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TO PAUSE IN SEPTEMBER OR NOT TO DIVIDES FED WATCHERS (1340 EDT/1740 GMT)
For the Fed, when to pause hiking interest rates or not is the big question, and it's making Wall Street rather anxious.
With the Federal Reserve's tightening cycle barely started, a debate is simmering over when and if the U.S. central bank might pause raising rates to assess the economic landscape.
The question has created such a stir it has divided the best of Wall Street shops.
The Fed is much more likely to shift to 25 basis point hikes in September than to do nothing as it's well behind the curve, global economists Ethan Harris and Jeseo Park at BofA Securities said in a note on Tuesday.
"A pause is possible but is unlikely to last long unless the economy and inflation slow much more than expected," they said.
However, BofA rates strategists Ralph Axel and Bruno Braizinha last week differed. But they made clear their view was not the base case of the bank's economics team, whose take has been incorporated into their rates forecast.
A pause when the federal funds rate reaches 1.75%-2% at the FOMC meeting in September could become more likely if financial conditions worsen and data soften, the strategists said.
"We believe the market may assign a higher probability to these pause scenarios over the next couple of months," the rates strategists said. "As this happens, it should become evident that peak yields in the belly and the backend of the curve are behind us," they said.
Fed policy-makers hiked rates by half a percentage point at the May 3-4 meeting in a bid to counter rampant inflation. Minutes of the meeting showed most participants said further hikes of that magnitude in June and July could be appropriate.
No word yet on September.
(Herbert Lash)
BEAR-MARKET BOUNCE BEFORE BOTTOM FALLS OUT (1215 EDT/1615 GMT)
U.S. stocks finally perked up last week. In fact, the S&P 500 popped more than 6%, for its biggest weekly rise since November 2020.
That said, Michael J. Wilson, equity strategist at Morgan Stanley, says in the absence of a peace agreement in Ukraine, he thinks it's difficult to construct a case for more than a bear market rally.
As Wilson sees it, higher inflation and slower growth have now been become the consensus. However, he doesn't believe it has been fully discounted.
Meanwhile, he thinks falling PMIs suggest at least 10% downside from around current levels, while a recession would provide even greater risk. Sustainable rallies will require growth rates to bottom, which is something Wilson doesn't see happening until later this year.
Wilson says that the market achieved his near-term minimum downside target of 16.5x EPS and 3,800 on the S&P 500 when it slid intraday to 3,810.32 on May 20.
Therefore, he thinks it's not surprising that there's been some relief given the extent of oversold conditions.
However, since Wilson believes that inflation remains too hot for the Fed's liking, he thinks any surprise pivot that might stoke animal spirits in the short-term, will be too immaterial to alter the equity price downtrend.
Wilson's bottom line is that last week's strength will prove to be another bear market rally with maximum upside near 4,250-4,300, or around 2%-3% above current levels. The Nasdaq and small caps are likely to outperform, "as is typical during such rallies - i.e. more heavily shorted areas do the best."
Wilson thinks the turning point for the next leg of the bear may coincide with the next FOMC meeting where "it will likely be clear they are far from dovish," as well as the beginning of Q2 pre-announcemnet season and the time when companies guide their numbers down before reporting.
"We stand by our call that the S&P 500 will trade close to 3,400 by the end of 2Q earnings season-i.e., mid-August."
A decline to the 3,400 area would put the S&P 500 down nearly 30% below its Jan. 3 record close.
(Terence Gabriel)
EUROPE: MAY WAS A 'SELL', BUT NOT FOR EVERYONE (1145 EDT/1545 GMT)
There it is, no last-minute turn-around: the STOXX 600 ends the day down 0.9% and exits the month of May with a 1.7% loss.
Of course, it would have been much worse without the 6% rebound the index pulled off from the lows touched during the first half of the month.
Nonetheless, the pan-European index now stands 9% lower than it was at the beginning of 2022.
So far, March has been the only month of gains for the STOXX 600 but other national benchmark indexes have managed to secure much better results.
Take the FTSE 100, London's blue chip index, heavily loaded with miners, oil & gas stocks and banks, gained about 0.8% in May and is up 3% year-to-date.
The British benchmark also managed to end the day up 0.1% when most of its European rivals finished deep in the red.
"Once again stronger commodity prices, led principally by oil, have been the foundation of the FTSE 100’s strength", commented IG analyst Chris Beauchamp.
As you can see below, the only monthly loss suffered by the footsie was in February, a performance which contrasts with the broader European market:
It's fair to say that there isn't much optimism for what's to come next with data showing a new 8.1% inflation record for the euro zone and oil prices jumping to the news of an EU ban on most Russian imports.
"The ban, amid already high inflation and intense supply chain pressure, will push the Eurozone into a recession", Rabobank analysts who see the economy contracting by 0.1% in 2023, argued in note.
(Julien Ponthus)
COOLING DAYS: CONSUMER CONFIDENCE, HOME PRICES, CHICAGO PMI (1130 EDT/1530 GMT) Data released on the first day of the U.S. summer season showed the economy was moving past its heatwave, a welcome development for Fed watchers hoping for the proverbial "soft landing," and inflation to cool down without the unpleasantness of recession.
The mood of the American consumer dimmed a tad this month, but not as much as expected.
The Conference Board's (CB) Consumer Confidence index shed 2.2 points to deliver a reading of 106.4, a brighter number than the 103.9 consensus.
Diving into the report, inflation expectations eased and the "jobs hard to find" element grew, both signs of a cooling economy - and perhaps counterintuitively, good news in that it implies waning demand and eventually inflation easing.
