Chipmakers are cause for broader concern

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Another frazzled Friday, with risk appetite dimming owing to a combination of trade war casualty Broadcom and Middle East tension between Iran and the US.

Nothing resonates risk aversion quite like the price of gold hitting a 14-month high just shy of $1,360 an ounce, with the haven up from $1,270 inside the past month. In turn, 10-year benchmark yields in Germany, Spain, Portugal and Greece all set new record lows on Friday. 

Expectations of a global central bank easing cycle now includes China after the country’s industrial output hit a 17-year low in May. The big event to come is next week’s US Federal Reserve meeting and how policy officials frame their stance over the summer.

A dovish pivot looms ahead of the G20 meeting at the end of the month, although Friday’s solid retail sales data for May and large upward revision for April, suggests the consumer is in fine fettle. That allows the Fed to stay patient, signal a readiness to act, but not commit to a near-term easing.

The better tone in US data helped trim some haven gains in gold and government bonds, but the mood across equities remains defensive in tone. Some would argue it’s a case of good news on retail sales dimming the chances of Fed action. Instead, the news from Broadcom overnight represents a knock against the sunny assumption of a second-half recovery for global earnings growth. 

Broadcom’s cutting of its full-year guidance shows how the trade war is hitting semiconductors, an industry that’s the tip of the spear for companies reliant on global supply chains. Hock Tan, chief executive of the chipmaker, said during a conference call with analysts:

“We’re talking about uncertainty in our marketplace, uncertainty in terms of order reduction as the supply chain . . . compresses.”

More broadly, a 9 per cent rebound in the Philadelphia Semiconductor index, known as the Sox, since the start of June, is waning. Broadcom’s warning weighed on the Sox, leaving the benchmark heading back towards a test of its 200-day moving average.

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Russ Mould at AJ Bell says the Sox has “traditionally been a good indicator of wider stock market momentum and risk appetite since its launch in summer 1994” as the reliance on semiconductors for a range of products makes them a “good proxy for economic growth and broader end-market demand”.

The Sox was up 20 per cent on the year before Broadcom’s salvo, so the worry is whether this represents a harbinger for the broader market. 

Rather worryingly, Russ also reminds us:

“The index peaked before the wider FTSE All-World benchmark both in 2000 and 2007 and bottomed before headline indices such as the S&P 500 began to find its footing in 2002 and 2009.”

Quick Hits — What’s on the markets radar

Inflation expectations plumb to a new low — The latest University of Michigan survey out on Friday shows its forward starting measure of US inflation expectations — starting in 2024 and ending in 2029, or a 5yr/10yr tenor — dropped to 2.2 per cent, a record low. Arresting this trend is crucial for the Fed and as Jim O’Sullivan at HFE notes: 

“Fed officials have been fretting that low inflation expectations could become self-fulfilling to some extent.”

The latest three-day gathering of policymakers at the European Central Bank’s annual forum in Sintra from Monday will certainly focus on tumbling expectations for inflation. The eurozone’s five-year inflation swap rate starting in 2024 plumbed to a fresh record low on Friday, below 1.12 per cent. Six weeks ago, this measure of forward starting inflation expectations was at 1.42 per cent. US 10-year inflation expectations on Friday dipped below 1.66 per cent, taking us back to late 2016 and a 30 basis point drop since the Fed meeting at the end of April into May. 

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Here’s an update for the US and eurozone forward measures that ran earlier this week.

Haven trade favours the yen — Trade war and Middle East tension along with soft Chinese data are just the right cocktail for bolstering the yen. Combine that with expectations of further easing by Australia’s Reserve Bank duly sent its currency cross with Japan towards its “flash crash” cycle low set in January. The AUD/JPY cross touched 74.60 and Brad Bechtel at Jefferies notes: 

“AUD/JPY grinding lower and a sub 75.00 level is definitely a red flag given we typically don’t trade below here except in ‘flash crashes’.”

Italian bonds find buyers — A big day for the record books for eurozone benchmarks also features the Italian 10-year yield briefly dipping below 2.30 per cent, an area not seen since last May when populism sent a shudder though the BTP market. The political temperature between Rome and Brussels remains chilly to say the least, but investors do like bonds paying above 2 per cent.

Mark Dowding at BlueBay Asset Management makes the point:

“Italian government bond spreads are largely the same as the sub-index of BB-rated euro high-yield corporate bonds — yet Italy is a zero-risk-weighted asset, benefiting from robust institutional support within the EU.”

Next week’s EU Summit could well provide some tasty headlines about Italy and its budget for markets and traders. 

Oil’s limited bounce — That’s the story with Brent, up some 3.5 per cent, or $2 a barrel, to about $62 in the wake of attacks on tankers near the Strait of Hormuz on Thursday. The reaction highlights expectations of plentiful supply. As noted by the International Energy Agency, non-Opec supply will accelerate from 1.9m barrels a day to 2.3m b/d next year.

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The other side of the coin is weaker growth sapping demand. BNY Mellon note the New York Fed’s regular Oil Price Dynamics Report highlights “that while oversupply had been the key dynamic for oil prices, they were seeing demand factors starting to weaken as well”.

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