Markets are repricing for the best of times or maybe they just want to wait out the heat and so play for carry and sell volatility on the hope that nothing new happens.

It’s summer, so thoughtful analysis done on the beach matters more than reaction to tweets and ugly headlines. This is a market that may be wise to vacation in the mountains instead as the next peak maybe hidden in the clouds. The risk-on and risk-off roller coaster of the last two weeks appears to be stalling out and the ride may be over as the vacation mode for markets hits volumes and leaves trading desks thinly staffed with decision makers away.

This makes an opportunity to those seeking some hedging protection from larger swings into Autumn when the clash of politics and economics will relentlessly return. The peak of earnings performance in 1Q may prove modest to 2Q and this is the focus for the weeks ahead in US shares. As for economics, with CPI out of the way, the FOMC reaction function to growth data will be in play as FOMC Chair Powell testifies to Congress.

As for the Trump negotiation tactics on trade and NATO – many still expect a deal rather than a dump for the world order. All of this puts the S&P 500 back in play with the 2800 top breaking out opening tests for 2882 again. Peaks that prove to be mere mountains change moods. Stocks rebounding puts us all back to watching the perception of central bankers about financial conditions and the role of animal spirits in driving the economy. How we handle another week of Trump/Putin, China/EU and G20 Finance Ministers will likely be viewed in this lens with a healthy dose of doubt.

Question for the Week Ahead: Is the USD more of a problem than US tariffs?

The surprise last week was in the ability for the global markets to ignore the escalation of US/China trade skirmishes and to focus on growth and benign inflation. The role of copper as a predictor of pain in equities clashed notably with JPY and CHF last week, along with gold. The safe-haven FX world unwound some of the risk-premiums despite no clear path forward on trade issues.

US President Trump’s visit to Europe didn’t soothe but added to geopolitical doubts with his push for more military spending for NATO nations, criticism of UK May’s Brexit negotiations, and with his upcoming Putin summit in Finland grabbing headlines. The USD rallied last week and this was perhaps the most interesting break in recent correlations to risk-sentiment in equities. A stronger USD has been associated with more trouble globally whether its politics or trade. Over the last month, the best indicator for US S&P 500 and USD trading is the GBP, not the JPY (-60% for GBP/USD vs. -20% for USD/JPY).

The other factor for markets and the USD is the role of the USD gains in slowing demand for US products. This is something that 2Q earnings reports and 3Q outlooks will focus upon – particularly in the context of global trade disorder.The USD rise in 2Q was modest but notable and its showing up as a factor more than trade according to FactSet. However, it's early days in 2Q earnings calls and so it’s worth focusing on this point as it balances the risks of more FOMC rate hikes and a stronger USD from that against the US tariffs and safe-haven flows.

The role of US rates offsetting US equity pains has been the rule since Greenspan and the 1987 crash. The correlation of stocks to rates has been a key driver for 60-40 portfolio logic and for the outsized returns in risk parity products over the last 20 years. Whether this remains the case continues to hang over the markets but benign inflation and US 10Y rates remaining below the current CPI level make it just a bit less scary. We are not at a level where rates matter to markets as in previous summers 2013 and 2016.

The last factor that shows up in all markets both last week and in the bigger picture 2018 as a whole, is volatility. This makes the hedging of FX or commodities or any key input to margins and earnings that much more difficult for business. The risk-reward indices used by most include this uncertainty. Investors should be looking for the best returns per unit of volatility – and that makes all asset classes less fun in 2018.

Market Recap:

Trade concerns dominated the last week and brought significant volatility again to most markets aggravated by light summer volumes. The week started down on trade, but rallied back only to stutter again on Wednesday with Trump pushing $200bn in new China tariffs and talking tough on NATO. The lack of an immediate response from China was met with relief, however, helping stocks rebound on Thursday.

Investors also seemed reassured by President Trump’s affirmation of his commitment to NATO at the organization’s summit in Brussels. The role of higher energy prices on the markets was clear in US PPI up 0.5% m/m, 3.4% y/y in May but CPI was slightly less than fear even though it’s at 2.9% y/y – the highest in 6 years.

Bonds were not worried as safe-haven and coupon reinvestment buying met last week’s US supply and more from Europe. The mood in Europe was clearly mixed with German ZEW falling to 6-year lows – back to Greek crisis levels. Japan was different as stocks rallied sharply, JPY fell beyond 112 and budget warnings there are on the rise. In EM, focus last week was still on Turkey with Erdogan pushing against the central bank independence and TRY off 6% in a hurry.

Equities:

The MSCI all-country World Index rose 1.04% on the week. The MSCI EM index rose 1.48% on the week. Despite the roll-out of China trade tariffs and the threat of more, markets stabilized and focused on growth and relatively benign CPI. Volumes remained light this week – S&P 500 is 15% below the 2-month average. Within the S&P 500 Index, information technology shares performed best, while utilities stocks lagged.

