SignalPlus Macro Research (20230728): Strong US Economy Sparks Market Flight to Safety
Yesterday, the market experienced significant volatility unexpectedly, with actual changes far exceeding the levels on the day of the FOMC meeting. First, yesterday's U.S. economic data once again showed overall strength, including initial jobless claims and continued jobless claims unexpectedly lower than expected (22.1 million and 1.69 million respectively), and durable goods orders (4.7% increase compared to the expected 1.3% growth) exhibited strength. However, core PCE also softened, with a 3.8% increase compared to the expected 4.0% growth. Second-quarter real GDP grew by 2.4% compared to the previous quarter, higher than the expected 1.8% growth, in line with the forecast of the Atlanta Fed's GDPNow model, with strong performances in domestic sales (+2.3%), consumer spending (+1.6%), and business fixed investment (+7.7%) surprisingly.
The exceptionally strong U.S. economic data led to a rare steep decline in U.S. bonds, as the market reacted in accordance with the Fed's "data-dependent" path. The 2/10 yield curve steepened by 5 basis points, and the 10-year yield closed up 13 basis points. However, yesterday's strong U.S. macro data was not the only highlight, as the unexpected dovish stance of the European Central Bank and rumors of hawkishness from the Bank of Japan triggered a moderate but sudden flight to safety in the market.
First of all, in terms of Europe, the European Central Bank unanimously decided to raise interest rates by 25 basis points. The committee stated that it expects inflation to remain high in the long term. However, hawkish remarks stopped there, and all subsequent remarks were much milder than traders had expected. ECB President Lagarde stated that "due to weak domestic demand, the short-term economic outlook has deteriorated. Officials maintain an "open attitude" towards the actions to be taken after the rate hike yesterday. She specifically pointed out, "We may raise interest rates, or we may stay put." In addition, the official statement contains some clever wording, indicating that interest rates will be "set" at a sufficiently restrictive level, rather than "adjusted to" as mentioned in June. Finally, similar to Powell's mention of the "overall nature" of the data in the press conference, Lagarde specifically emphasized that they will "deliberately" rely on data when deciding on the next course of action.
Due to the dovish remarks from the central bank, the euro experienced its largest intraday decline in several months. Market expectations for two future ECB meetings are at a cycle low, slightly below 17 basis points. Similar to the Federal Reserve, there is still a long period of time until the next ECB meeting (September), and there will be a series of inflation and employment data releases in Europe over the next 7 weeks. During this period, the market can only adjust and react on its own.
As for Japan, news reports indicate that the Bank of Japan is considering adjusting its yield curve control (YCC) target and allowing long-term interest rates to "to some extent" exceed the upper limit of 0.5%. However, this news does not cite any sources and it needs to be made clear that the original article states that policymakers just want to "discuss" the "adjustment". Former Governor Ueda made it very clear that the Bank of Japan will not adjust their YCC unless their views have changed. The good news is that the answer will be revealed soon, but the damage to the asset market has already been done, as this news coincided with a rebound in New York's morning session.
Under the influence of the news, Nikkei futures fell by 2%, SPX futures fell by 1.5%, and gold futures fell by 1.8%. Long-term yields rose simultaneously, and negative sentiment persisted until the New York close. Traders hurriedly hedged in the last minute "just in case".
The stock market reacted negatively to the sharp decline in the yield curve and the accompanying rise in financing costs. In the S&P 500 Index, the sectors sensitive to interest rates, such as real estate and utilities, performed the worst. The US regulatory authorities announced plans to impose stricter capital requirements on large banks, requiring banks with assets exceeding $100 billion to increase their capital buffers by an additional 16%. Eight mega banks will face a 19% increase, leading to poor performance in the financial sector. Financial stocks fell 1.3% during trading. As mentioned before, the rescue by SVB is completely different from the rescue plan during the Lehman period. This time, the rescue comes at the cost of shareholders' equity, and regulatory costs will gradually increase over time.
All attention will be focused on the Bank of Japan meeting today. However, Japanese government bonds continue to be sold since the start of the New York session, and the 10-year benchmark yield has exceeded the central bank's upper limit of 50 basis points for the first time since March.
In the cryptocurrency sector, price movements are still limited, with not much noteworthy. However, there have been some disappointing news in the past 24 hours. Venture capital giant Sequoia Capital has reduced its cryptocurrency fund from $585 million to $200 million, and the Department of Justice has decided to withdraw additional charges against SBF as part of the extradition request from the Bahamas.
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