Risk sentiment improved across markets on fresh hopes around China and UK fiscal policy.
US equities bounced higher again, now aided by China stimulus headlines, while UST yields continue their march higher with the 2s10s curve still inverted but steepening.
A significant focus remains on whether the Fed will hike by 50 bp or 75 bp in July – with all eyes on CPI next week as an important determinant of their direction. Still, I think the market may look past any higher June CPI and UMich inflation expectations, given the pullback in gasoline and the stable inflation expectations. But the market would be more positively active to signs of peak inflation.
Commodities and oil rallied on the headline that China is considering allowing local governments to sell CNY 1.5tn of special bonds in 2H to support infrastructure funding. And should temporarily alleviate the margin call domino effect across commodity desks where profits have been wiped out since the last FOMC And should temporarily ease the contagion effect into oil markets.
The eye-watering $ 11 move on July 5, the third-biggest absolute drop since Brent futures started trading 34 years ago, was likely exacerbated by margin calls and thin liquidity as US traders returned after the long holiday weekend and were forced into catch-up mode to the overall economic doomsday crisis in Europe.
The sharp correction in Brent Crude of late, from an intraday high of over $120/b on June 29 to a low under $100/b yesterday, reflects softening sentiment as fears of a recession grow rather than fundamental changes in the physical market.
But recession worries may have peaked in the US as the better-than-expected ISM services and gasoline inventories reduction relieved concerns about US consumption
And while negative Covid headlines in China do not help, thoughts of a delayed China reopening suggest a demand surge yet to come and, against the backdrop of a tight physical market, it should support the medium-term outlook for oil.
Still, with risk management in control, desks could be forced to use steep headline-driven commodity rallies to reduce long exposure, assuming that imminent recessions on both sides of the Pond are now close to a baseline.
If you were looking for the FOMC to ease up due to growing demand risk, it certainly does not look like the hawkish duo is about to back off on the rate hike pedal soon. Fed’s Waller said he supports another 75 bp hike in July, then 50bp in September. He thinks the Fed needs to follow the market pricing to front-load hikes and that the Fed cannot allow inflation expectations to de-anchor. Fed’s Bullard expressed a similar view that the Fed needs to keep inflation credibility.
Gold bulls were likely looking for a tempering from the hawks on the board, but no dove was in sight.
Originally published by Stephen Innes, Managing Partner, SPI ASSET MANAGEMENT