by Pinchas Cohen
The Big News
- Moody’s cut on rising debt and slowing economic growth leads to Chinese equity declines
- Aussie and metals dragged down following China's downgrade
- German and French economies improving
- Draghi to speak, after stimulus face-off with Germany and in-house infighting
- UK equities and currency rise in defiance of terror
- Oil rallies sixth day straight day
World Events
Despite investors' return to risk-off sentiment yesterday—following new details regarding the ongoing investigation into President Donald Trump's administration's ties to Russia, and the terrorist attack in Manchester—US and European markets still rose in value.
Ironically, the FTSE futures, which was the only one of the European or US futures indices in the green yesterday morning, is the only one of the group that has now closed in the red.
Today, equity traders received fresh bad news following credit agency Moody’s downgrade of China’s rating – for the first time in nearly three decades - on a weakening economic outlook and rising debt. As a result, China’s stocks fell.
The damage affected not only Chinese stocks but other assets as well. The Australian dollar and metals fell—iron ore led industrial commodities and nickel led base metals—which all followed Chinese shares down.
Australia is a large supplier of the metals for the Chinese economy, and China is Australia's largest trading partner. The Aussie’s positive correlation to Chinese shares is often the preferred FX proxy for China’s economy. Considering that Moody’s downgrade came as a surprise, pressure on the Aussie dollar should continue.
This slowdown of China's economic momentum makes local assets higher risks; the divergence to other global indices which are trading around new highs suggest a lower expected return. As such, further capital outflows could occur.
However, traders were happy to note that the equity hit was localized to China and Hong Kong markets, while stocks in Japan and South Korea climbed, suggesting China’s credit rating cut won’t necessarily affect other global exchanges, for now.
With the exception of the DAX, other markets including a variety of European equities and US futures marked gains at the close of yesterday's trading.
Both the FTSE 100 and sterling rose, in defiance of yesterday’s suicide bombing in Manchester, even after Prime Minister Theresa May warned that further attacks could be imminent.
The S&P 500 recovered most of the value erased after the May 17, which plunged nearly 2% after a concern arose that President Donald Trump won’t be able to deliver his reflation agenda while being investigated for reportedly telling former FBI director James Comey to layoff the investigation into former National Security advisor Michael Flynn ties with Russia. After a string of scandalous discoveries, traders are on the lookout for any further potential negative developments on Trump-Russia investigations.
On the economic front, traders are mired in doubt about the pace of inflation and have traded up Treasuries to higher yields ahead of next month’s Fed decision. A rising demand for Treasuries occurs when traders’ expectations are lessened of a higher yield.
Fed Bank of Philadelphia President Patrick Harker said June “is a distinct possibility” for the U.S. central bank’s second interest-rate increase of 2017. He told reporters that another downside surprise on inflation would “worry me a little bit.”
The Price of a Good Economy
It’s important to keep in mind, however, that higher interest rate is not guaranteed to drive up the stock market. Rising interest rates, followed by the Fed’s plan to start shrinking its $4.5 trillion balance sheet this year, will be hard on the Federal budget. This because the Treasury’s income will suffer a hit with more expensive borrowing and a shrinking balance sheet, leaving the Fed with lower excess earnings to cover its costs.
These shortfalls are reflected in the President’s proposed budget and projections released earlier this week. “It’s the price you pay for a good economy,” said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics in Washington and former Fed board official.
These changes are coming thanks to a strong economy: The Fed is closing in on its goals of maximum employment and stable inflation near 2 percent. The positive momentum also means that the administration’s budgets will later enjoy higher tax receipts than the Obama administration saw.
Upcoming Events
- Draghi will also have an opportunity to address two hot issues:
- ECB President Mario Draghi speaks in Madrid at 14:45 CET (9:45 EDT). The euro continued its recent advance, thanks to strong and consistent PMI releases around 55.0, a good indicator of near-term growth and the German IFO survey of business confidence hit its highest level in 2 years. As well, there's now reduced political risk, and a united front toward the Brexit negotiations.
- 1. Stimulus Unwind: While Draghi lieutenant Peter Praet advocates caution, talking only of easing within current guidance, another lieutenant, Benoit Coeure warns that moving too slowly can potentially lead to bigger financial shocks. Irrespective of whose approach is right in the long term, any hint by Draghi of quicker stimulus easing is sure to push the single currency on a lower current in the short term.
- 2. German Face-Off: Though it actually started last year, it was started when Germany’s inflation suddenly spiked on euro weakness and questions over the central bank’s loose monetary policy.
- Trump’s current international tour heads to G7 and NATO meetings in Europe.
- OPEC will meet in Vienna on Thursday, with major oil producers edging closer to extending an agreement to curb output.
- Indian assets will be closely watched after stocks and the rupee fell in Tuesday trading after the country’s army said it launched military raids into a Pakistan-controlled part of Kashmir to destroy camps hosting terrorists.
Market Moves
Currencies
- The Dollar Index opened 0.5% higher but is now 0.4% lower, at 97.32. Traders are eager to see whether the dollar will resume yesterday’s 0.33 percent rise after 7 of 8 sessions recorded a decline of 2.70%.
- The pound rose 0.1 percent to $1.2972 as of 8:15 a.m. in London, following a two-day loss.
- The euro was little changed at $1.1181.
- The Australian dollar fell 0.3 percent, breaking a three-day advance.
- The yen fell 0.1 percent to 111.84 per dollar.
Commodities
- Nickel slumped 1.7 percent and copper fell 0.6 percent. Iron ore futures dropped 4 percent, adding to a 3 percent slide in the previous session. China is the top user of these materials.
- Oil rose 0.3 percent to $51.62 a barrel, adding to a five-day advance.
- Gold fell less than 0.1 percent to $1,250.43 an ounce, after dropping 0.8 percent on Tuesday.
Stocks
- The Stoxx Europe 600 Index was little changed, while the MSCI Asia Pacific fell 0.1 percent, with more stocks rising than declining.
- The Shanghai Composite rose 0.1 percent, reversing an earlier drop of 1.3 percent. The Hang Seng slipped less than 0.1 percent.
- Futures on the S&P 500 slid 0.1 percent. The underlying gauge rose 0.2 percent Tuesday, reaching as high as 2,400.85, two points from a closing record.
- Japan’s TOPIX index increased 0.6 percent, Australia’s S&P/ASX 200 Index rose 0.2 percent, and South Korea’s KOSPI advanced 0.2 percent.
- Indonesia’s benchmark index slumped 0.8 percent.
Bonds