We are still in the easy phase of monetary tightening

Markets 

Window dressing, quarter- and month-end rebalancing, and the June 30 redemption deadline are all factors in play over the next few days. Hence folks are trying to get books in line ahead of Friday with a thought here that pension fund rebalancing should support the broader tape. Accordingly, you will hear a lot of anecdotal " market is struggling for direction " comments. Still, from an institutional trader's perspective, the significant month-end market rebalancing may well explain some of the current intra-day and intra-market "flip-flopping " as everyone is trying to get their books right.

But make no mistake, the tilt to the tape is still risk-off despite an easing in oil prices and slightly lower yields, but support comes from the flight to quality at play. For the most part, playbooks are mirroring from last week, where the safe-haven yield play trade outperforms alongside the movements in rates, which is the biggest driver of action under the hood. 

I do not envision equities recovering until the US rates market is pricing more meaningful cuts from the Fed. Unfortunately, it might take a negative print for US non-farm payrolls later this year to get there. That suggests equities demand could remain mute for at least the next four to six months as interest rate hikes work through the US economy.

Implied Fed pricing has declined over the last few weeks – from a peak of 4% to more like 3.50 %. But that is a ton of rate hike risk for the market to digest. And this type of Fed pricing will sit painfully amid forecasts that the ISM manufacturing index could be below 50 on Friday.

We are still in the 'easy' phase of monetary tightening when hiking rates are not controversial. But this will change towards the winter festive holiday season if activity slows, and public pressure grows. The Fed hopes that Fed Funds will be roughly neutral or above by then, and the central bank can pause or at least go back to more gradual 25bp steps.

With less of an open playing field for central banks to sprint to the finish line of their respective end-of-year terminal rates without raising eyebrows, the Fed needs to hammer the rate hike down multiple times immediately. But with all roads leading to a recession, it is probably better to position for the worst or super defensively this year. 

Oil

Oil traded well off the intraday highs as the slide was set in motion after the EIA data showed a smaller crude inventory draw than expected and a bearish unexpected product build with gasoline inventories rising by 2.65mn barrels, possibly indicating that higher prices at the pump are begging to trigger demand destruction at the pump as consumer sentiment continues to deteriorate worldwide. In addition, Refinery utilization increased by 1%, suggesting that refineries have more room to produce more gasoline for the market.

 Front-month RBOB futures are down 1% on the day while the crack spread tightens, which should be a good thing for inflation.

OPEC+ meets today, and the group is expected to go forward with its planned 648k bpd supply hike for August, bringing target output back to pre-pandemic levels. The deliberations scheduled in the weeks ahead are creating some jitters, primarily because the US President is visiting Saudi Arabia, which could grow more complicated with questions around what the group will do with its remaining spare capacity.

High volatility is causing traders to hit the buy or sell button quicker than usual on any sign of upward or downward pressure points. Vols are exacerbated by the noisy interplay between the Fed and the Whitehouse. They are both on a mission to lower oil prices, with the latest economic hammer drop was Powell sounding the recession alarm bells in Sintra when conceding there is no guarantee of a soft landing. But then, taking specific aim at higher oil prices, he suggested higher rates will not drive the US into a recession, but inflation (aka higher oil prices) will. 

Forex

Forex traders are reacting to the slightly different tones between Powell, Bailey, and Lagarde from the ECB forum in Sintra, which are driving EUR and GBP lower.

Chair Powell sounded determined to bring inflation down as he wants to slow growth down to match the current supply constraint. And while aiming for higher oil prices, he said the Fed being overdone regarding hikes is not the main risk to the economy, but high inflation is. 

In contrast, BoE's Bailey and ECB's Lagarde are less hawkish. Bank of England governor Bailey said a 50bp next month is data-dependent. When asked about the high Spanish inflation, Lagarde responded that German inflation was lower in June.

We are not entirely sure how to allocate dollar strength because of comments by Fed Chair Jay Powell or the general global growth and risk-off concerns. However, wider 2-year interest rate differentials and the S&P500 in the recessionary bearish territory are potent signals to stay long USD and why the greenback could remain on a rampage into H2.

The Swiss franc has appreciated above parity to the euro this morning. Many FX traders think the Swiss National Bank will welcome this move and will not intervene to stop it unless it were to accelerate much quicker and further.

A stronger currency is the easiest way to keep inflation in check in Switzerland, and the SNB seems determined to use the channel as much as possible until inflation drops back into the target range at some point next year.

Last week we advised our clients to buy tickets to the parity party, now we think EURCHF could drop to 0.95 over the next few months.

Gold

With the greenback holding court due to sticky inflation pressures, precious metals prices are still on a reasonably steady downtrend that warrants monitoring through month-end over the next couple of days. More sellers have been coming to market while strategic buyers have been absent due to the wealth erosion effect of lower stocks, and Asia currencies are still weak.