The "present situation" index fell 3.3 points to 149.6, while the "expectations" component eased down to 77.5, a 2.5 point drop.
"The decline in the Present Situation Index was driven solely by a perceived softening in labor market conditions," writes Lynn Franco, senior director of economic indicators at CB. "That said, with the Expectations Index weakening further, consumers also do not foresee the economy picking up steam in the months ahead."
The narrowing of the gap between those two elements is a good omen for those fearing impending recession.
As seen in the graphic below, when the gap between the two grows, recession has historically been soon to follow:
U.S. home price growth unexpectedly heated up to record levels in March.
Year-on-year growth rate of the S&P Corelogic Case-Shiller 20-city composite climbed one percentage point to an astounding 21.2% - the hottest reading in the index's 35-year history - defying the slight decline to the even 20% analysts predicted.
Once again, the happy trio of tight supply, materials scarcity and solid demand fueled the growth. But a spate of housing indicators for more recent months suggests the house party may be winding down.
"The good news for buyers is that these are signs pointing to a stabilizing market ahead," says Steve Reich, COO of finance at America Mortgage.
Home sales, mortgage applications, building permits and homebuilder sentiment - they all show a sector groaning under the weight of its own success, with home prices and climbing mortgage rates causing the dream of ownership to drift beyond the grasp of many potential buyers, dampening demand.
"Mortgages are becoming more expensive as the Federal Reserve has begun to ratchet up interest rates, suggesting that the macroeconomic environment may not support extraordinary home price growth for much longer," says Craig Lazarra, managing director at S&P DJI. "Although one can safely predict that price gains will begin to decelerate, the timing of the deceleration is a more difficult call."
Of the 20 cities in the composite, 19 posted increases in their top decile. Tampa took Phoenix's crown, its home prices surging 34.8% year-on-year, with Phoenix and Miami placing and showing at 32.4% and 32.0%, respectively.
It should be noted, however, that the Case-Shiller report is more ancient history than most economic data. More recent indicators (CPI, PPI, PCE, wage growth, import prices) all point to March as the inflation peak.
The graphic below shows the 20-city composite against the Mortgage Bankers Association purchase applications index:
Factory activity in the Midwest surprised to the upside in May, by accelerating.
MNI Indicators' Chicago purchasing managers' index (PMI) gained 3.9 points to 60.3, defying economists' call for a deceleration to 55.0.
A PMI number over 50 indicates a monthly increase of activity.
The report is sunnier than the Philly Fed and Empire State manufacturing data released earlier in the month and bodes well for the Institution of Supply Management's nationwide PMI report due on Wednesday, which is expected to show a modest slowdown of activity expansion.
"Other regional surveys for May are, on net, suggesting modest slowing in manufacturing," says Rubeela Farooqi, chief U.S. economist at High Frequency Economics. "Overall, even as the survey data are signaling some moderation, manufacturing output continues to expand in spite of supply network dislocations and shortages."
Wall Street was lower in early trading, with the S&P and the Dow setting course for a near-flat May, with the tech-heavy Nasdaq set for its second straight monthly decline.
Cyclicals and economically sensitive transports were among the biggest losers.
WALL STREET HIT BY FEARS OF INFLATION, MORE HAWKISH FED (1000 EDT/1400 GMT)
Wall Street is falling about 1% early on Tuesday after data showed inflation in the euro zone rose to a record high in May and a Federal Reserve governor raised the possibility of a harsher crackdown on rising prices than previously expected.
Ten of 11 S&P 500 sectors are in the red, with the exception of a gain in energy, as oil prices rally after the European Union agreed to a partial and phased ban on Russian oil and China decided to lift some coronavirus restrictions.
European Union leaders agreed on an embargo on Russian oil imports that will start toward year's end. Contracts for West Texas Intermediate and Brent are poised to end May with a sixth straight month of gains as oil trades around $120 a barrel.
Fed Governor Christopher Waller said on Monday the U.S. central bank should be prepared to raise rates by a half percentage point at every meeting from now on until inflation is decisively curbed.
U.S. President Joe Biden will meet Federal Reserve Chair Jerome Powell at 1:15 p.m. (1715 GMT) as inflation surges to 40-year highs and the president in a Wall Street Journal opinion piece called tackling rising prices his top economic priority.
Here is an early snapshot:
(Herbert Lash)
S&P 500: TRYING TO SHAKE THE BEAR'S GRIP (0900 EDT/1300 GMT)
For most of this year, bears have certainly been in control. . However, last week brought an end to some eye-popping weekly losing streaks for the major U.S. indexes.
With this, there appears to be a change in the air given the market's sudden willingness to take on some risk.
Since late last year, the S&P 500 started underperforming a composite of its defensive sectors including: real estate, staples and utilities :
In fact, the SPX / defensive composite ratio peaked in early-November. It then diverged into the S&P 500's early-January peak.
Of note, major SPX tops in late 2018 and early 2020 were also preceded by a bearish divergence vs the defensive composite. Against this, major SPX lows in December 2018 and March 2020, came with a bullish ratio convergence.
More recently, on May 19, the SPX ended down 18.7% from its early-January peak. However, the SPX / defensive composite ratio bottomed on May 11 and had risen to a more than two-week high. Since May 19, the SPX has rallied 6.6% on a closing basis.
It now remains to be seen if this return of animal spirits will become a full-blown stampede or if it will prove to be just a fleeting spurt - click here:
That said, constructive VIX action, improving market internals and sudden chip-stock relative strength may be other signs that the bear's grip may be may be loosening.
(Terence Gabriel)
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(Terence Gabriel is a Reuters market analyst. The views expressed are his own)