The Overnight Report: Rotation Into Laggards

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By Chris Weston, Head of Research, Pepperstone

Good Morning.

-US CPI review
-A September Fed rate cut is a lock
-The USD follows US 2yr yields but it’s the JPY that stole the show
-Gold eyeing a test of the all-time high
-US equity moves – A monster switch from tech to value
-Asia opening calls the ASX200 to open at a new all-time high

It’s been a big day in the trenches for traders and we’ve seen some punchy intraday moves, all-time highs coming into play, but also sizable reversals seen in some of the very extended/over-loved positions.

US CPI was always the marquee risk this week, and it was the landmine that traders really needed to be set in front of their screens to react to. Headline CPI fell -0.1% m/m – the first decline since mid-2020. More importantly, we saw US core CPI coming in at 0.06% m/m (3.3% y/y), below expectations, with core services pulling back to 0.13% driven by a big decline in airfares, and a further moderation in shelter.

We watch for the US PPI inflation report in the session ahead, which will galvanise our conviction on forecasting the US core PCE inflation read (due 26 July), which the Fed set policy to.

The reaction in the bond market to the CPI print was straightforward, with the yield on the US 2yr Treasury yield falling from 4.63% to 4.48% before better supply was seen, and we see yields ultimately closing out -11bp to 4.51% on the day. The US 10yr Treasury closed -7bp, so a less pronounced move and we’ve seen curves bull steepen a touch.

US rates markets now price a full -25bp cut by September, so it’s game on for easing to start in September in the eyes of the market. We can also see -60bp of cuts priced for the December meeting, so the debate is now whether we see two or three -25bp cuts by year-end.

For the first time in a while, the market will listen closely to speeches from Fed officials, as they will want to hear clearer signs that the Fed is looking to open the door to easing, with increased confidence to start the cycle.

USDJPY and the JPY crosses were the focal points in FX markets, with USDJPY rates smashed 417 pips post-CPI, in a move which smells very much like an intervention it appears the MoF and BoJ may have turned momentum trader, grabbing their moment to hit the market when it was at its most vulnerable. Comments from key Japanese currency officials may be heard through the session ahead, but one can imagine they will be purposely vague.

AUDUSD saw good flow, with the pair trading higher into 0.6799 before fading back to the flatline following a reversal lower in the S&P500 futures EURUSD kissed the 1.0900 level before sellers found form.

Gold saw big flows, with the yellow metal trading US$2380 to a high of US$2424 before consolidating the bulls are now gunning for US$2431 (the 12 April spike high) and more so the all-time high of US$2450 there’s a bit of wood to chop to get there, but the wind is to its back.

Possible intervention aside, the moves in US equity markets were prolific. The initial euphoria to the US CPI print saw NAS100 futures rally 0.5% off the bat with the index falling just shy of 21k – S&P500 futures also rallied 0.5%, breaching 5700. What happened next caught many by surprise and forced the day traders to react dynamically to the change in price action.

When cash equities opened, funds moved aggressively out of growth, AI-related plays and big tech and moved into value areas of the market and small caps we did see some individual stock news, such as Tesla delaying the unveiling of its robotaxi until October, but the broad move was driven by rotation and switching across styles and factors.  

Tesla closed -8.4% with 218m shares traded a solid flush. The MAG7 index closed -4.4%, and we can see within the S&P500 sectors that REITS, utilities, materials, and industrials all worked well. Breadth was quite upbeat, with 79% of S&P500 stocks closing higher, but it were the well-loved names that saw the selling and maybe this was partly technical given just how extended these plays are. Volumes through the S&P500 and NAS100 were 13.3% and 8.4% respectively above the 30-day average.

The Russell2000 was the play of the day, with the small-cap index closing up 3.6% and just shy of the 28 March high of 2135 the small-cap index is still -13% off the all-time high it reached on November 2021, but that gap may be closing in this run. In fact, we saw a 5.6% outperformance of the Russell 2k vs the NAS100, the third biggest outperformance ever.

We’ve seen rotation play out quite a bit of late, but we certainly haven’t this pronounced the rotation moves also haven’t lasted more than a one- or two-day affair, so we’ll see if this switch has legs and whether we do see a period of underperformance from tech.

Turning to Asia, the big development is that we should see a new all-time high for the ASX200 on open and again when value areas of the market fire up then the ASX200 is one index where global capital will seek out so the challenge for the bulls today is to hold the index above 7910 (the former high printed on 2 April). Banks should fire up on open, as should material names although BHP’s ADR suggest the miner opens a touch lower.

All this said, today is a new day and the market may see things differently after this position flush still, it is clear the market feels the Fed now has the evidence it needs growth is moderating, as is inflation and investors can re-weight positions with greater conviction towards areas of the market that typically work in a late-cycle environment.

Samer Hasn Market Analyst at XS.com

Gold continues to advance for the third day in a row and exceeds the level of US$2,400 per ounce in spot contracts, as well as for COMEX’s futures.

Gold’s gains come amid more optimism about the possibility of cutting interest rates in the US after a faster-than-expected slowdown in inflation. While the escalation of military actions in the Middle East and Ukraine comes to provide support for the yellow metal to maintain its gains.

Consumer Price Index (CPI) inflation slowed from 3.3% to 3% in June, versus expectations for it to decline to 3.1%. On a monthly basis, prices unexpectedly contracted by -0.1% for the first time since 2022. This came under pressure from a -2% decline in energy prices, including gasoline prices which fell by -3.8%, on a monthly basis.

