The Jackson Hole meeting involving top officials from the world’s biggest central banks has indicated their intention to follow through with the aggressive monetary stance to combat rising inflation. With large recession risks faced by both the EU and US in the nearest future, top bankers, for now, seem to choose short-term pain to economies and markets over inflationary damage. Naturally, market participants did not meet such stance with enthusiasm, with equities entering their 8th month of what now looks like a “decent” bear market. In the US, the S&P 500 fell by 4.2% with volatility index (VIX) rising to its highest level since mid-July. Similarly, we saw the European STOXX 600 down by more than 5%. Worsening labor market, below-trend growth and likely large rate increase in September suggest that the US market can forget about the “Fed put” (at least for now) and should prepare itself for a rainy autumn.
China’s economy showed little improvement due to further lockdowns and continued property crisis. Moreover, fears induced by Fed rate hikes did not help the situation, as the recovery is not looking as solid as expected with growth prospects weakening further, to just 3.5% for this year. Whilst the PBOC has cut multiple key rates, there is limited room to ease due to concerns over inflation and capital flight. Such rate cuts and worse-than-expected economic data have contributed to yuan’s weakness as it traded at 6.93 against US dollar following the Jackson Hole meeting. The official manufacturing PMI remained below the 50-point mark (the reading stood at 49.4 in August), which separates contraction from growth. New home prices in the biggest 100 cities barely moved, while the property market continued to struggle despite the central bank’s recent decision to boost credit demand by cutting the mortgage rate for home buyers.
European and US equity markets
EU and US in the bad shape
Recession risks have seemingly risen in the USA, even with a number of economic indicators surprising to the upside. Housing market is causing problems while consumer confidence and labour market are still looking strong. Meanwhile, it is difficult to imagine how the EU could possibly avoid contraction, as weakening economic sentiment, concerning labor market and soaring inflation are just a few casualties of the deepening energy crisis. JPMorgan Chase expects annualized growth rates of -2% for the euro area in the fourth quarter of the year. Inflation in the Eurozone accelerated to yet another record reading of 9.1%. A particularly worrying jump in the services costs and the 5% inflation for non-energy industrial goods should clearly alarm the policymakers, who, together with many market participants, expect the ECB to act aggressively.
Benchmark 10-year bond yields
EU and the energy crisis
Another month of pain has urged further conversations regarding the energy market reform and potential price caps in the EU, with a number of significant meetings on the matter planned for September. Whilst natural gas prices in Europe eased to €230 per megawatt-hour as of recently, they have seen a record level of near €317 in early August. An allegedly temporary Nord Stream pipeline supply cut has proven to be a stress test for Germany that revealed that its gas stores are filling up faster than planned. Still, as we approach the heating season and increased demand for oil and natural gas, the picture looks quite bleak. Despite the targeted gas use cut of 15%, supply and demand concerns along poor market liquidity will keep bullish momentum and the corresponding filling of gas stocks.
Balancing the gas and electricity markets has been a major struggle for the EU. Alongside a consensus on a quick emergency instrument, it is likely to be a big discussion point at the upcoming bloc meetings and in Mrs. von der Leyen’s annual State of the Union address.
High Yield bond Indexes
Bonds, rates and US dollar
As central banks’ September meetings are approaching, bond yields are heading higher from the recent correction lows. Charts suggest that ten-year yields might stay in recent trading ranges for months to come, but short-term bond yields could move higher in the near term should Fed and ECB “walk the walk”. That would mean the US yield curve could get even more inverted, putting more pressure on stock prices. We still look to buy short-term US bonds around the 3.25-3.50% yield mark and EU high-grade around 1.20%.
EUR/USD downtrend is still intact and during the last 4-6 weeks the pair has an established trading range of 0.9950-1.0350. While the dollar looks strong, we have to say that we see some evidence of this dollar rally gradually getting “mature”. It is far too early to talk about the complete reversal of the trend, but we should at least consider the risks of a reasonable upside correction.
A possible lower low in metals
Precious metals had another rough month. Gold managed to rise just above 1800 dollars per troy ounce and then dropped all the way back to XAU/USD 1700 level at the end of month. In the coming weeks, this level of support will define further short-term direction for the metal, so gold bulls must be very careful, as we have warned in our last memos.
Silver is also struggling after July’s rally. The next level to watch here is XAG/USD 15.90, where we would certainly add to long positions. Oil still “sits” within the recent ranges and is not giving market participants any chances for “proper action”. We still wait for oil to drop lower to 80-85 dollars per barrel levels, where we would consider going long the asset with price targets being 120 dollars per barrel.
Gold price, USD/oz
Liquidity to be an additional issue for the markets
Despite every effort from central banks, it is still questionable if raising interest rates will seriously influence the pace of inflation. Surely, these efforts will put more strain on already weakening economic activities and exacerbate fading consumer sentiment around the world, affected by shockingly high energy prices and diminishing purchasing power.
Liquidity will be another important issue as the Fed will begin running down its securities holdings by ~$95B/month, or double the pace of that, which began in June. Risk assets are quite sensitive to these liquidity flows. So far, the Fed has only reduced its holdings by $52 billion in total, or roughly $17B/month. In other words, the pace of runoff from September will increase not twofold, but roughly five to six times.