Growth fears drum up support for bonds, but what next for Oil?

European stocks are poised for a lower open later on Tuesday, Asian stocks have been mixed and S&P 500 futures are pointing to a small gain. The prospect of weaker global growth and central banks that are unlikely to be quick to cut rates in a meaningful way are weighing on sentiment. The third glitch at the NYSE, in the wake of the US moving to T+1 trading settlement may also be knocking risk sentiment. At the start of Monday’s trading session everything looked rosy, and stocks were moving higher after risk sentiment wavered in May. However, as we progressed through the day a mixture of concerns about US growth and a collapse in the oil price weighed on markets, with the main US blue chip indices managing to eke out a gain, largely due to the strong performance from big tech.

Crude sells off on growth concerns

The Brent crude price sunk 3.65%, and fell below $80 per barrel, closing Monday’s session just above $78 per barrel. This is the lowest level since February. While a sharp sell off in the oil price was not unexpected due to 1, the decline in growth prospects for the US, and 2, the news from Opec that it will start winding down its production cuts from next year, the steepness of the sell off was unexpected. We think that the Opec news is less relevant for the future of the oil price for a few reasons. Firstly, the reversal of production cuts is likely to remain slow and steady, and secondly, if the price of crude oil falls too sharply then we could see Opec cut production further in order to support the price of oil.

We believe that the trajectory of growth in the US is having a bigger impact on oil prices. The daily correlation between the Brent crude oil price and the 10-year Treasury yield has strengthened throughout 2024. At the start of January, this correlation was 27%, which is considered insignificant. By March it had risen to 40%, which means that the price of a barrel of oil and the 10-year US Treasury yield moved together 40% of the time. By the middle of May, the correlation between these two assets had surged to 73%, which is statistically significant. If you want to know where the oil price will go next, watch US Treasury yields.

Is ISM survey data over-doing a US economic slowdown?

The US 10-year yield fell 11 basis points on Monday and is trading at 4.38%, its lowest level since mid-May. The trigger for this sharp decline was the US ISM manufacturing report for May. It was 48.7 vs. expectations for a reading of 49.5. More worrying was the sharp decline in the new orders component, which fell to its lowest level in nearly a year at 45.4, which does not bode well for future readings. We have noted before that the survey data has tended to be weaker than the hard industrial data in the US. For example, US durable goods orders rose at a 1.3% YoY rate in April, we will watch out for the May release later today, and US industrial production is only down 0.3% YoY. Thus, the weak survey data may not be painting the full picture of the US economy. However, we are getting closer to the June FOMC meeting, so every data point matters. The manufacturing ISM has a decent correlation with the S&P 500, so weakness in this index could make it harder for the main US blue chip index to extend recent gains. It is also significant since the recent downturn in US economic data, with more negative surprises than positive surprises as measured by the Citi economic surprise index, has turned lower once again. Thus, signs are starting to emerge that the US economy is slowing, and this is playing out in the bond and commodity markets. It could start to play out in the equity market too.

US rate cut expectations moved forward on weak data

The slowdown in the US economy is also causing a recalibration in Fed rate cut expectations. The market now expects 41 basis points of cuts from the Federal Reserve this year, with the chance of the first cut coming in November rather than December rising slightly. If the US economic data continues to surprise on the downside, especially if non-farm payrolls are weaker than expected, and a rate cut could be pushed even further forward. But, if rate cuts are happening because the US economy is falling off a cliff, we don’t think that it will trigger a rally in stocks, instead it could cause more risk aversion.

Is AI immune from US growth fears?

With economic data knocking momentum as a factor driving the stock market, we may see the US main index struggle to find its feet on Tuesday, and global stocks could follow suit. The tech sector saved the S&P 500 from closing on Monday with a loss, with Nvidia rallying nearly 5%. This was based on its new chip launch; however, it also highlights how a company like Nvidia has both defensive qualities and appears to have completely disentangled itself from the economic cycle. Even if the US economy does weaken, for now, the market does not seem to think that it will impact the AI boom.

Is the meme stock craze dying down?

Later on Tuesday, we will be watching the oil price to see if it can recover some of Monday’s lost ground, or if the sell off gathers more steam. UK BRC like for like sales are also worth watching to see how the UK consumer is holding up, and US durable goods for May are also released. These are definitely worth watching, if they suggest that the ISM manufacturing report is over-emphasizing a potential slowdown, then we could see stocks and Treasury yields start to rise once more, which may also spur a recovery in the oil price. GameStop rose more than 20% on Monday, as meme stocks seem to be back in vogue, however, interest faded during the day. Could this be a sign that the meme craze is not catching the retail traders’ imagination as it did during the pandemic? News that retail broker E*Trade is weighing up kicking off Roaring Kitty’s Keith Gill from its platform, could also dampen demand for meme stocks. E*Trade are worried about stock manipulation in light of Gill’s large position in GameStop that he posted about on Sunday evening. We shall have to see if this impacts GameStop’s performance on Tuesday.