This decline in inflation has led to more hope that the Federal Reserve will cut interest rates next September. This hope has reached the highest levels since attention was drawn to this month as the starting point towards a less tightening path for monetary policy. The probability that the Fed will cut rates by -25 basis points is more than 76% in September, according to the CME FedWatch Tool.

This slowdown in inflation has also put pressure on bond yields to decline significantly and has brought the real yields on 10-year Treasury bonds to the lowest level since the beginning of June at 1.197%, which may also enhance gold’s gains.

On the geopolitical side, the conflicts in Ukraine or the Middle East do not appear to be on a path other than escalating further, and this is what may preserve gold’s luster as a safe haven.

The details are many, but I believe that in the end they only serve the narrative of continued escalation more and more on various fronts.

In Gaza, it seems the military operations there are heading to a new round, especially in the north, with leaflets being dropped warning of further escalation. This also comes with the cancellation of restrictions on the delivery of 500-pound bomb shipments from the US that were imposed last May, according to The Wall Street Journal.

Whereas the abolition of these restrictions comes after a series of large-scale operations in Rafah, which led to waves of condemnation from the international community, regarding the civilian victims there. But now, with the lifting of restrictions with the exception of those on 2000-pound bombs it suggests the US is not doing what is necessary to put pressure toward stopping the escalation.

The trend of military operations expanding again in Gaza, in conjunction with the lack of progress on the negotiating track at least what appears to be public keeps the fuse on the South Lebanon front burning. This comes with the Israeli side’s insistence on continuing military operations until its goals are achieved, which is to completely eliminate Hamas’ military capabilities in response to the demands of the extreme right. This does not seem realistic to the military command there, nor even to the US.

On the other hand, David Ignatius spoke in an opinion article in The Washington Post, citing sources from US officials, that the parties to the conflict have agreed on the “framework” and are negotiating the details. While Ignatius conveyed officials’ concerns this progress does not mean reaching a final agreement is imminent.

In fact, negotiations have faltered in the past, despite some progress achieved at the time, after which we saw to waves of escalation greater than before. We also do not forget the pressure exerted by the Israeli far right to obstruct such an agreement, in addition to the procrastination that Benjamin Netanyahu may undertake until the expected return of Donald Trump to the White House, in a bet that he will free Israel’s hand in the region without any rebuke.

This prolongation of the war, as I mentioned, will maintain fears of a flare-up on the southern Lebanese front, and this time it may be on a larger scale than what we witnessed in 2006, whether on the part of the parties that will be drawn into the conflict directly or on the level of Hezbollah’s military capabilities.

The outbreak of a full-scale war there threatens to drag Yemen, Syria, Iraq, and Iran deeper into this conflict, and this may ultimately threaten global supply chains passing through the Red Sea or even the Gulf of Oman. In addition, a report in The Washington Post talked about the development of Hezbollah’s arsenal of guided and unguided munitions, which may carry explosive warheads weighing from 20 to more than 1,100 pounds, with a range that may reach more than 180 miles, and air defenses that can target aircraft UAV at least at an altitude of 90,000 feet, in addition to coastal defense systems.

This arsenal, accumulated over decades, can target the Israeli depths, even in Tel Aviv, and may threaten its gas fields in the Mediterranean. Therefore, the potential war will not be limited at all, and this may push Israel to drag the US directly into this conflict, even if the latter refrains from doing so currently.

Not far from the Middle East, the war in Ukraine is preparing to take a new turn of unprecedented escalation. Some NATO countries are preparing to provide the first batches of F-16 aircraft to Ukraine. While this type of support is considered a bypass of the red line drawn by Russia, that may respond to this step with more unprecedented escalation. While donor countries may impose restrictions on the ground missions that these aircraft may carry out, like prohibiting them from striking the Russian interior, and limit their missions to short-range air defense only, according to The Wall Street Journal.

During the past weeks, Ukraine has targeted Russia with advanced munitions provided to it by the US, and this was a red line as well. This is what prompted Russia to mount an unprecedented escalation and Vladimir Putin’s statement that he is ready to cooperate with any party, whether internationally recognised or not, to confront his enemies, in addition to a series of strikes that caused Ukraine to lose half of its ability to generate electricity.

As for the political side in the Eurozone, a state of uncertainty prevails, especially after the results of the French parliamentary elections, which resulted in a reality of extreme polarisation between contradictory parties.

The political uncertainty there would keep the region’s bond yields French in particular maintaining their upward trend, and this may preserve the euro some of its strength against the dollar, which may continue to decline, and this, in turn, will be in favor of gold as well.

While the Dollar Index is at its lowest levels in more than a month at 104.2 points, due to the continued hope of the possibility of achieving an interest rate cut this year.

In contrast to all this, Wall Street does not seem to be attracted enough to the brilliance of the yellow metal. The NASDAQ100 and S&P500 were able to close at more historical highs in a sign of high sentiment and risk appetite.

In addition, major physical gold ETFs continue to record outflows from time to time and have lost more than US$4bn in investor funds since the beginning of the year, despite everything we have witnessed and the historical gains of gold. In contrast, bond ETFs are enjoying more generous inflows this year, taking advantage of lower prices and attractive bond yields.

The Australian share market over the past thirty days

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