Gulf escalation keeps markets risk-off

Thursday was a clear risk-off session, with nowhere to hide: equities were lower, while oil, yields, and the USD caught a bid.

Risk-off weighs on equities

Key US equity benchmarks took a sizeable hit, despite Intel’s numbers landing too late in the day to help. The S&P 500 – albeit finishing off its session lows – wrapped up down 1.2% at 7,408, with the Nasdaq 100 also shedding nearly 2% and the Dow Jones off by 1% on the day. Breadth showed 213 names ended higher on the S&P 500, while 290 were lower, with sector-level breadth weak across the board – only four sectors in the green and seven in the red. Despite relatively strong earnings numbers, I feel that market participants are struggling to justify their lofty valuations.

Overnight in Asia, a similar picture emerged despite Intel headlines, as the broader tech pullback and the jump in oil prices outweighed the good news from chipmaking. Japan’s Nikkei and Topix, as well as South Korea’s KOSPI, all ended the day lower.

Brent clocks US$100 

Away from equities, oil prices remain front and centre, with Brent crude touching gloves with US$100/barrel yesterday amid supply fears and inflation concerns. We are up by nearly 40% in the month of July! Following Yemen’s Houthis saying they had attacked two Saudi oil vessels in the Red Sea, President Trump told Axios that a decision on a ‘massive attack’ on Iran is close.

Tensions are naturally high and, in my view, are out of control, which threatens a broader escalation. At this point, it is a guessing game about where this goes, and unless there is something concrete in terms of a deal between the US and Iran, oil remains higher in my view. Technically, Brent has scope to continue north, targeting US$104.05, with US$100 potentially employed as a pocket of support.

FX and rates: USD and yields bid

For FX and rates, on the back of the oil price rally, we recently saw a jump in the USD index, and US Treasury yields bear flattened.

The rally in the USD has lifted USD/JPY to just shy of ¥164 – a level not seen since late 1986! If you need a textbook example of an uptrend, check the daily chart of USD/JPY. Although I do not expect the pair to climb as high as ¥167.80 before Japan’s MoF steps in, this is the next obvious resistance level on the daily timeframe.

For bonds, we are seeing elevated yields, bolstered by rising inflation expectations and perhaps a more aggressive Fed – the OIS market is pricing in nearly 40 bps of Fed tightening, up from just 25 bps a week ago.

Day ahead: PMIs in focus

The highlight of the session is the first batch of July flash S&P Global manufacturing and services PMIs, providing an early read on how businesses across the major economies are faring this month. France and Germany report at 7:15 am GMT and 7:30 am, respectively, followed by the eurozone aggregate at 8 am, then the UK at 8:30 am, with the US rounding things off later in the day at 1:45 pm.

As I am sure you are aware, most short-term traders use these reports to spot divergences. For example, if the eurozone prints come in strong and the UK’s come in weak, a EUR/GBP long could present a scalping opportunity. 

Worth flagging is that this month’s fieldwork runs straight through the re-ignited Middle East tensions and the return to US$100 crude, so today’s readings should capture more of the cost and confidence hit than June’s survey did.