Market Recap (Jul): Falling rate expectations

Updated August 1, 2022

Stock markets bounced handsomely in July rebounding from a very tough first half of the year. There were two main drivers: easing expectations for interest rate rises and positive earnings updates from several big tech and energy companies. The rally delivered the best month of performance since late 2020. The question on many investors lips is whether the low is now in place, or this is a bear market rally in a broader downtrend?

Gloomy economic data on the back of a perceived dovish “pivot” by Chair Powell and the US Federal Reserve has seen money markets pare back the Fed’s aggressive path of policy tightening. Futures pricing on the last day of July implied the Fed’s main funds rate would peak at 3.3% next February. Contrast this with the mid-June prediction of 3.9%.

But just a day after the Fed and a “technical” recession was signalled by US Q2 GDP data, the Fed’s favoured inflation gauge was still flashing red. The core PCE deflator was higher than expected, at 4.8%. This remains at uncomfortably high levels last seen in 1982 and will still most likely require policymakers to hike rates into restrictive territory.

Major events of the month, in numbers

*0.9952 EUR/USD: The world’s most popular currency pair traded through parity in the middle of the month. Natural gas supply worries went into overdrive with Russia cutting its capacity to the region after the restart of the Nord Stream I pipeline after maintenance. A black swan event (zero supply) was suddenly a real possibility and will continue to be a risk going into winter. That has shifted the growth outlook for the euro, even as inflation continues higher and troubles the ECB hawks.

*+9.1% S&P500: The blue-chip equity index rose in July clawing back some of its losses after a disastrous start to the year. The S&P500 fell 21% in the first six months of the year. This was the worst performance in more than 50 years. The tech-heavy Nasdaq performed even better, gaining 12.3%, the most since April 2020.  This came after the 29% plunge in the first half of 2022. Does the rally have more legs?

*2.67% US Treasury 10-year yield: The yield on the widely followed 10-year US Treasury has fallen from near 3.5% in June and a high of 3.1% in July. Essentially, bonds have gone bid with the speed of the move catching many traders out. Yields are under pressure as economic growth deteriorates and markets question the Fed’s hawkish intentions. The lower bound of the sideways trading range has recently been pierced. Confirmation worsens the picture with next support at 2.55%.

*139.38 USD/JPY: The high seems a distant memory today from when it was posted in mid-July. The major is correlated with US 10-year rate differentials, mainly due to the BoJ’s commitment to yield curve control. That narrowing has now pushed USD/JPY back below 135 and towards next major support at 131.34. The latest US wage and inflation data may slow the descent of US yields. But the yen may also retain a small bid on growing odds of a US recession as the Fed hiking cycle continues.

* $1680 Gold: The precious metal saw prices fall to lows not seen since the spike bottom in August 2021 at $1677.  Rising US rates and a strengthening dollar weighed on investor appetite. Net longs had also dropped significantly since March and recently touched their lowest level since 2019. That showed fewer institutional investors expected a rally. But rally we have, as especially real rates (those adjusted for inflation) have fallen sharply. Next resistance above sits at $1786.

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