The S&P 500 achieved a new all-time high on Friday, although safe-haven (and on an historical comparison, quite expensive) sectors such as utilities and telecoms led the charge higher. The spike in safe haven sectors underscores a growing feeling that the massive run up in equities over the past few weeks may have run out of steam. Markets seems to have speculatively priced in the next couple of months of potential monetary and fiscal stimulus within a few weeks, but with the BOE and ECB meetings having come and gone with no new easing announced, market participants are nervous that this week the BOJ may again disappoint the reflationistas.
The real winners in this scenario appears to be the US markets and the US dollar. The DXY dollar index gained 0.5% and rallied to a four-month high on Friday.
The US flash Markit Manufacturing PMI surged to 52.9 and the Services PMI eased to 51.2, while both are far less reliable than the ISM PMIs it provides further evidence of the solid momentum in US activity. There seems to be a self-perpetuating cycle of better US data, stronger US dollar and gains in the US markets.
However, the flash UK PMIs saw both manufacturing and services PMIs dive below 50 deep into contractionary territory, which would be consistent with the UK entering a recession in the third quarter. The pound dropped 0.9% against the USD as markets largely locked in an August rate cut by the BOE as a certainty.
The US dollar rally is beginning to prove troubling for the commodities complex with all of the major commodities falling on Friday, including copper (1.0%) and iron ore (-2.3%). The Baker Hughes crude oil drill rig count came out Friday, gaining by 14 for its fourth consecutive weekly gain in a row. The rising rig count appears to display a delayed response to the big rally in crude oil prices, but the growing excess supply of refined products such as gasoline and diesel from the US and China is causing consternation among market participants over oil price moves in the second half of the year. WTI Crude lost over 1% on Friday.
The rising US dollar and pullback in commodity prices could begin to increasingly cause problems in the emerging markets complex, which has been one of the biggest winners in the post-Brexit rebound. Emerging market bonds and equities continue to see strong inflows according to BAML and EPFR’s data. One of the main EM bond fund ETFs, VanEck Vectors JP Morgan EM Local Currency Bd (NYSE:EMLC), appears to be feeling the pain of the USD rally after losing 1.9% over the past week.
The solid US market close should help the Asian session at the open today with most markets in the region looking like they would open higher based off indications from Friday’s session. The materials and energy space look like they may be in for a bit of trouble today as they price in moves in commodity spot prices on Friday. In particular, this will not be good for the Aussie dollar, which is not only struggling from a stronger USD and weak commodity prices, but also will see 2Q CPI released on Wednesday. Most in the market (ourselves included) are expecting an even weaker CPI read than the 1Q, and that will likely be enough to see the RBA cut interest rates again the following week.