Data deluge to determine next steps for stocks and the USD

As we start the first week of July, the focus is on the economic data that is scheduled for release at the start of the new month. While the US is out for the Independence Day holiday at the start of the week, it is gearing up to be a crucial trading week as global PMIs are due, along with US ISM reports, June’s private sector payrolls report, JOLTS job openings and the NFP report, which will give an important steer on labour market tightness along with the inflationary trends coming from wage data. Stock markets are a touch weaker as we start July, but that follows 2% plus gains for the US stock markets last week. Unsurprisingly, gains in the FTSE 100 were muted by comparison, and the UK index was up by only 0.7% last week, continuing a theme of underperformance by the UK index so far in 2023. In the FX space, the pound is making a comeback, and is the best performer in the G10 FX space at the start of the week, up some 0.44% on Monday, and close to $1.27, after falling below $1.26 at one-point last week.

Economic data to determine if the US gets its soft landing and the stock rally continues

The soft-landing theme is gaining traction as we lead up to some key economic releases this week. US stock markets gained 2% last week after a raft of better-than-expected economic data. Durable goods were stronger than expected, new home sales surged in May, Q1 GDP was revised higher and the PCE rate, the Federal Reserve’s preferred measure of inflation, fell a notch to 4.1% for Q1. This is higher than the Federal Reserve’s target rate of 2%, however, it does show that the Fed’s aggressive tightening stance has paid off and is reducing inflation. There are big expectations that the “soft landing” theme will continue as we move into Q3, with analysts expecting non-Farm payroll growth to moderate to 200k for June. Payrolls have developed a habit of beating expectations, however, if job growth does moderate for June, then it could help extend the rally in US stocks that have stunned market participants so far. Interestingly, the rally in stocks started with the tech sector at the start of 2023, but now it has begun to broaden out, which is a bullish signal.

USD: it all depends on interest rate differentials

The dollar index declined last week, and has had another weak start to July, it is currently lower by 0.15%. The logic behind the fall in the greenback is that interest rate differentials are the key driver of FX markets right now. The spread between US and German and UK interest rates has narrowed sharply. For example, the spread between 1-year US and German sovereign bond yields is currently 1.84%, which is one of the lowest levels so far this year. The spread between the US and UK 1-year yield is only 2 basis points. As the US dollar’s yield advantage has been eroded by 1, the Fed seemingly winning the fight against inflation and 2, the ECB and the Bank of England continuing to hike interest rates, it has weighed on the greenback and we expect this theme to continue in the near to medium term.

The pound is riding high

The FX market’s focus on the yield differential is why this week’s economic data is so important. If US data suggests a soft economic landing - labour market tightness is loosening and inflation is weakening, then the dollar may struggle going forward as it supports the Federal Reserve staying on pause. Although the UK’s economic outlook remains murky, this is not denting bullish interest in the pound. Speculators have boosted bullish bets on the pound to the highest level for 9 years. This is one reason why the pound is higher again on Monday and is recouping some of last week’s losses. CFTC data showed that net long positions in GBP for the week ending June 27th was 52,000 contracts, up from 46,600 the week prior. This suggests that speculators, which make up a large chunk of the FX market, have become more bullish on the pound. We believe that this is due to expectations of even higher interest rates for the UK through to the end of the year.

However, while we see the pound continuing to move higher in the next few weeks, we would be wary of FX moves in August and beyond. GBP/USD could face some stiff resistance at $1.30, a level this pair has not reached since April 2022. While demand for GBP is strong now, if the growth picture starts to deteriorate then expect GBP to fall. For now, growth in the UK has surprised on the upside even as yields rise, which is good news for sterling. However, if the balance shifts, then GBP could be in trouble.

And finally…

Elsewhere, it is worth noting that European electricity prices turned negative on Monday, which is a noteworthy for two reasons: 1, it could add a temporary boost to European productivity as businesses may be asked to produce more to use up the surplus energy, and 2, it could help to bring down headline inflation further in the coming months. The question is whether a decline in headline will lead to a decline in core and service price inflation, that may not happen for some time, which could limit scope for the ECB to be less hawkish. Another interesting nugget of information about stock market dynamics, after Apple reached a valuation of $3 trillion last week, it is now worth more than the entire FTSE 100 and it’s also worth more than the Cac 40!