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The bear party went on in June with equity indices falling, bonds yields rising and some investors being close to panic mode. American stocks fell by more than 20% from their peak values thus entering what many call “bear market”. In June alone, the tech-heavy Nasdaq 100 dropped by 9%, while S&P 500 and Russel 2000 gave away 8.39% and 8.37%, respectively. Yields on 10-year Treasury bonds at some point “touched” the 3.5% mark. Whether the triumph of the bears has reached its climax and whether it is finally time to “buy the dip” is still an open question.
The Federal Reserve declared war on inflation, which, although beginning to show some signs of a slowdown (Personal Consumption Expenditures Price index remained at 6.3% in May for the second month in a row, and its component, which does not take into account food and fuel prices, continued its gradual decrease), still remains well above the target level of 2%. On June 15, the Federal Open Market Committee of the Federal Reserve raised federal funds rate for the third time this year, this time by 75 basis points. This is the sharpest rate increase since 1994.
After June’s rate hike to 1.50-1.75% and Powell’s announcement that another 75-bps increase could be on the cards in July, market participants decided to adjust their outlook. Back in spring, market saw federal funds rate at 2% by the end of the year and at 3% in 2023. Now, expectations stand at 3.5% by year-end, and 4% in 2023. However, some investors believe that the Fed should act faster.
European and US equity markets
Prices in bond markets continued to fall. Declining investor sentiment towards equities created negative spillover effects to other risky assets such as high yield bonds. ICE Bank of America High Yield indices show that in June the risk premiums in the US and Europe have increased by 1.65 and 1.67 percentage points respectively, while in emerging markets those have risen by 1.42 percentage points. This means that in July the average yield to maturity of these indices has already reached double digits in emerging markets, that is, 11.1%, while in the US it stood at 8.8% and in Europe at 7.3%. Even though yields and risk premia are very high, historical data indicates that there is a possibility of yields increasing even further. We advise you to be careful with buying corporate high-yield bond segment just yet, as recession might have serious negative implications for the risk-endowed companies. Investment grade bonds with an average duration (3-5 years) seem to be a better choice.
Benchmark 10-year bond yields
When it comes to the greenback, it could see at least some sort of a correction. The ECB, following the Fed, started talking about a possible increase in rates already in July. The briskest are waiting for an increase in the deposit rate by as much as 50 basis points, which would mean an exit from the negative rate zone. In its comments, the ECB has so far been cautious about the possible hike and has never voiced the magnitude of the planned change in policy. We tend to expect a 25 basis point increase in the deposit rate in July, with the REPO rate likely to remain at zero for now. Such a move could give the euro a little self-confidence and allow for a correction to the EUR/USD 1.10 levels (this is our maximum expectation at the moment). However, in the longer term, we still expect continued pressure on the European currency and the test of parity in the EUR/USD pair.
As dollar “sits” on twenty-year highs, precious metals feel some pressure. Gold, after a higher interest rate-induced drop in March-April, started consolidating at around $1810 per ounce. Yet, the downfall seems to be renewing, with the test of the major support level at $1700 per ounce approaching. Although picture in silver looks better to our eye, the metal is also under serious threat. We keep viewing silver dips as long-term buying opportunities, and are watching next key support level at XAG/USD 18.6. As before, we warn to be careful with leverage.
Oil remains extremely volatile, with a lot of noise surrounding the commodity. With this noise being mostly negative lately, the possibility of a drop back to $90-95 per barrel is definitely on the cards.
High Yield bond Indexes
Gold price, USD/oz
Covid-19 curbs eased in China with demand reviving. Services activity increased at the fastest pace in almost a year in June with Caixin services PMI showing a 54.5 reading compared to 41.4 in May. Additionally, manufacturing activity was positively impacted by the lifting of Covid-19 lockdowns – the Caixin/Markit manufacturing purchasing managers’ index soared to 51.7 in June (indicating the first expansion in four months. Recovery remains fragile as the country sticks to its zero Covid tolerance strategy.
In Europe, rising prices hurt demand and that led to a decrease in manufacturing production for the first time since the initial wave of Covid-19. S&P Global final manufacturing PMI decreased to 52.1 in June compared to 54.6 in May (the lowest level since August 2020). The new orders index decreased due to consumers holding back purchases, deterred by soaring prices and recession fears. Annual inflation in Eurozone increased to a new record high and reached 8.6% compared to 8.1% a month ago, driven by a spike in energy and food prices. Decrease in investor morale added to negative news, decreasing to lowest level since May 2020 – Sentix’s index for the Eurozone dropped to -26.4 in June from -15.8 in May. Manufacturing activity in US also slowed ¬– the ISM survey’s index of national factory activity decreased to 53.0 (the lowest reading in two years), compared to 56.1 in May. In addition, measure of new orders contracted for the first time in two years, indicating that the economy is cooling.
Ahead of us are two summer months with the Fed meeting on July 26-27 and the beginning of the reporting season. Summer is traditionally a quiet season in financial markets. Over the past 29 years, the average change in the S&P 500 in June was +0.2%, in July +1.01% and -0.2% in August. Naturally, today’s difficult geopolitical situation implies an increase in the general level of anxiety. Nevertheless, we adhere to the view that summer months will become the period of market consolidation before it makes a decision on its path in the second half of the year.