The Week Ahead

Stocks are in a buoyant mood as we start August. Futures are in positive territory on Monday, with European indices expected to open higher today, and US futures expected to carry on last week’s rally. The Nasdaq is currently expected to open higher by more than 0.8%. Last week, US stocks made a stunning comeback from Thursday onwards and the gains are expected to continue this week. The question now is, can US indices outperform their European counterparts this week, after falling behind for the past month?

Oil price boost for markets

The 5% drop in the oil price is also helping to boost sentiment. Overnight, President Trump said that negotiations to find a peace deal with Iran could start today, which has led Brent crude to fall back towards $83 per barrel. This will ease inflation fears and could also act as a dampener on bond yields, which rose sharply last week, especially at the long end, where 30-year US Treasury yields jumped to their highest level for 19 years.

Economic data and earnings to spur price action  

This is another huge week for financial markets. Firstly, there is a large amount of fresh economic data, including the latest labour market data from the US. 20% of the S&P 500 report earnings this week, including Palantir and SanDisk. SpaceX will also release its first earnings report on Tuesday. The market wants to know if the tech selloff is over, what the yen will do next after unprecedented multilateral intervention to prop up the currency, and US Treasury yields are also in focus.

If anyone thought things would be quiet for markets this August, they are only heating up.

3 main themes dominate markets

Last week three main narratives dominated price action as we rounded off July trading. The first was a week of two halves for the tech trade. The first half of the week saw severe tech deleveraging, which included a 17% sell off for South Korea’s Kospi index. Then came tech earnings, and a powerful rally on Thursday that drove Microsoft higher by 16%, and gave hope that the severe drawdown in the AI favourites, that started on 22^nd June, could be at an end.

Nasdaq 100

Source: XTB

Microsoft winning the AI race  

The rally in Microsoft is symbolic for a few reasons. Last week’s Q2 results showed that Copilot could be a big winner in enterprise AI. It increased the number of subscriptions to 30mn and is part of the Microsoft 365 suite of products. Thus, it is already well integrated into products that hundreds of millions of people use every day, and the growth trajectory is huge for Microsoft, which has now proven that it can monetize its AI investments.

Can chip stocks make a comeback?

Value in the tech space is shifting to some of the big Magnificent 7 names, after a bruising start to the year. However, there could also be a recovery in the chip sector. Several of the Magnificent 7 including Alphabet, Meta, Microsoft and Amazon are all increasing their AI capex plans for this year, which should give the AI trade another late summer burst of energy.

Did the AI trade reach a bottom?

Due to both of these factors, we could have seen the short-term bottom in the tech sell off as we march further into Q3. The question now, is there a strong rally ahead of us when August and September are traditionally the worst months for stock market returns?

USD/JPY in focus

The second narrative that dominated the market last week was the intervention in the yen. USD/JPY fell more than 4% last week, At the start of the week, the yen is higher by another 0.5% vs the USD and is trading at 156.60. The intervention came after a surprise hold from the Bank of Japan sent the yen sharply lower. The confirmed intervention cost the Japanese authorities $50bn, with another $10bn of support coming from the US and potentially South Korea. This time the intervention worked, but the question is, for how long?

FX intervention and manually propping up a currency does not have a strong track record of working in the long term, and this rate of FX intervention is unstainable over longer time periods. Thus, will the market test the resolve of the authorities? Although the yen is off to a strong start on Monday, if it does drop this week then it will put dramatic pressure on the Bank of Japan to raise interest rates in the coming months to try and naturally boost yen strength.

USD/JPY

Source: XTB

The fallout from the Fed

The third narrative from last week was Treasury yields. Long end yields surged, the US Treasury yield curve steepened sharply,  the 2s-10s yield curve is 48bps, while the 2s-30s yield curve is at 98bps, up 18bps last week, which is a huge move in one week. The 10-year yield closed the week at 4.69%, while the 30-year yield rose to its highest level since 2007 and closed the week at 5.23%. The impact on  the housing market could be severe and is worth watching in the coming months.

Yields are rising in the US even though the Fed kept interest rates unchanged at last week’s meeting. When rates are on pause, it is natural for the yield curve to steepen, after all, inflation is above the target rate. However, it is the unrelenting rise in yields that could unnerve investors. Interetsingly, stress in the long end of the US yield curve did not impact the global equity market rally at the end of last week. However, if yields do keep surging, then we could see pressure in the equity space.

While the Fed’s message was blamed for causing the volatility in the US Treasury curve, we think that this is unfair. Fed chair Kevin Warsh reiterated that the Fed would return US inflation back to the target rate, and there are some who think that he is nearly as hawkish as the three dissenting members of the FOMC who voted to hike rates last week. Interetsingly, Treasury yields are rising at the same time as the Fed is shifting to a potentially hawkish stance when there are signs that inflation is moderating and the labour market is weakening. PCE inflation was weaker than expected for Q2, and the labour market was much weaker than expected in June, we need to see if the pattern reoccurs for July.

However, yields are also rising because there is huge supply of debt. It is not just governments who are funding their activities with debt, the AI infrastructure build out is also increasingly funded by debt. When supply outstrips demand, yields have to rise to attract investors. Thus, we may not see bond yields moderate any time soon.

The key questions that investors are asking as we start a new week, where will the oil price go next? Have tech stocks, specifically chip stocks, bottomed out, and will a sell off in long end Treasury yields hurt equities?

Below, we look at the two main events to watch in the week ahead:

1, Non Farm Payrolls

While the focus on Monday is on an improving geopolitical backdrop and a falling oil price, the focus as we move through the week will be the US Non Fram Payrolls report, which will be another test of the resilience of the US labour market. This is a pivotal release for financial markets, and there are 4 things in this report that are worth watching. These include the payrolls number, the unemployment rate, wage growth and the labour force participation rate.

This data will help to define the future of Fed policy, and could be a major market-moving event, especially since the Fed is no longer offering forward guidance. The Fed is particularly worried about demand side inflation fears and a wage-price spiral, so the wage data is worth watching closely.

Economists currently expect a 91k increase in payrolls and for the unemployment rate to tick up a notch to 4.3%. If we get a major surprise in the data then USD/JPY is worth watching closely to see if an upside surprise weighs on the yen.

2, Earnings

This is a massive week for earnings reports on both sides of the Atlantic. Tech earnings will be watched closely after strong reports for Microsoft and Amazon helped to spur a major rally. Apple did not impress with last week’s report, and its stock price slumped more than 7% on Friday, although it did show signs of stabilization overnight.

Palantir, SpaceX and SanDisk are the highlights in the US earnings calendar for this week. SpaceX’s share price dropped sharply last week and fell 3% on Friday. It closed the week at a record low below $110. The question now is, can the earnings report, especially forecasts of future revenue, help the stock price to recover?

SpaceX

Source: XTB