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July was hardly a month of surprises and revelations. As expected, the Fed and the ECB raised rates by 25 basis points sticking to their usual mantra of importance of economic data for making further decisions. The market nonchalantly interpreted this rhetoric as a sign that the maximum level of rates in this cycle was (or will soon be) reached. Notably, under the Taylor rule, which is usually used by central banks as a benchmark for rate decisions, discount rates should be 8.55% in the US, 11.60% in Europe, 13.85% in the UK and 5.95% in Japan.
The market is not happy with the behavior of benchmark bonds
The dynamics of the US Treasury market was generally in line with our expectations. The spread between 10- and 2-year bonds began to narrow: 10-year yields increased by 12 basis points to 3.95%, while 2-year yields remained unchanged (4.9%). Such a dynamics of the yield curve does not quite fit into the expectations of the market, which would prefer to see a decrease in yields on the short end of the curve (which is usually favorable for the stock market). Therefore, if the real situation continues to go against the hopes of market participants, this will most likely have a negative impact on markets in general.
European and US equity markets
U.S. equity indices reach major resistance levels
Rally in equities continued in July. The S&P 500 has come close to the 4600-4650 levels we mentioned last month. It is likely that growth may continue further, however, we believe that the factor of declining earnings, as well as risks of further growth in long-term yields, may have a negative impact on further developments in equities. For the time being, we do not recommend taking short positions in the asset class, but we consider it wise to start taking profits.
The dynamics of Russell 2000, an index of small and medium capitalization companies, looks a little different: the index seems to have reached the most important resistance level at 2000 points and, with a high degree of probability, we might see it slide to the lower level of its price corridor near the 1700 points mark. We continue to believe that this segment of the stock market is the weakest and most risky for investments in the context of persistently high rates and gradual liquidity restrictions (the Fed’s balance sheet continues to systematically decline).
Gold price, USD/oz
Oil gains, precious metals continue to struggle
Nothing important was happening in FX and precious metals markets. EUR/USD pair pushed above 1.1200 mark only to fall back below 1.1000 at the end of month. Gold was once again unable to break the 2000 dollars per troy ounce “triple top” resistance zone, so we are up to some downwards pressure up until bulls clear XAU/USD 2050 mark. Silver could not make any significant progress either and now risks another setback with XAG/USD 22.30 area looking vulnerable.
Oil prices finally saw some “life”, reporting a monthly gain of 14%. Natural gas is still weak, but “risks” are certainly skewed to the upside. We stick to our view – it is worth to keep some long positions in energy market going into fall and winter.
Benchmark 10-year bond yields
U.S. labor market signals weakness
China’s direct economic losses from natural disasters increased to USD 5.74bn in July, due to severe weather brought by two powerful typhoons, which will result in a drag on quarterly growth. Chinese manufacturing activity shrank (unexpectedly) – the Caixin manufacturing purchasing managers’ index decreased to 49.2, compared to 50.5 in June. The Caixin reading was in-line with results of a government survey, which focuses on bigger, state-run enterprises. On the other hand, Chinese service sector managed to grow slightly due to resilience in consumer spending – the Caixin services PMI showed a 54.1 reading for the month of July.
Eurozone’s manufacturing activity contracted as demand slumped – HCOB’s final Eurozone manufacturing PMI decreased to 42.7 in July, compared to 43.4 in June (lowest reading since May 2020). Demand fell sharply even though input costs were falling. In addition, block’s dominant service industry showed a reduction with headline services index decreasing by 1.1 point to a 50.9 reading in July. Speed of inflation in Eurozone decreased further in July, showing a comforting signs for the ECB to consider cutting on aggressive monetary policies.
The U.S. services sector slowed down as businesses faced higher input prices – the Institute for Supply Management’s non-manufacturing PMI decreased to 52.7 in July, compared to 53.9 in June. U.S. manufacturing was largely unchanged, as it appears to be stabilizing at weaker levels with PMI increasing by almost half a percentage point to a 46.4 reading. Still, July was the ninth month in the row when the manufacturing PMI stayed below 50 points mark (demarcation line of growth and contraction), while factory employment decreased to a three-year low, indicating that layoffs were accelerating. Overall, the U.S. economy added fewer jobs than expected during the month.
High Yield bond Indexes
Corporate profits – not as good as it looks
As of the moment of writing, 51% of S&P 500 companies have reported their quarterly results. EPS were better than analysts’ expectations for 80% of companies, which is above the average of 77% of the past 5 years and above the average of 73% of the past 10 years. However, on average, companies beat expectations by 5.9%, which is below the 8.4% of the past 5 years’ average (6.4% of the past 10 years). Combining the stated figures with those expected by the end of the reporting season, we could see that the second-quarter earnings-per-share declined by 7.3%. This is the largest decline since the second quarter of 2020 (down by 31.6%). It is also worth noting that this is the third quarter in a row when companies included in the index report a decrease in profitability.