The Fed will always do the right thing (once all other possibilities are exhausted)

The local market started on a strong positive footing before fading to close flat on the day. There was an interesting divergence between risk managing global investors and positive retail investors. Micro and small-cap stocks led the way, while large and mid-caps barely moved after the selling into the close. The macro risk is elevated with US inflation data and financials starting the US reporting season tonight. Utilities and industrials lead the way higher while property and energy lead the way lower.

Markets on extreme valuations are walking into US inflation, US reporting season, China GDP and Option/Futures expiry week in Australia and US. At a time when all asset classes are correlated, risk management becomes very hard. That may be why global financials like Blackrock and Macquarie are becoming global property managers.

US inflation is expected to mainly be at the previous hot level as the US Fed keeps pushing that inflation is transient. 

• What happens if that overshoots? 
• How long will the market’s buy into the “transient” fantasy? 
• How long is transient anyway?

Let’s be real. No central bank is going to raise rates…ever…unless they are forced to. There is only one central bank with that problem and that is the US Fed. It has the global currency and risks substantially devaluing its currency and bringing on hyperinflation. 

The European Central Bank is going to update the world with its new plan. When your existing model is a Japan-style Ponzi scheme, there isn’t a lot of room to move and the ECB may not reach real positive rates for decades. The ECB may flag QE tapering in the future but in reality, it will add more QE before getting there. Meanwhile, the US Fed is stuck talking down inflation while in reality it’s rising. At some point, the market will lose faith and that will force US Fed to taper. Just like RBA, US Fed is hoping that fading economic growth brings down inflation and keep asset prices supported. 

Central Banks continue to back trickle-down economics of pumping asset prices to solve economic structural problems. The historic trend suggest that it is only making the economic problems bigger and the debt mess deeper. There are no real exit plans from multi layered Central Bank stimulus policies. The simple fact is the unwinding of stimulus by major Central Banks will take decades of tightening. There is no political will power or reform agenda to make that change. Logic suggests that the change will happen by external catalyst like inflation. It may be different this time!

US reporting season starts this week with financial leading the way. Data clearly shows that Q2 was the peak in economic, corporate profit and stimulus growth rates. It is hard to see upgrades beating high expectations into the future where economic growth is fading. Inflation is real and it’s pushing up cost for most corporates. Financials will do well due to their exposure is mainly to asset bubbles but real world economy businesses are going to have tougher outlook statements. The old adage comes to mind…History is not a good indicator of future performance!

China GDP growth update should be strong given the recent data update and they will guide to lower numbers like any smart managers. It is easy to beat weaker expectations. The move by China to curb inflation and boost lending suggest China is feeling the fading global recovery.

The option/futures expiry week has had some seasonal effects due to extreme leverage in the markets. History suggest market outperform into expiry and underperform after. It may be different this time!

NSW cluster remains elevated and it seems inevitable that mockdown to lockdown will hit the fourth week. Given the details in the new government support package and moves by sporting bodies and private schools, it looks inevitable that we are going to be in lockdown into August.

Let us run through the main data points released in the last 24 hours…

Annual consumer inflation rate in India was little changed at 6.26% in June from 6.30% in May of 2021, lower than market forecasts of 6.58%. A slowdown was seen in cost of pan, tobacco and intoxicants (3.98% vs 10% in May); miscellaneous (7.28% vs 7.52%); clothing and footwear; and housing (3.75% vs 3.86%). In contrast, inflation accelerated for food (5.15% vs 5.01%); fuel and light (12.68% vs 11.58%); and clothing and footwear (6.21% vs 5.32%). Retail inflation stayed above the central bank target range of 2%-6% for the 2nd month, due to high global commodity prices.

Industrial production in India rose 29.3% year-on-year in May of 2021, below market expectations of 32% as regional lockdowns in most states to contain the second wave of the coronavirus pandemic hurt activities. Manufacturing production advanced 34.5%, led by motor vehicles, trailers and semi-trailers (208.2%) and textiles (165.2%). Also, output rose for mining (23.3%) and electricity (7.5%).