• US S&P500 rose 1.5% to 2,801.31 on the week. The DJIA rose 2.30% to 25,019.41 and the NASDAQ rose 1.79% to 7,825.98 on the week. The Cboe VIX index fell 8.90% to 12.39% on the week. With just 5% of the S&P500 reporting 2Q results 89% beat earnings and 85% beat revenues. The 2Q earnings are still estimated at 20% according to FactSet.
• The Stoxx Europe 600 rose 0.70% to 385.03 on the week. The German DAX rose 0.36% to 12,540.73 on the week. The French CAX40 rose 0.99% to 5,429.20 on the week. The UK FTSE 100 rose 0.58% to 7,661.87 on the week while the Italian FTSE MIB fell 0.15% to 21,892.35 on the week.
• The MSCI Asia Pacific Index rose 1.04% to 165.61 on the week. The Japan Nikkei 225 rose 3.71% to 22,187.96 on the week. The China Shanghai Composite rose 3.06% to 2,837.66 on the week. The Hong Kong Hang Seng rose 0.74% to 28,525.44 on the week. The Korea Kospi rose 1.67% to 2,310.90 on the week. The Australian ASX All Ords fell 0.06% to 6,351.90 on the week while the India CNX Nifty 50 rose 2.29% to 11,018.90 on the week.

Fixed Income

The risk-sentiment and data mixed with supply to drive global bonds last week. The US trade war reality started the week with bond buying but successful auctions and benign CPI data left many back in the easy for longer policy thinking camp despite ECB talk for faster action and mixed FOMC comments.

• US Bonds see bear flattening after supply despite modest CPI. Closes for the week: 2Y up 4bps to 2.578%, 3Y up 2.2bps to 2.652%, 5Y up 0.7bps to 2.725%, 10Y up 0.5bps to 2.827%, 30Y up 0.2bps to 2.931%
• Canadian 10-year bond yields rose 9bps to 2.219% on the week – BOC hike as expected but sounded more hawkish and less rattled over trade.
• Japan JGB yields rose 1bps to 0.04% on the week – reflecting JPY and Nikkei moves more than anything new from BOJ – though focus is on month-end meeting and CPI target
• Australian 10-year bond yields up 1bps to 2.63% on the week – tracking US and China growth story with little interest
• UK Gilt yields up 0.5bps to 1.27% on the week with focus on Brexit and politics with resignations Monday from Boris and Trump Friday criticism. Data and BOE still key.
• German Bund yields up 4.5bps to 0.335% on the week with Merkel politics still focus against mixed data and ECB hawk talk with 0.25-0.50% summer prison expectations.
• French OAT yields off 2bps to 0.615% on the week – less positive data, better periphery.
• Italian BTP yields off 16.5bps to 2.54% on the week – good auctions, less political fears
• Spanish Bono yields off 4.5bps to 1.255% on the week – tracking Italy, stable data.
• Portuguese 10-year bond yields off 7bps to 1.72% on the week – tracking Italy.
• Greek 10-year bond yields off 8 bps to 3.805% on the week – watching German block to disbursement but tracking rush to yield and risk-on.

Foreign Exchange 

The US dollar index rose 0.76% to 94.68 on the week with focus on 94.45 as base and 95.20 and 95.53 as resistance.The worst performer in G10 was SEK despite Riksbank minutes and slightly higher CPIF. JPY and CHF were next with safe-haven’s unwinding.  In EM FX the USD was mixed, LATAM: MXN up 0.8% to 18.882 – AMLO honeymoon, BRL up 0.3% to 3.85; ASIA: CNY off 0.7% to 6.69 – talk of 6.80 rather than 6.73 cap, KRW off 1.3% to 1128.50, INR up 0.4% to 68.489; EMEA: RUB up 0.6% to  62.532, ZAR up 1.45% to 13.26, TRY 4.8385 off 6%. In crypto currencies: BTC 6340 off 3.7%, with futures off 6% on the week and ETH 445 off 5.4% on the week.

• EUR: 1.1685 off 0.5% on the week with 1.1610 and 1.1550 beckoning against 1.1740-1.1820 resistance. ECB vs. FOMC, politics, growth driving.
• JPY: 112.30 up 1.6% on the week – with 112.40-50 break running into 112.87 resistance and 113 barrier despite risk-on and EUR/JPY 130.80 up 0.85% on the week with 130 back as risk-pivot.
• GBP: 1.3220 off 0.35% on the week and EUR/GBP .8825 off 0.1% on the week – focus is on Brexit politics with Boris out, Trump criticism and 1.31 base against 1.3350 with BOE key.
• CHF: 1.0015 up 1.35% on the week and EUR/CHF 1.1705 up 0.85% - less fear means weaker CHF with 1.00 pivot for 1.02 in play and cross back bid with 1.18 next.
• CAD: 1.3160 up 0.65% on the week – despite the BOC hike and test of $ support, weaker with oil, NAFTA and politics driving 1.3050-1.3280 key.
• AUD: .7425 flat on the week – testing sharply lower on trade – but market looks short and NZD .6750 off 0.8% on the week – data and crosses driving with .6850 capping rallies.

