Gold, Bitcoin defensive plays as markets grapple with the growth outlook

Gold and Bitcoin shone in a sea of red, with equities, bonds and oil all down. US economic data still points to expansion, notably in the wage/inflation sensitive services sector, while for Europe there is evident slowing. The Fed’s takeaway will be that higher rates are required to tame inflation, and the market payoff could be fear of an economic recession. It feels like we are a tipping point.

Bottom line – risk-off.

TODAY’S MAJOR NEWS

Transitory or intransigent inflation? Slowdown or recession?

Is inflation transitory or intransigent? My colleague Arlan Suderman has an interesting take on this important question. He argues that inflation is a matter of supply and demand. Prices rise when the demand for a goods, services, or jobs, is greater than the supply. Supply chains were disrupted when the pandemic hit, so decisionmakers assumed that emerging inflation was simply due to supply not being able to keep up with demand. There was some truth to that. The supply was disrupted by the pandemic, and those disruptions were expected to go away as we emerged from the pandemic, although government regulations continued to keep many of those restrictions in place well into 2021, and even into 2022. Nonetheless, it was this focus that led most decisionmakers to declare that inflation was transitory in nature, and that therefore monetary policy could remain accommodative – inflation would take care of itself with time.

Suderman continues that this overlooked the demand side of the equation. The whole purpose of the fiscal and monetary stimulus implemented during the pandemic was to sustain demand to keep our economy from collapsing. Nobody knew the scope of the stimulus needed, as these were unprecedented times. No decisionmaker wanted to be blamed for bringing down the economy due to being too conservative on stimulus. So, both fiscal and monetary stimulus errored on the side of over-doing it, with each type contributing roughly $5 trillion to the economy. Demand surged far above expectations, let alone the ability of supply to keep up. Inflation surged far beyond the transitory factors, becoming deeply ingrained into the economy.

For central banks, removing that stimulus at a proper pace became a major challenge when they had no previous experience with this type of scenario. Inflation for consumer goods has already fallen below the 2% mandate, illustrating its transitory aspect. However, its estimated that 4+ million people left the work force to retire early coming out of the pandemic, because their 401K’s performed so well. A significant portion of the stimulus also ended up in financial markets. There’s a clear correlation between stimulus and the S&P 500 stock index.

How do we explain the evidently tight labor market? Around 5.5 million people say they want to work, but they haven’t even looked for a job in the past 12 months. As a result, demand for workers remains stronger than the supply, keeping wage inflation strong. The Federal Reserve cannot increase the supply, but it can slow the demand – that’s what Powell told both Houses of Congress this week. More work needs to be done to slow demand for workers, and that means inflicting more pain on the economy.

As I have noted in recent days, the yield curve (2 year versus 10 year bond yields) is now markedly inverted, and that has typically been the harbinger of an economic recession. As the Fed raises rates further, this could be self-fulfilling. The absence of growth might be our next big issue, not the nature of inflation.

Oil weaker on global demand and dollar strength

Crude oil prices posted further losses this morning, down 5% in the past several days, as traders focus on weak Chinese economic data, and reduced demand in the US and Europe. As markets digest the likelihood of higher US rates, the dollar is finding support and moving through its 50- and 100-day moving averages. A strengthening dollar raises the global cost of oil for customers using the dollar to purchase energy needs, potentially crimping demand. It will be interesting to watch the next move from the next OPEC+ producer countries when they meet in Vienna on July 5-6. Saudi Arabia led the move to cut global output by 3.6% in June.

US Purchasing Manager’s Index (PMI) still signals service sector expansion

• S&P’s US Composite PMI was revised slightly lower, dropping to 54.3 in May from its preliminary reading of 54.5 but still an improvement from the 53.4 seen in April
• This was the fastest expansion in US business activity seen for the index since April 2022 (readings above 50 indicate expansion)
• Expansion was driven largely by the US service sector, with the Services PMI coming in at 54.9, revised down from its initial 55.1 reading
• This was also the strongest reading for the indicator since April 2022 as demand for services continues to show strength
• The US manufacturing sector continues to lag, with the Manufacturing PMI being revised 0.1 lower to a 48.4 final reading in May (readings below 50 indicate contraction)
• This was a reverse on expansion reported in April after five consecutive months of contraction
• One other interesting takeaway from today's PMI data was the improvement to the employment portion of the respective indexes, not reassuring for the Fed as it looks to tame wage inflation
• The Kansas City Fed's Manufacturing Production Index also added to the negative sentiment on manufacturing, with its June reading contracting further to -10 from the -2 reading seen in May

Eurozone Purchasing Manager’s Index (PMI) signals manufacturing slowdown

• Today’s preliminary S&P/HCOB Eurozone Composite PMI fell to 50.3 in June, well below the expected 52.5, and 52.8 seen last month
• This is now the second consecutive monthly drop in Eurozone PMI and marks the lowest level seen since January, clouding Europe’s economic outlook
• This suggests an economy slowing rapidly, and worsening economic conditions in Europe are weighing on its financial markets
• The services sector continues to outperform the manufacturing sector, allowing the Composite PMI to hold narrowly in expansionary territory.
• Services showed unexpected weakness, with the Eurozone Services PMI falling to 52.4 in June, below the expected 54.5, and 55.1 in May
• European manufacturing continues to weaken, with the June PMI falling to 43.6, despite the expectation of no change, and May's 44.8 reading
• This is the worst contraction in European manufacturing business activity seen since the initial fallout of the COVID pandemic in early 2020

TODAY’S MAJOR MARKETS

Equity markets

• The Nasdaq Composite index fell 0.5% in morning trade, with the S&P 500 and Russell 2000 down 0.4% and 0.9% respectively
• Global markets were also in a bearish mood, with the DAX, Nikkei 225, and FTSE 100 indexes off 1.8%, 1.5% and 0.5%, respectively
• In what is becoming a strange contrast to falling equity markets, the VIX, Wall Street’s fear index, fell again to 12.9, highlighting how little ‘fear’ can be extracted from derivative markets opinion on cash equities (something we will revisit next week)

Currencies, Bonds and Crypto

• The dollar index rose 0.5% against a basket of currencies to 102.9, exhibiting safe haven status
• Euro/dollar Sterling/dollar were down 0.5% and 0.2%, respectively
• The inverted yield curve stayed above one percent, with yields on 2- and 10-year Treasuries both higher at 4.78% and 3.75% respectively
• Bitcoin move decisively over 30k, up 3.3% to $31,057

Commodities

• Gold prices were 0.3% higher at $1,929 per ounce
• Crude oil prices fell 0.8% to $69.0 per barrel
• Grain and oilseed markets were sharply lower on further profit taking

Analysis by Arlan Suderman, Chief Commodities Economist: Arlan.Suderman@StoneX.com

Market outlook by Paul Walton, Financial Writer: Paul.Walton@StoneX.com