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June 19, 2023 - Could this have been the most important week of the year ?



Considering the information and data we received last week and looking back to this period a few months for now, perhaps it will have marked an inflection point in the markets. In the below bullet points we will highlight some of the news and events that took place and will explain some of them, further in our report:

  • The FED stopped raising interest rates , after more than a year of continuous hikes. Whether it will start again or not, remains to be seen. Will this week mark the end of this aggressive rate hike cycle? As of today however, the probability of another hike in July is more than 50%.

  • And ironically (or not), China chose the same week to cut its own key interest rate by 10bp, for the first time in 10 months. It could not have come at a better timing, to remind the world that the world's second economy in size does not suffer from inflation and can proceed with both monetary and fiscal stimulus, at a time when the west is reducing stimulus on all fronts.

  • Then, the French Finance Minister signaled government spending cuts, in order to avoid a downgrade by rating agencies and try to control the fiscal deficit, which is becoming a real burden now that interest rates have reached levels not seen in more than a decade. France narrowly avoided a S&P ratings downgrade earlier this month, but its AA rating is still at risk. S&P warned it could lower the rating within 18 months if government debt as a share of GDP does not decline steadily over the 2023-2025 period, or if government interest expenditure increases above 5% of revenue. Cuts in spending have an adverse effect on economic growth.

  • And it is again remarkable that this information came as reports from China circulated on Friday, that they are on exactly the opposite path. Or in other words, China is about to release fiscal measures (such as more government spending on infrastructure or tax cuts) to stimulate the economy, the exact opposite of the recent news from the Eurozone and the US, where part of the US debt ceiling deal was to reduce government spending.

  • The US Secretary of State , Mr. Blinken, travelled to China over the weekend, becoming the first US official of such a high rank to visit the country in a very long time. Taking also into account the words of Mr. Biden during the recent G7 meeting, that relationships with China will soon enter a "warmer" period ("melting of ice" to be exact), one could think that this trip could be considered the one to have started this process.

  • And we close this "laundry list" by stating some market facts for the week: The S&P500 hit a new high for 2023 and Apple together with Microsoft registered a new record high for their share prices. Are more gains to come ? Or these levels (approximately) will be remembered as the high of the year ?


So, the FED finally paused, but it gave conflicting messages about what comes next. In the famous "dot plot", which are the forecasts of where interest rates will be in the next two years, compiled by the 18 members of the FED team (but only 12 of them actually vote), it was crystal clear that they expect 50bp more increases by the end of 2023. This came as a surprise , especially if we stop for a while to consider that just three months ago, in March, the market was looking at aggressive rate cuts which would start in the summer. Of course, this view is now gone. Mr. Powell in the press conference downplayed the questions that these announcements are a guidance for a definite July increase and another one in September. Instead, he emphasized that everything depends on the incoming data (jobs and inflation, basically), offering some hope that this could have been actually the end of the hiking cycle.


The ECB remained on its hawkish path, raising interest rates by 25bp as expected and signaling more increases in the coming months. In a stark contrast with her peer at the FED, Mrs. Lagarde used the press conference to send the message that not only at the July meeting there comes another rate hike, but more could follow after the summer holidays. Of course, until then there is plenty of time and plenty of data that will be announced. And if the recent downward revision of the Eurozone Q1 GDP to a negative number is any guide, then it is very difficult to make a case for interest rates to be raised much higher from here.


US inflation fell further in May, but core prices remain sticky. The headline CPI number fell significantly in May, to 4.1% vs the 4.9% annual rate of inflation in April. This big fall from the almost 10% of last year, was rather expected, simply due to what we have described many times in the past , the "base effect", or in other words comparing annual growth with an already high number. As we said one year ago, for inflation to move to 0%, prices do not have to fall, but simply be at the same level. At the same time, the fall in commodities and other goods' prices has also helped a lot compared to 2022. The headline number is expected to fall closer to 3% in the summer, which is still higher than the 2% target of the FED. But the issue is with core inflation, which excludes the cost of energy and food and reflects the more everyday life of the citizens of the world (rents, hotels, travel and other services). The May number was announced at 5.3%, only slightly less than the 5.5% of April and it is what keep central bankers up at night.


A disappointing set of macroeconomic data was announced in the US, giving us more confidence that the economy is weakening faster than many people think. And although the headline Retail and food services sales rose 0.3% in May, above expectations, the April level was revised down by 0.3%. For the control group of stores used to track goods spending in the calculation of real personal consumption expenditures, the May increase of 0.2% was more than offset by the downward revision of April by 0.4%. Nominal sales are now only 0.06% above where they were in January. Putting retail sales and food services sales together and stripping out gasoline stations and autos, nominal sales are 0.3% lower in May than in January. The initial jobless claims were announced at 260k, which marks the second consecutive week of a high number. Of course, as we have already said many times, it would take a number above 300k of weekly unemployment claims in order to cement the case for a coming recession, but the trend looks to be higher.


Equities moved convincingly higher, with China outperforming its peers for the first time in a long time. The S&P500 touched an important level at 4425-4435, which is a new high for the year, while Nasdaq's return for the year now exceed 30%. Europe also moved higher but its broad indices still remain slightly lower than the year's high registered in April. In terms of sectors it was the usual suspects which drove the markets higher : Discretionary, Technology and Communications.


Bonds fell in value and yields moved higher, but the moves were rather muted, given the hawkish central bank actions of last week. The US 2-year finished the week at 4.72%, up from 4.60% the previous week, while the longer-duration yields rose by less than 3-4bp. This is explained by the fact that the higher the central banks take their interest rates, the higher the probability of a recession becomes , pushing investors to the long end to lock-in high rates for longer.


The USD sold-off, as the ECB continued raising rates while the FED stopped for now. Th EURUSD spiked to almost 1.1000 again and as a reminder it was trading below 1.0700, just two weeks ago. Gold failed to benefit from this move, as bond yields moved higher , which usually does no bode well for the yellow metal. It finished the week at 1970$, higher from the 1940$ levels of the previous week.



Chart of the Week : Can Chinese equities continue their rebound ?



The chart above shows the MSCI China index for the last two years. An almost 50% rally from the October 2022 low, when the government decided to abandon the zero-covid strategy, was followed by an almost 25% drop since the peak in January. From a technical aspect, the recent rebound from the low which coincided with the April 2022 low can be considered a positive development. Especially when one looks at the greater picture, a nice "reverse head & shoulders" has been created (the three circles, with the middle one being the "head" and the other two the shoulders). Usually this type of technical formation is very bullish, and the rebound should come as no surprise. However, now the index has reached the red dotted line, which is a short-term resistance from the January high and this could be difficult to overcome, for now. But if this line breaks on the upside, we could see an acceleration of the move higher.


Disclaimer

• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Chart of the Week : Factset

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