Challenging to ascertain a clean read

Markets

US stocks are little changed on Friday and on pace for a flat week as investors digest a slew of earnings across a range of sectors, a mix of economic data points, and an emerging outlook that might soon include the end of the Fed hiking cycle and an economic soft landing.

One of the key stories for the week, however, is the disconnect between how corporate executives and investors seem to be thinking about the economy and how the economy (and corporate earnings) are actually performing. The core of this debate can be seen in this week's Philly Fed, where we saw an improvement in the shipments, new orders, and employment components of the index. Still, the index nevertheless suffered a steep decline (to -31.3) driven by an erosion in sentiment around 'general business conditions.

And beyond this economic survey, we continue to see this disconnect between what people feel is happening to the economy (or markets) and what is actually happening to the economy and markets.

Many investors have expressed bearishness on the market’s front, yet the S&P 500 is up almost 8% ytd -- a pretty strong return for a broad index of stocks in a “bear market." (and also coming with a VIX that has dipped below 17). And while some have complained that the gains in the index can be attributed to just a handful of stocks, a quick sort of gainers and losers ytd refutes this assertion. The number of stocks trading up ytd outpaces the number of stocks trading down by 3:2. In other words, not only is the S&P 500 trading up ytd, but a broad group of stocks within the S&P 500 is trading up.

Earnings season has painted a reasonably constructive picture on the economy front. However, there are some signs of cracks. With the regional bank’s turmoil having taken place only 6 weeks ago, it is still likely tricky to fully know how resulting tighter lending standards may impact growth in the future.

But it is challenging to ascertain a clean read on anything happening this week. One of the most challenging things about navigating this bear market and the widely anticipated coming recession is that we’ve had to differentiate between real and nominal economic and market variables like nothing in recent decades. Very few buy or sell side types have navigated an inflationary environment like the current one, which adds to the confusion. I haven’t either, of course, and I have been doing this trading gig longer than I want to remember.

Oil

Oil prices cratered more than 5% during the week as fears of higher global interest rates and weak US economic data fueled demand concerns. Unquestionably for most, this is a surprising turn of events given the latest OPEC production cut and robust reopening data from China. And oil bulls found little solace even with the US markets on the cusp of the summer travel season.

Fears of higher interest rates fueled the US dollar's strength throughout the week, discouraging oil-importing countries from purchasing dollar-indexed crude. But oil market risks are broadening out well beyond the dollar beta.

Many factors could derail current bullish expectations, including the risk of extending the Fed tightening cycle beyond the 25 bps markets expect in May, a debt ceiling event, or even an escalation in US-China geopolitical tensions. Indeed the landscape is covered in recessionary potholes.

And as far as global interest rates, the Fed is not alone in its inflation fight, as the ECB and BoE will likely attempt to tamp down raging inflation fires by cooling the economy via rate hikes.

Forex

The beat in EU service sector activity is the most critical implication for the ECB from yesterday’s EU activity data, suggesting the market could drift towards a higher probability for a 50bp hike, especially if flash inflation prints this upcoming week are strong given the services price news was somewhat mixed (moderating but still very high). The takeaways from the UK PMI were similar. However, the prices of the services charged component ticked up again, corroborating the signal from the price and wage data earlier this week. Despite the similar releases (and if anything more concerning price news in the UK), EUR/GBP moved higher on the net through the releases, which probably reflects that there is still debate over 25bp/50bp for the ECB in May while a 50bp BoE hike seems like a tall order given their reluctance to hike (and relatedly that they have already slowed to a 25bp pace). 

In Japan, core inflation accelerated and beat expectations today. In the near term, the new BoJ leadership is not rushing to tweak YCC given global growth concerns. Instead, the most direct impact of today’s inflation beat on next week’s BoJ meeting could be via the new inflation projections, which should signal the speed and extent of BoJ policy normalization later this year.

ASEAN currencies are trading weak despite the robust China activity data. So after pricing a fair bit of policy divergence on Fed rate cut bets, Asia FX traders pared those bets after a chorus of Fed speakers continued to look through the mini-banking crisis and will follow through with at least one more hike in May. But this should not come as too much of a surprise given Asia FX beta to the US dollar tends to overshadow the RMB greatly.

We are bullish on the RMB but acknowledge the continued risk of an FOMC policy extension beyond May amid the heightened geopolitical conflict between the US and China. And despite the Biden administration trying to feel out the possibility of finding areas of limited economic collaboration, FX investors may require a higher risk premium than what is currently priced for China's FX and related assets.

Our preferred gauge of China FX flows shows net outflows of around US$12bn in March, compared to inflows of US$22bn in February. Cross-border RMB flows suggest small outflows in the month. North and Southbound stock connect channels showed small outflows in March.