US stocks kicked off the week on a slightly positive note on the back of weak economic data – that fueled the Federal Reserve’s (Fed) pause expectations, glim hope that the debt ceiling talks between Joe Biden and Kevin McCarthy could lead to resolution and on Microsoft gaining EU approval to buy Activision.
But all of the latter are weak reasons to jump on a bullish trade because,
1. the New York Empire State Manufacturing index slumped to -31.80 in May, versus a slump to around -3.70 expected by analysts. Slowing activity brings forward the idea that the Fed will stop hiking interest rates on slowing growth, but Minneapolis Fed head Kashkari warned investors that the Fed will tighten more, Atlanta Fed’s Bostic said the Fed should hold, but in no case cut the rates this year, while Chicago Fed’s Goolsbee didn’t want to promise a pause in June. He said that he watches the data and remains ‘extra mindful of the hikes’ impact on credit conditions.
While a June Fed hike is still off the table, activity on Fed funds futures hint that investors see higher odds for a rate hike next month. The probability of a 25bp hike now stands at 19%. But of course, the data and how the debt ceiling talks go will be crucial in what the Fed could and would do.
2. Even though investors bought hope of a possible breakthrough on US debt ceiling impasse when Biden and McCarthy meet today, McCarthy warned that they ‘are nowhere near reaching a conclusion’. The negotiations will likely remain tight as Republicans ask decent spending cuts to accept a debt ceiling relief, while Biden is not willing to compromise on spending into the election year. Therefore, even if Biden was to blink, he’d better do it at the last minute – to show his electors that he did his best to avoid an otherwise unavoidable default. Anything else would probably be a political mistake.
In this context, there is little chance we will see a resolution to the US debt ceiling issue today. And that’s certainly why the US 2-year yield pushed higher yesterday despite the scary NY manufacturing index read. The 2-year yield is again in a tight range around 4%, with looming risks to the upside in the short-run, which could lead to an interesting buying opportunity at discount for investors who bet that the US won’t default on its payments and that the Fed will loosen its policy later this year.
P.S For investors, a default means US government not servicing the debt. Period. Investors don’t care much whether the US government workers will get paid or not. They just care about whether the US will be able to service its debt. So here, there is a nuance. And even in an extreme case, like in 2013 when we saw the US government shut for weeks, it wasn’t considered a default because 1. US didn’t default on its debt payments, so for investors, frankly speaking, there was no default whatsoever. Ut even politicians didn’t call the 2013 government shutdown a default, they said it was just a ‘lapse in appropriations’. So even in case of a government shutdown, the US can avoid a proper default.
3. Microsoft won the EU approval to buy Activision. The European Commission says its analysis shows that the huge $69bn acquisition would not harm competition because Microsoft will let its cloud rivals offer titles such as Call of Duty on their own platforms for 10 years, the US and UK regulators are not convinced. The British regulators clearly said they stand by their decision that it’s not a go!
Weak Chinese data
The latest economic data released in China showed that retail sales and industrial production grew slower than expected in April, while fixed asset investment unexpectedly fell. Crude oil traded past $71pb yesterday on news that People’s Bank of China boosts liquidity to fuel growth in China, but as long as the hard data is not there to confirm improved activity, it will be hard for oil bulls to justify an advance above the 50-DMA, which stands a touch below the $75pb.
Moving forward
Investors will keep an eye on European growth and sentiment data, the US retail sales figures and Home Depot earnings. In the coming days, other US retailers including Target and Walmart are due to announce earnings to give a sense of how US consumers are coping with the sticky-high inflation.
The latest GDP report revealed surprisingly resilient consumer spending – which in return puts a positive pressure on inflation expectations, and Fed bets. Therefore, any further resilience in retailer earnings would keep the Fed hawks alert.
