By Dean Popplewell
Tuesday May 31: Five things the markets are talking about.
Capital markets are back to full participation after yesterday’s holiday observance in the U.K. and U.S.
A number of key releases are expected to dominate trading for the remainder of this week: Thursday’s ECB rate decision and OPEC’s meeting in Austria, and on Friday, there is the granddaddy of economic releases, May’s non-farm payroll (NFP) report.
The Fed is doing its job of leading the investor to the well, but are they finally drinking the ‘Kool-Aid’ of higher rates sooner rather than later?
Fed funds futures contracts have pushed up toward a +30% probability of a +25bp hike in June, and a near +59% chance of a hike in either June or July.
1. Sterling slides across the board
One of the biggest currency movers in the overnight session has been GBP. Month-end requirements, new Brexit positioning and technical resistance/support (GBP/JPY 164.00 and EUR/GBP €0.7575) levels have managed to trigger a plethora of stop-loss orders in the pound vs. the majors.
GBP/USD is trading down -0.2% at £1.4601, paring earlier gains when it failed to reach last week’s outright high of £1.4740. The pound is being seen as rather vulnerable after gaining strongly recently on a perceived lower risk of a U.K. vote to exit the EU on June 23. Recent polls and bookie odds continue to be streets apart, but that gap is closing.
William Hill bookmakers this morning indicated that +85% of referendum bets over the long weekend was for ‘leave’ and this has required them to shorten their ‘leave’ odds. While the latest ORB/Telegraph poll also shows the gap closing – +51% for staying in EU (down from +55% on May 23) and +46% for leaving (up from +42%).
2. Eurozone remains in deflation
No surprise to the market that the eurozone remains in deflation again this month. Data reported this morning indicates that euro consumer prices were -0.1% lower on the year, a slightly smaller fall than the -0.2% recorded in April.
Inflation has been below the ECB’s target for more than three-years, including two-years where it has been at -0.5% or lower.
Today’s print again occurred despite the recent pick-up in energy prices. Perhaps more of a concern is that the core-rate of inflation remains low at +0.8%, but up from last month's +0.7% print.
The ECB will likely raise its inflation forecasts Thursday, reflecting in part the energy pickup, but weak growth will continue to hamper the central bank’s ability to meet its target.
One of the major problems is that Tier I central banks have been looking to the Fed to do most of the heavy lifting for them. Will euro inflation receive an additional boost if the Fed were to raise its short-term interest rates over coming months? Many believe so as rate differentials would be expected to weaken the EUR (€1.1142) and raise prices of imported goods and services.
3. Draghi to be asked some tough questions
The European Central Bank (ECB) is not expected to make any new decisions or to significantly alter the direction of euro monetary policy at its upcoming meeting on Thursday. That being said, investors should expect Mario Draghi to be put on the back foot when it comes to his Thursday’s press conference at 08:30am EDT. In the month of May the single currency (€1.1135) has been relatively contained.
Euro policy makers will most likely be asked why regional inflation expectations are not moving in line with the rising oil prices (Brent $49.30), and also whether inflation expectations are still firmly anchored. Crude prices have rallied +83% from their February 11 low ($26.05-12-year low) and the price increase is yet to be fully seen in the real economy.
Questions may also be raised with regards to low wage settlements in the eurozone, and also how the ECB would act if Britons decide to leave the European Union (Brexit referendum June 23). Unlike sterling, the EUR has yet to see a significant negative impact in the event of “what if” Brexit was a possibility.
The odds from some bookies on the U.K. voting to stay in the EU are at their lowest yet. The “remain” camp is trading at 1.23 (+81% chance) and the “leave” has drifted to 5.20 (+19% chance). However, do not be surprised as the event gets closer the odds to change accordingly.
4. U.S treasury’s plummet in holiday trade
On Monday, U.S. 10-year futures contracts fell by the most in more than three-weeks after Yellen’s Friday comments suggested that an improvement in the U.S. economy would warrant raising interest rates in the coming months.
The market was not looking for anything from the Fed Chair. However, what she said ended up being a tad more “hawkish,” especially for her. September 10-year futures contracts fell -14 ticks for an implied yield of +1.85% – the biggest decline since May 9.
With Ms. Yellen making her comments lunch time Friday, it comes as no surprise that fixed income traders are still reacting to them because the market closed early in NY for the U.S. Memorial Day holiday. Fed Funds futures show that the odds of a U.S. interest-rate hike by July have more than doubled to +59%.
Naturally, the potential for higher U.S. yields has revived the greenback this month, with the dollar versus its major peers up more than +3%.
5. Global shares print one-month highs
Global stock markets have mostly held on to their recent gains again today, with major bourses on track to end the month sharply higher.
Yesterday, European markets closed higher after hints from the U.S. Federal Reserve’s Janet Yellen and James Bullard about when the Fed might next raise interest rates. It seems that investors are deeming a Fed rate hike as a positive sign of a growing, robust economy, nevertheless, policy makers still require further data points before committing to their next rate hike.
Global indexes have also risen despite Chinese equities experiencing overnight its second “flash” crash in index futures in as many months.
The DAX in particular is being helped by yesterday’s data that showed German import prices for April fall -6.6% vs. -6.2% forecasted and by today's better than expected German May Unemployment Rate printing fresh record lows of +6.1%.
Indices: Stoxx50 -0.3% at 3,071, FTSE -0.1% at 6,244, DAX -0.3% at 10,302, CAC-40 -0.3% at 4,489, IBEX-35 -0.2% at 9,089, FTSE MIB -0.3% at 18,228, SMI -0.6% at 8,238, S&P 500 Futures flat