After two violently volatile days in which the market soared (Monday) then promptly retraced all gains (Tuesday), the overnight session has been relatively calm with futures and oil both unchanged even as the BBG dollar index rose to the highest level since April 4. This took place despite a substantial amount of macro data from both Japan, where the GDP came well above the expected 0.3%, instead printing 1.7% annualized, which pushed stocks lower as it meant the probability of more BOJ interventions or a delay of the sales tax hike both dropped. Meanwhile, in China we got proof of the ongoing housing bubble when new property prices were reported to have soared 12.4% Y/Y in April, which in turn pushed the local stock market to two month lows amid concerns the rampant housing bubble sector could divert funds from stocks. Yes, China is trading on the “risk” one bubble will burst another bubble.
At the end of the day, however, it was all about two Fed speakers yesterday and, as Bloomberg put it, financial markets reawakening to the risk that the U.S. expedites interest-rate increases, and that's buoying the dollar while denting emerging markets and commodities. Additionally, the US 2s10s curve hit its flattest level since 2007. As noted above, the USD has risen rapidly in the past few weeks and as of this morning climbed to a seven-week high and Treasuries fell, pushing two-year yields to highest since April, after Atlanta federal reserve President Dennis Lockhart and San Francisco's John Williams said Tuesday two rate hikes may be warranted this year. Chinese stocks tumbled to a two-month low, while the rand led the selloff versus the greenback amid mounting political tension in South Africa. Copper and gold fell for the first time in four days.
Looking at markets, DB's Jim Reid summarized the situation relatively well as follows:
The mood of markets is pretty temperamental at the moment with sudden reversals in sentiment seemingly occurring every few days. The S&P 500 closed -0.94% last night, wiping out Monday's gains. Fedspeak seemed to be a driver and it was interesting to see the US 2s10s curve hit its flattest level since 2007. Specifically it was the joint comments from Atlanta Fed President Lockhart and also San Francisco Fed President Williams that sparked interest after both suggested that they continue to see two to three rate hikes this year. Lockhart also added that markets are currently more pessimistic than he is, while Williams made mention of June being a live meeting and even went as far as to say that his view of gradual hikes also means 3-4 hikes in 2017. Balancing all this were comments from Dallas Fed President Kaplan shortly after who said that a hike may well be warranted in the ‘not-too-distant future' but warned of the need to consider uncertainty including Brexit risk.
In any case it was the initial hawkish comments which helped to fuel a decent flattening across the Treasury curve. 2y yields ended 4.5bps higher at 0.833% with 10y yields ‘just' 1.9bps higher at 1.773%. That means the current 2s10s spread of 94bps has marked a new tight for the year and you have to go back to December 2007 to find the last time the spread was this narrow. All of this has also resulted in a decent repricing in Fed Funds futures. The probability of a hike next month has now risen to 12% from 4% on Monday while a July hike has increased to 28% from 19%. The December meeting odds are now sitting at 65% from 56%.
And while oil is largely unchanged as of this moment with WTI trading in the mid-$48 range, buoyed by renewed fears from the Canadian wildfires which appear set to keep millions of barrels of production offline for several more days, keep a close eye on copper, which this morning is down 1.6% to $2.06/lb, hitting its lowest price in three months.
But going back to the story of the day, especially ahead of today's only notable news release the FOMC April minutes, all eyes remain on the dollar and the suddenly renewed probability of a rate hike. The dollar has rebounded in May after declining in the previous three months as the Fed pushed back expectations for rate increases this year. A strengthening U.S. economy and the biggest jump in consumer prices in three years have led traders to boost the odds of a move in June threefold to 12 percent. The Fed will release the minutes of its April policy meeting on Wednesday.
“Expectations appear to be that minutes will signal that a summer hike is on the cards,” said Stuart Bennett, head of Group-of-10 currency strategy at Banco Santander SA in London. The “solidly hawkish” rhetoric from Fed non-voting members of late is proving to be dollar positive, as the possibility of a hike is not priced in by markets, he said.
Futures on the S&P 500 were little changed after equities tumbled on Tuesday. Investors will look Wednesday to earnings from retailers including Target Corp., Staples Inc., Lowe's Cos. and Urban Outfitters Inc. for further indications on the health of U.S. consumers after a slew of disappointing results cast doubt on their willingness to spend. The Stoxx Europe 600 Index slipped 0.1 percent. Burberry Group Plc dropped 3.7 percent after the luxury-goods retailer added to the industry's gloom by posting a second straight drop in annual earnings. Sonova Holding AG tumbled 7.1 percent after the Swiss hearing-aid maker's second-half earnings missed estimates.
Minutes from the Fed's April meeting will also be in focus for clues on the trajectory of interest rates after hawkish comments from regional presidents. The first month with even odds of higher borrowing costs also moved up to November from December.