Commodities

The S&P/GSCI total return index off 2.70% to 2710.78 on the week. Cotton led the rally in commodities with Cocoa close behind, while trade related commodities still lag from lumber to wheat to soybeans also notable was the fall in energy prices with Natgas off 3.7% and oil off same.

• Oil: $71.01 off 3.7% on the week (Aug futures).Brent $75.33 off 2.3% on the week (Sep). Oil tested $70 support and mostly held with USD bid and focus on technical washout from last week. $73-$74 resistance key with Libya output increases driving over big US crude inventory draws.
• Gold: $1244.32 off 1.16% on the week. USD gains, $1250 now resistance with $1235 and $1225 support. Silver off 1.6% to $15.815, Platinum off 2.1% to $829.15, Palladium off 1.55% to $939
• Corn: $340.25 off 5.25% on the week (Sep) with $354.75 (Dec). Trade issues and good weather leave farmers stuck. Wheat off 3.55% to $497 (Sep) on the week. Soybeans off 6.7% $818.60 (Aug) and $834.25 (Nov)
• Copper: $2.8230 off 1.1% on the week with $2.80 tested but mostly holding. Equities vs. trade fears/China growth key.Copper Futures (Sep) off 1.75% to $2.7750. Iron Ore up in August 0.9% to $63.66 and Sep $63.43.

Calendar for the Week Ahead 

The focus on geopolitics isn’t going to go away, China and EU summit will focus on trade, US Trump/Russia Putin on the election interference and Syria/EU/China. Markets get just 2 EM central bank decisions – South Africa and Indonesia – but focus is on FOMC Powell 2-day Congressional testimony. The Beige Book and RBA meetings also out. As for the data – focus remains on CPI with UK and final EU, along with the China 2Q GDP and usual June data looking for signs of weakness. The US industrial production and retail sales will be key for GDP forecasts. Japan CPI will be focus for BOJ meeting at the end of July. The end of the week brings another geopolitical event with G20 central bankers and FinMin in Argentina – expect even more trade and USD push back.

Monday, July 16: Japan Marine Day Holiday, China IP, retail sales, GDP, Trump/Putin meeting, China/EU summit, US retail sales.

• 1000 pm China June retail sales (y/y) 8.5%p 8.8%e
• 1000 pm China June Industrial Production (y/y) 6.8%p 6.5%e
• 1000 pm China June Fixed Investment (ytd) 6.1%p 6.0%e
• 1000 pm China 2Q GDP (q/q, y/y) 1.4%, 6.8% p 1.6%, 6.7% e
• 0230 am India June WPI (y/y) 4.43%p 4.93%e
• 0500 am Eurozone May trade surplus E18.1b p E19.7b e
• 0830 am US July NY Fed Empire State Manufacturing 25p 22e
• 0830 am US June retail sales (m/m) 0.8%p 0.5%e /ex autos 0.9%p 0.4%e / control 0.5%p 0.4%e
• 1000 am US May business inventories 0.3%p 0.4%e

Tuesday, July 17: NZ CPI, UK Jobs, US IP, FOMC Powell

• 0645 pm New Zealand 2Q CPI (q/q, y/y) 0.5%, 1.1%p 0.5%, 1.6%e
• 0830 pm RBA meeting minutes
• 0930 pm China June house prices 4.7%p 4.7%e
• 0400 am Italy May industrial sales and orders
• 0430 am UK June claimant count -7.7k p +2.5k e / May ILO 3M unemployment 4.2%p 4.2%e/ May 3M average earnings 2.5%p 2.5%e / ex bonus 2.8%p 2.7%e
• 0500 am Italy June HICP (m/m, y/y) 0.3%, 1%p 0.3%. 1.5%e / CPI 1.4%p 1.4%e
• 0540 am German 2Y Schatz auction
• 0830 am Canada May Manufacturing shipments (m/m) -1.3%p 0.6%e
• 0915 am US June industrial production (m/m) -0.1%p 0.5%e
• 1000 am US FOMC Powell Congress testimony
• 1000 am US July NAHB housing market index 68p 69e
• 0400 pm US May TIC total flows $138.7b p $52.3b e / long term $93.9b p $35b e
• 0430 pm US weekly API crude oil inventories -6.796mb p -3mb e

Wednesday, July 18: EcoFin Meeting, UK PPI/CPI, EU final CPI, US housing starts, FOMC Powell, Fed Beige Book.