Median year-ahead inflation expectations in the US grew to 4.8% in June 2021, a new high for the series and the eighth straight month of increases, as the economy recovers from the pandemic hit. Meanwhile, expectations for inflation over the next three years remained unchanged at 3.6%, the second-highest level ever. The survey also showed households' labor market expectations continued to improve as the mean perceived probability of losing one's job in the next 12 months decreased to 10.9%, a new series' low, and the mean perceived probability of finding a job in the next three months increased to 54.2%, the highest reading since February 2020.

The NAB business confidence index in Australia fell sharply to 11 in June 2021 from 20 in the prior month, amid COVID-19 lockdowns in New South Wales and Victoria. Confidence weakened in all industries except mining and manufacturing, with recreation & personal suffering a steep drop as businesses were shut. That said, confidence remains around twice its long-run average after strengthening in early 2021. Business conditions also saw a sharp fall after reaching a new high in May, as trading (35 vs 45), profitability (25 vs 39), and employment (17 vs 25) all declined Also, forward orders came off the record highs hit last month but remained elevated (15 vs 24), as does capacity utilization (83.9 vs 85.0). The decline was led by falls in finance, business & property, and mining, though a number of other industries saw solid declines as well. "The hope is that, as like previous episodes of shutdowns, that businesses bounce back on reopening," said Alan Oster, NAB group chief economist.

China's trade surplus was at USD 51.53 billion in June 2021, far above market consensus of USD 44.2 billion and compared with a surplus of USD 44.8 billion in the same month a year earlier. It was the largest trade surplus since January, amid further recovery global demand. Exports soared 32.2 percent from a year earlier to USD 281.42 billion while imports jumped 36.7 percent to 229.89 billion. The country's trade surplus with the US increased to USD 32.58 billion in June from USD 31.78 billion in May. For the first half of the year, China’s trade surplus with the US widened to USD 164.92 billion from USD 132.46 billion in January – May. Considering the first half of the year, the trade surplus widened sharply to USD 251.52 billion, from USD 164.33 billion in the same period of 2020, as exports surged 38.6 percent year-on-year to USD 1.52 trillion, while imports jumped 36 percent to USD 1.27 trillion.

Exports from China surged 32.2% year-on-year to USD 281.42 billion in June 2021, above market consensus of 23.1% and after a 27.9% gain in May. This was the twelfth straight month of growth in outbound shipments, as solid foreign demand offset local COVID-19 outbreak, higher raw materials, and logistic bottlenecks.

Imports to China rose by 36.7% year-on-year to USD 229.89 billion in June 2021, compared with a market consensus of a 30% growth and after a decade-high figure of 51.1% a month earlier, as domestic demand moderated following the latest COVID-19 outbreak in some regions. Purchases grew for natural gas (22.56%), copper ores & concentrates (5.09%), and coal (12.27%). In contrast, arrivals fell for crude oil (-24.53%), refined products (-39.0%), unwrought copper (-35.09%), iron ore (-12.06%), steel products (-33.4%), soybeans (-3.92%), edible oil (-0.2%), and rubber (-13.48%), and meat (-17.08%).

Annual inflation rate in Germany was confirmed at 2.3% in June of 2021, matching the preliminary estimate, and slowing from a decade high of 2.5% in May. Energy prices made one of the highest upward contributions (9.4% vs 10% in May) due to low base effects from last year. The CO2 charge introduced at the beginning of the year is also weighing. Excluding energy, inflation was 1.6%. Compared with the previous month, the CPI increased 0.4%, also matching the initial estimates and slowing from 0.5% in May.

Comments on US market last close… 

US market moved higher on low turnover despite consumer inflation expectations beat expectations. RUSSELL +0.08%, NASDAQ +0.21%, S&P +0.35% and DOW +0.36%. VIX ticked lower and still above 16. We get latest inflation update tonight and markets were muted ahead of that. USD and Bond yields were higher and yet stocks like Tesla was up more than 4% pushed markets into positive territory. Commodities eased on stronger USD. US market kept the positive sentiment from European and Asian markets. Banks and Property were the best while Staples and Energy were the worst.

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