LCG: Equities fall before the Fed decision, but energy stocks gain. Trump’s tweets slaughter trade deal hopes.

Jul 31, 2019

European equities recorded sharp losses on Tuesday. DAX sold off to a month low and closed the session 2.18% down. All sectors traded lower; healthcare (-2.74%) and technology (-2.41%) stocks led losses. Lufthansa tanked as much as 7% after announcing disappointing second quarter earnings due to slowing demand and fierce price war within the sector. Lufthansa also warned that second half could be challenging.

Then, multiple missiles from North Korea painted the equity markets in red in Asia. On top, Donald Trump talked China down via his tweets, meanwhile the US officials were in Shanghai trying to negotiate a trade deal with China. ‘Trump’s got China back on his heels, and the United States is doing great’ he said, slaughtering investors’ hopes for a suitable progress at the first face-to-face meeting between the US and China since May. His untimely tweets confirmed once again his reluctance to get a trade deal done in the foreseeable future. Hence the slowing China story will continue occupying the headlines for some more time.

Official PMI data showed today that the contraction in the Chinese manufacturing activity slowed in July. But services grew at a slower pace, leaving the composite PMI little changed at 53.1.

Stocks in Hong Kong (-1.18%) were offered on threats that Beijing could intervene if the HK police cannot stop violence in the streets, a scenario that would highlight China’s growing influence on the city, the exact reason why protesters are in the streets.

Shanghai’s Composite (-0.53%) edged lower, as some, but not all technology stocks gained in the morning session. Overall, Chinese tech sector (+0.41%) held on to its gains on hopes that despite all, the US-China talks could be positive for Huawei and the domestic tech companies.

US equity futures diverged positively from the rest of the market. The S&P500 (+0.17%), Dow (+0.28%) and Nasdaq (+0.40%) futures edged higher after Apple reported all-time high revenues and encouraging outlook despite declining iPhone sales.

Samsung on the other hand reported 56% fall in its second quarter profit, following a 60% fall in first quarter profits due to declining memory chip prices. Japan’s export ban to South Korea did not have a negative impact just yet, thanks to existing stockpiles, but investors also worry about the future of business if tensions don’t ease between these two countries.

FTSE futures (+0.09%) were better bid in the overnight trading session. The FTSE 100 closed 0.52% lower, after extending gains to 7727p, near one-year high, earlier in the session. The strong negative correlation between British chips and the pound holds tight even with the rising no-deal Brexit risks, although the insolvencies among smaller-size British companies hit a five-year high.

Energy stocks (+1.26%) outperformed in London. Brent crude recovered to $65 a barrel as growing tensions in Straits of Hormuz increased supply concerns in the Mid-East, while the US crude inventories fell for the seventh straight week.

UK energy companies could follow up on Asian energy sector gains at the open.

The FTSE 100 is expected to open 15 points higher at 7662p.

In the foreign exchange markets, Cable dipped to 1.2119 on Tuesday, as UK’s new Prime Minister Boris Johnson said he sees no point in meeting European leaders if they are not open to renegotiate the Withdrawal Agreement. And European leaders will unlikely change their stance face with the UK’s increasingly aggressive tone. Hence, the UK is walking decidedly toward a no-deal exit on October 31st.

The euro-pound jumped toward the 0.92 mark, the highest in more than two years, as the pound got smashed on no-deal Brexit pricing. Provided the very low level of net speculative positioning in this market, there is a real potential for a further rise in euro against the pound.

The turbo decline in pound, on the other hand, will further weigh on European business sentiment, as exports from the Euro area become increasingly expensive for British households, at a time when the bloc is already dealing with a slowing demand due to global trade tensions. European business climate index dived below zero for the first time in nearly six years. French GDP growth eased to 0.2% q-o-q in the second quarter from 0.3% printed a quarter earlier. The EURUSD remained offered by 1.1160 level, as weak economic data kept the European Central Bank doves in charge of the market. And a possible US dollar rally posterior to the Fed decision could throw the pair under the 1.1100 mark as soon as this week.

Fed decides as oversees economic data and company earnings show signs of further distress

Disappointing overseas earnings and weak global economic data offer a credible justification for lower interest rates in the US. The Federal Reserve (Fed) will likely cut the Fed funds rate by 25 basis points today, if not more, as FOMC members will accentuate the rising downside risks due to a weakening global economy, that could hit the US businesses sooner rather than later if they do not act now.

The Fed could still surprise the market with a 50-basis-point cut, but such action would make it harder to keep the market motivated in the coming quarters, as a larger cut today would require larger cuts in the future as well. The Fed may want to avoid such commitment and to have a better control on investors by keeping the possibility of more cuts on the table instead of going full-blast lower at today’s meeting. The probability of a 50-basis-point cut is down to 18% according to the pricing in the US treasury markets.

Doves’ reaction to a 25-basis-point cut should remain limited as lower Fed rates are fully integrated in asset prices, unless Jerome Powell sounds more dovish than he already has over the past month. But we cannot underestimate the power of Powell’s words, as he has managed to keep the doves inspired despite strong economic data over the past weeks.

Speaking of strong data, the ADP employment report due before the Fed decision, should confirm that the US economy added 150’000 new nonfarm jobs in July, higher than 102’000 printed a month earlier. A better-than-expected figure could cheer investors up, with the Fed’s growing emphasize on what’s turning bad elsewhere rather than what’s doing good at home.

Opening calls

FTSE is expected to open 15 points higher at 7662

DAX is expected to open 30 points higher at 12177