• 0430 am UK June PPI output (m/m, y/y)  0.4%, 2.9%p 0.2%, 3.1%e / core 0.2%, 2.1%p 0.1%, 2.3%e /input (y/y) 9.2%p 7.6%e
• 0430 am UK June CPI (m/m, y/y) 0.4%, 2.4%p 0.2%, 2.6%e / core 2.1%p 2.2%e
• 0500 am Eurozone June final HICP (m/m, y/y) 0.5%, 1.9%p 0.1%, 2%e / core 1.1%p 1%e
• 0830 am US June housing starts 5%p -3%e / SAAR 1.35m p 1.323 e / permits 1.301m p 1.328m e
• 1000 am FOMC Powell Congressional Testimony
• 1030 am US weekly EIA crude oil stocks -12.63mb p -6.18mb e
• 0200 pm US Fed Beige Book

Thursday, July 19: Japan trade, Australian jobs, UK retail sales, Indonesia and SARB rate decision, US claims

• 0730 pm Japan July Reuters Tankan 26p  
• 0750 pm Japan June trade balance –Y578.3bn p –Y20bn e / exports 8.1%p 7%e / imports 14%p 5.5%e
• 0830 pm Australian June Westpac LEI -0.2%p +0.2%e
• 0830 pm Australian 2Q NAB business confidence 7p
• 0930 pm Australian June jobs 12k p 17k e / rate 5.4%p 5.4%e / Participation 65.5%p 65.5%e
• 0200 am Swiss June trade surplus CHF2.76b p CHF2.75bn e
• 0430 am UK June retail sales (m/m, y/y) 1.3%, 3.9%p 0.5%, 3.8%e / ex fuel 1.3%p 0.3%e
• 0440 am Spanish 3-5-10Y bond sale
• 0500 am French 3-5Y bond sale
• 0500 am Indonesia rate decision – no change from 5.25% expected but cuts in deposits to 4.0% from 5% and lending to 5.5% from 6%.
• 0830 am US weekly jobless claims 214k p 220k e
• 0830 am Canada June ADP employment 2.9k p 25k e
• 0900 am FOMC Quarles speech
• 0900 am South Africa Reserve Bank rate decision – no change from 6.5% expected.

Friday, July 20: OPEC meeting, Japan CPI, German PPI, Canada retail sales and CPI, G20 FinMin and Central Bankers in Argentina

• 0730 pm Japan June national CPI (y/y) 0.7%p 0.0%e / ex food and energy 0.3%p 0.4%e / core 0.7%p 0.8%e
• 1230 am Japan May all industry activity index 1%p 0%e
• 0200 am German June PPI (m/m, y/y0 0.5%, 2.7%p 0.2%, 2.9%e
• 0400 am Eurozone May C/A surplus E28.4bp p E26b e
• 0430 am UK June PSNB G3.36b p G3.5b e
• 0830 am Canada June CPI (m/m, y/y) 0.1%, 2.2%p 0.3%, 2.5%e / core -0.1%, 1.3%p 0.3%, 1.4%e
• 0830 am Canada retail sales (m/m) -1.2%p 0%e / ex autos -0.1%p 0.5%e

Conclusions: Are animal spirits lagging? 

Maybe it’s just summer and its easy to hold a passive long position and go on vacation, or maybe it’s that the stories we are told about the future aren’t happening yet. The last week brought US CPI and the preliminary July Michigan Consumer Sentiment and they haven’t fully been filtered into the market price – even though many see 2800 S&P 500 as the top of the channel rather than the middle. The glass half-full or half-empty balance maybe tilting in the next week. The argument about consumers has been that higher oil/gasoline prices has neutralized the effect of the US tax reform boost. For companies, higher prices and tariff fears have eaten away at the tax reform windfall.Whether these stories are true comes out in the data.The US Consumer appears to be doing just fine, though clearly off its peak.

The CPI remains on an upward trajectory and the role of energy in that mix is clearly in play for the next quarter. The role of the FOMC reaction function to markets is going to be the central player in the story for next week with FOMC Powell likely grilled on all of the above, along with the role of trade tariffs, budget deficits and immigration. This is the last hurrah for Congress ahead of the more intense Autumn campaigns with many looking at the CPI and Sentiment as key for whether the US gets more stalemate or a Democrat Party in control of Congress.

 All of which brings us full circle back to the PPP of the USD and the role of productivity, technology, innovation and the support of trade and immigration on pushing the US to be competitive to the rest of the world. The USD decline in buying power has been matched by many other nations, whether we see a larger inflation and devaluation continues to be the biggest worry for investors.