 50-DMA and is consolidating near that level this morning.){kind=link}