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The key political themes from last week: Brexit and US-China trade wars are set to take a back seat on Monday as the market focuses on some key US earning releases and gears up for a week of crucial economic data and central bank statements.
Earnings releases including Bank of America and Blackrock will give some more colour to the Q2 earnings outlook for the finance sector, after JP Morgan smashed earnings expectations last week. Netflix results, scheduled for release after the market close today, will also be watched closely. This is one of the first new wave of tech titans to release Q2 earnings, and since tech has been the key driver of the S&P 500’s recent rally (the S&P 500 tech sector reached its highest ever level on Friday, as you can see in chart 1 below), a strong set of earnings for Netflix could help lift the sector, and the entire S&P 500, in the coming days.
The S&P 500 reached its highest level since early February at the end of last week, and early indications on the US futures market suggest that the S&P 500 is set to open higher today. Its performance this week is likely to be dominated by how well US financials and tech stocks performed in Q2. It is worth noting that Netflix may be a key driver of the S&P 500 in the short term. The stock reached a record high at the end of June, but it fell sharply on Friday, after UBS downgraded it to a “hold” from a “buy”. Taking into account Netflix’s drop on Friday, sentiment towards the stock is strong, it is up some 170% in the last year, and so if it can beat estimates of Earnings per Share of $0.79, then we could see the tech sector continue to fuel the rally in US indices.
The dollar is on the back-foot today, and is down versus all of its G10 counterparts bar the yen, which continues to slide. Safe havens are being dumped this week as geopolitical and economic tensions fade to the background. We expect the pound to be in the spotlight this week as we wait for key UK economic data ahead of the next BOE meeting next month. While the market is fairly confident that the BOE will hike rates next month (and woe betide any central banker who doesn’t give the market what it wants) the real driver of sterling will be expectations for rates further out along the curve. A strong set of labour market, wage and retail sales data could drive expectations of a second rate hike before year-end, which may give GBP/USD the boost it needs after it dipped below key momentum indicators last week, including the 50-day sma. A strong set of data could trigger a move in GBP/USD back to 1.3323 – the 50-day sma and a key first line of resistance.
Overall, the moves across global asset markets have been confusing in recent weeks: trade wars intensify yet global stock markets rally and gold falls? We believe that what is really driving financial markets is actually taking place in the bond market. The important US yield curve has continued to invert (where longer-dated yields are falling at a faster pace than shorter-dated yields), which is a sign that the market believes that the Fed will cut short its rate-hiking cycle, potentially as early as next year. Lower interest rates help to boost stock markets, as investors anticipate that the cost of capital will fall, which can trigger a flurry of buying in global stock markets, as we have seen. However, for gold, an inverted yield curve is negative, since the yellow metal is an inflation hedge, the yield curve suggests that in future inflation won’t be a problem so investors have less reason to buy gold, or gold-indexed funds.
An inverted yield curve also indicates economic slowdown and even recession, however, at this stage, when the US economy is doing very well, the market can ignore the warning signs from the inverted yield curve and concentrate on the good news story: potentially lower interest rates in future.
Just how inverted is the yield curve? As you can see in chart 2, which shows 10-year US Treasury yields – 2-year US Treasury yields, the yield curve has been inverting (when 10-year yields fall at a faster pace than 2-year yields) since 2013. What has really changed is how dramatic the inversion is, it is now less than 25 basis points, which is the lowest level since 2007. If it continues in this fashion then the yield curve could turn negative, when 10-year yields are lower than 2-year yields, which is a key indicator that a recession is coming. While the yield curve and the S&P 500 do not have a long term decent correlation, between 2007 and 2008 the S&P 500 dropped by a whopping 52% as the financial crisis took hold, prior to 2007, the yield curve turned negative during the dotcom bubble. This time, the yield curve may be warning us that the next crisis is on the horizon. For now that is not on investors’ minds, instead the prospect of lower yields may drive markets higher, but for how long, that is the question.
Source: ForexCFDs and Bloomberg
The latest UK labour market report for May/ June was more of the same: the unemployment rate remains at a record low of 4.2%, yet wage data stubbornly refuses to go anywhere. The bright spot is job creation, which continues to defy expectations. The UK economy has created more jobs than expected in the three months to May, with 137k jobs created, better than the 115k expected.
This is the third month in a row where job creation has been strong, suggesting that Q2 was a good month for employment, which gives a flicker of hope that wage inflation may be triggered down the line. Interestingly, jobless claims jumped last month to 7.8k; however, this is suspiciously similar to the -7.7k decline in May, so this blip in the labour market report can be ignored for now.
Wage data declined a touch to 2.7% from 2.8%, in line with expectations. The upside for low wage growth is that employers are likely to continue to hire if labour costs remain this cheap.
The market reaction was muted, with GBP/USD trading within a tight range this morning. GBP/USD remains just above 1.3250, however upside continues to be thwarted by politics. Although Theresa May narrowly won a Commons vote on her Customs Union proposal with the EU on Monday evening, there are still threats to her leadership. With the next round of EU negotiations not due until October, when the bulk of the UK’s exit from the EU will be hashed out, we expect the pound to remain out of favour in the FX world, and upside in the major GBP pairs to be limited.
The FTSE 100 is higher today after Monday’s torrid performance. We don’t believe that this is due to the labour market data, and is instead a reversal after yesterday’s decline and is due to a pick up in energy stocks, in particular.
The pound is unlikely to move too much on the back of UK economic data unless we see some major positive surprises. Right now a rate hike in August is pretty much priced in, thus the BOE will have a limited effect on the pound in the lead up to the August 2nd meeting. Instead, the market is likely to look at this week’s data in terms of what it means for future rate hikes. So far, the data is not boosting the chances of a second rate hike before year-end, the market is pricing in only a 12% chance of rates being at 1% by year-end. This is lower than the 14% chance expected last week, suggesting that political noise from the Brexit negotiations is limiting rate hike expectations for later this year.
Due to the high bar for a second rate hike from the BOE, if the UK economic data this week is inline with expectations then we may not see too much excitement in the pound.
Spreads may widen surrounding important news announcements, during political uncertainty, unexpected events leading to volatile market conditions or at the open/close of the business day and on weekends when liquidity is lower.