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Markets bet Fed has it wrong again

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By Jeffrey Halley  

The second day of Jerome Powell’s semi-annual testimony on Capitol Hill passed without incident, in contrast to Wednesday’s frenzy. The Fed Chair reiterated an unconditional commitment to fight inflation, but instead, markets continued to price in a recession stopping rate hikes in their tracks much sooner.

US yields fell once again, equities firmed once again, cryptos crept higher, while currency markets did almost nothing.

Assuming that the Federal Reserve will have to change course sooner than late 2023 isn’t an unreasonable assumption.

The Fed and a procession of central banks got inflation completely wrong and have been scrambling to reverse the mistake. Given their track record, assuming they are going to be wrong the other way is completely reasonable in that context.

The commodity space is also pricing in the recession outcome.

Copper plummeted overnight, and that has been the case recently with most industrial metals. Even soft commodity prices have fallen, and I’ve even seen a few headlines in Indonesia about small palm oil farmers’ incomes taking a hit.

Oil has taken a bath this week as well, and the increase in natural gas inventories overnight from the EIA data saw US natural gas prices fall as well.

Still, I remain unconvinced that inflation will magically stop in its tracks just because Mr Powell mentioned the ‘recession’ word.

Oil futures curves on both Brent crude and WTI remain in backwardation, which tells us prompt supplies are tight. The curves moved down in totality but didn’t really change shape.

We are reading headlines from around the world about potential blackouts as energy supplies and power generation capacity remain under stress. Russian oil and gas production will decrease as well as they run out of western parts to maintain production.

Most significantly, Germany activated phase two of its emergency energy plan overnight, as Russian gas flows continued slowing. If Europe is heading to international markets at short notice to hunt for supplies, energy prices aren’t going to fall much further.

The moves this week could still turn out to be the result of a financial market genetically pre-programmed to buy dips in equity and bond prices, thanks to two decades of central bank largesse.

It could also be a bear market correction as the stampede for the exit door got overdone in the short term, leading to a short-squeeze.

Maybe next week’s PMIs will give markets a better clue, or perhaps the July Non-Farm Payrolls and JOLTS data. It would be foolish to price out geopolitical stresses related to Ukraine/Russia conflict either, particularly in relation to European energy or Ukrainian food exports.

The FOMC meeting on July 26-27 may as well be next year, as at present, we can expect a lot more volatility between now and then.

The end of the week has a Friday feel to it with an extremely light data calendar in Asia.

Japan Inflation is already out, with the headline for May unchanged at 2.50%, and core unchanged at 2.1% YoY. That is the second month above the BOJ’s 2.0 target for headline inflation.

China’s Final Current Account for Q1 Friday afternoon is already old news, while the UK Retail Sales and German IFO Business Climate survey both have downside risks. And given the escalation of the energy situation in Germany, both Euro and Sterling could go into the weekend looking shaky once again.

US New Home Sales and Michigan Consumer Sentiment also have downside risks. Weaker than expected numbers do not provide a fertile ground for stock market exuberance, lower interest rates or not. If the data is disappointing, US equities could unwind some of this week’s gains.

Oil prices noisy but unchanged

Oil prices had another noisy overnight session, trading in wide intraday ranges. Ultimately, as the dust settled, both Brent and WTI finished unchanged for the second day in a row.

The unexpected postponement of the official US Crude Inventory data set due to technical issues likely played a major role in the neutral close, as the data set is one of the most closely monitored in the energy sphere.

Brent fell 0.30% to $109.65 overnight, gaining 0.40% to $110.10 a barrel in Asia. WTI fell 0.45% to $103.95 overnight, before rising 0.55% to 4104.55 in Asia. The net result is that oil prices are almost unchanged on a 24-hour basis.

Looking at the respective futures curves, both Brent and WTI are still heavily in backwardation, suggesting that prompt oil supplies remain as tight as ever, even as prices across the curves fall.

Increasing recession fears appear to be prompting a culling of heavy speculative long positioning in both contracts, even as in the real world, energy tightness is as real as ever.

The technical picture is interesting. Brent has tested its 100-day moving average, and the 2022 support line at $107.30, but managed to bounce back to $110.00. A daily close under $107.30 implies a deeper move potentially reaching $100.00 initially.

WTI’s technical picture is much softer, having closed below its 2022 support line at $106.30, and its 100-DMA, on Friday at $105.50. Failure of its weekly low at $101.50 could trigger a capitulation by speculative longs that moves WTI under $100.00, although I suspect a lot of the damage has already been done.

Gold falls overnight

Gold bugs once again appear to have lost patience, as the yellow metal fell by 0.82% to $1822.50 overnight, edging slightly higher to $1824.00 an ounce in Asia.

Probably most concerning, was that gold fell as the US Dollar remained mostly unchanged and US yields had another big move lower. Even cryptos managed to move slightly higher overnight.

With that in mind, it appears that gold is going into the end of the week looking vulnerable, although I am not betting against the $1800.00 to $1870.00 range trade continuing.

Gold has resistance at $1860.00 and $1880.00, the latter appearing an insurmountable obstacle for now.

Support is at $1805.00 and then $1780.00. Failure of the latter sets in motion a much deeper correction, potentially reaching $1700.00. On the topside, I would need to see a couple of daily closes above $1900.00 to get excited about a reinvigorated rally.

 

Jeffrey Halley is Senior Market Analyst, Asia Pacific at OANDA

Opinions are the author’s, not necessarily that of OANDA Global Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. Losses can exceed investments.