With Yen, Tech and the Fed in Spotlight, Oil Dimly Burns
This is a market of many contradictions and the question now is can energy pull itself back up?
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August is supposed to be a month to switch off the screens and head to the beach. That rule would have suited any trader who was on their desk and tried to navigate the market the last few weeks.
For anyone at their desk, however, it's been pretty wild. Japanese markets fell 25% in one day in August only to rally all the way back to the level where the panic first broke out on a fateful Monday. Despite that, the Nikkei is still down about 12% from its highs in July. Today the S&P 500, along with the Nasdaq, are up 7% from their lows last week, with every retail and trader conditioned to buy any pullbacks as it has been classified as the no-brainer index to be invested in.
The sell side commentary has flickered between the two extremes, each time presenting a narrative that suited the price action.
But the asset that started this panic, the yen, has actually not managed to recoup its losses. It is trading close to 148 -- after it was trading close to 154. After the collapse, the Bank of Japan immediately said that perhaps it may not raise rates any further, walking back talk from months before. It was as though the bank had no idea that raising rates in Japan would cause such a panic after decades of negative interest rates that allowed every fund manager to borrow in the cheapest currency ever getting margin called. Japan is in a mess. It can either save its currency or its markets, but not both. The dilemma is that Japan is waiting for the Fed to cut, which would allow the dollar to fall. That would in turn let Japan print more yen to support the nation's assets.
The Recession Question
As we saw yesterday, the U.S. economic data is softening, but it is still quite resilient. Initial jobless claims moved down again this week to 227,000 (from 234,000 last week and 250,000 two weeks ago), along with a jump in retail sales suggesting the U.S. consumer was still alive and well, albeit slowing down. U.S. 10-year bond yields are trading around 3.85%, still around the lows of 3.75% on "Black Monday" and certainly off the 4.2% level it had been trading at earlier. The bond market is not convinced that this was just a panic. Truth be told the bond market has been suggesting that the Fed is about to make a policy mistake, the two-year curve suggests that the Fed will need to cut about 1.5 percentage points, far from the quarter point that Fed Chair Jerome Powell has been toying with.
The jury is still out whether or not we are in fact in a recession. The U.S. consumer may be holding up, but it is injured and strained. Banks and small- and medium-sized companies are not able to lend and commercial real estate properties see further write-offs. Most of the companies have reported their second quarter 2024 earnings that showed the S&P 500 grew earnings by 11% year over year, but the guidance for the third and fourth quarters was lowered. We know the Magnificent Seven tech star names have been the ones holding the index up for most of this year, but it is assumed that the remaining 493 names will see a significant recovery in earnings into the fourth quarter, and investors are eager to play the "broadening out" trade. This is the hope, even though evidence suggests otherwise.
High Tech and Low Energy
Technology stocks were the ones bought following last week’s selloff, not energy names, as oil continues to trade around the high $70s, unable to move higher despite the geopolitical turmoil in the Middle East. Today we have about 5 million barrels daily of OPEC+ production cuts, talk of a war potentially on a country that exports millions of barrels of oil per day, and yet it is unable to rally. One begs to ask where it would be trading if exports were not restricted. Hedge funds are eager to play the enviable long energy vs. short technology trade, but last week showed that both sectors can fall if we are indeed in a recession.
Most sell side commentary is filled with how "cheap" oil is, but as we know in the world of commodities, cheap can always get cheaper. It is not about value, it is about inventories and how available they are. OPEC+ assumes 2.1 million barrels a day of demand growth this year, most coming from China, even though China has seen its demand fall off by 300,000 barrels per day for the first seven months of this year. After nudging its forecasts down by a mere 135,000 barrels a day, this assumes an unrealistic unheard of demand surge in last three months of the year.
It seems there are contradictions across asset markets, who is right, equities or bonds? Foreign exchange or commodities? Credit or volatility? Time shall tell.
