2023 Weekly Views

Highlights

Equity market

US equity markets kept a buoyant tone, and the S&P 500 closed the week above the 4400 mark for the first time since April 2022. The VIX index closed below 14% last Friday, reaching its lowest level in over three years, and nearly returning to the pre-pandemic level. There are various reasons behind this collapse in equity volatility. The resolution of the debt ceiling issue played a significant role in the decline of equity volatility in recent days. The US economy has demonstrated greater resilience than anticipated, including strong data from the US labor market. Earnings revisions have shown improvement in both the US and European markets, with cyclicals outperforming defensives, indicating a reduced probability of a recession and subsequently lowering volatility. The correlation among sectors within the S&P 500 and between the index stocks has decreased substantially, exerting further downward pressure on volatility. This can be attributed, in part, to the divergence in performance between mega-tech stocks and the rest of the index's components, as well as between cyclical and defensive stocks. Despite the current low equity volatility, other segments of the market still exhibit some stress. This is evident from the global financial stress indicator, which remains far above the pre-pandemic level.

Market update

FOMC & ECB as expected

The S&P 500 closed the week at 4,409.59, +2.58% higher. The Dow Jones closed at 34,299.12, +1.25%, with the Nasdaq higher by +3.25%. The volatility index VIX closed the week at 13.54 down from 13.83. The Euro Stoxx 600 surged +3.23%.

The 10-year UST closed at 3.76% up from 3.74% a week before. The yield curve is inverted with the yield spread between the 3-month and 10-year UST at -147bps. US Corporate Bond spreads: Investment Grade tightened 5bps at 202bps and High Yield tightened 17bps at 451bps. German 10-year Bunds yield closed at +2.47% up from +2.38% a week before. In Europe, Corporate Investment Grade spreads tightened 6bps at 173bps and High Yield spreads tightened 23bps at 442bps.

The US Dollar Index (DXY) depreciated -1.27% last week and closed at 102.24. The Euro closed at 1.0937 (+1.75%); the Yen depreciated +1.74%, closing at 141.82 and the Swiss Franc appreciated +1.05%, closing at 0.8938. Gold closed at $1,957.98 depreciating -0.16%. Oil was higher, Brent closed at $76.61 (+2.43%) and WTI at $71.78 (+2.29%).

Macroeconomy

FOMC meeting

In a unanimous decision, the FOMC paused in June after ten consecutive rate increases, and kept interest rates unchanged at 5-5.25%, as widely expected. However, the Fed delivered a hawkish surprise with the dot plot, as the median 2023 dot moved higher by 50bps to 5.625% (we expected +25bps). The economic projections also saw revisions to higher growth, lower unemployment, and higher core inflation this year, with 2023 core PCE estimate revised up to 3.9% from 3.6%. There was no change to Quantitative Tightening, as expected. Chair Powell justified the pause today by citing the need to assess uncertain policy lags and impact from banking sector stress. He framed today’s decision as a slowdown in the pace of hikes rather than a prolonged pause, maintaining the tightening bias. He repeated the “meeting-by-meeting” decision book, noting that the Fed did not discuss “anything about going to an every other meeting kind of an approach or any other approach”. Despite 12 (out of 18) participants anticipating two or more interest rate hikes this year, Powell did not commit to a rate hike in July, saying two things. “One, a decision hasn't been made. Two, I do expect that it will be a live meeting".  As expected, Powell kept pushing against rate cuts pricing this year by nodding to the dot plot where not a single participant wrote down a rate cut this year. He also noted he did not think a rate cut this year is at all likely to be appropriate.

CPI

US Core CPI remained strong in May, increasing 0.4% m-o-m. However, part of the strength in core CPI was driven by another outsized gain in used vehicle prices and strong (albeit slowing) shelter inflation. The Fed’s preferred gauge of underlying inflation pressures, core CPI (core services ex housing), rose by a much smaller 0.24% m-o-m, or a 2.9% annualized rate. Headline inflation fell sharply to a two-year low of 4.0%. This is sharply down from 6.4% at the start of the year. Such a large decline in headline inflation should tame the public’s inflation psychology and reduce risks of unanchored inflation expectations. Regarding jobs, Initial claims stayed elevated at 262k for the second consecutive week, but possible distortions from data in the states of OH and MN likely contributed to part of the surge.

ECB meeting

The ECB raised interest rates by 25bps at its June meeting and signaled that it has still “more ground to cover”, as expected. The ECB changed the opening sentence of its policy statement to "Inflation has been coming down but is projected to remain too high for too long". This change acknowledges the recent progress made in bringing down price increases but makes it clear that the central bank is still not satisfied with the inflation outlook. As in the May meeting, there was no pre-commitment to future rate hikes, but the ECB reiterated its determination to maintain a tight monetary policy for as long as required. During the Q&A session, Christine Lagarde said that the ECB is “not yet at destination”, adding that the ECB is “very likely to increase in July”. She also mentioned that the GC did not discuss “about skipping or pausing”. As regards ECB projections, they were hawkish. The new projections foresee core inflation averaging 5.1% in 2023 (up from 4.6%), 3.0% in 2024 (from 2.5%) and 2.3% in 2025 (from 2.2%), in part reflecting the robust labor market. Following the meeting, the market moved to price in a 100% chance of another 25bps rate hike in July.

China

Most indicators for Chinese economic activities in May missed the already-low market consensus again. Growth in nominal retail sales dropped and missed consensus. In sequential terms, retail sales growth was still meaningfully below the pre-pandemic level, indicating the strength of consumption recovery remained muted. The overall unemployment rate stayed unchanged at 5.2%. But the situation for youth (16-24 age group) became increasingly challenging, with the youth unemployment rate rising further to a historical high of 20.8%. The property sector continued to weaken, with almost all related indicators pointing to a broad-based slowdown. The downbeat data have likely increased the urgency for Chinese policy makers to push through more supportive measures in the near term. Indeed, the latest cuts in its key policy rates indicate a clear directional turn in its policies.

What to watch

• Monday: US Juneteenth holiday: stock and bond market closed; US NAHB Housing Market Index (June)
• Tuesday: China PBoC interest rate decision; US Housing starts (May) & Building Permits (May, Prel.)
• Wednesday: Japan: Tankan business sentiment (June); UK CPI (May)
• Thursday: Switzerland SNB interest rate decision; UK BOE interest rate decision; Euro Area Consumer confidence (June); US Initial Jobless claims (May)
• Friday: US PMI (June, Prel.); Euro Area: PMI (June, Prel.); Japan CPI (May)