Monthly Market Outlook

In May, the main topic of discussion was the debt ceiling talks. Surprisingly, only the stock markets remained mostly unaffected by the constant flow of news and significant fluctuations as the “x” day approached. However, there were significant movements in the price of gold and the dollar index. While stocks seemed to overlook the associated risks and enjoyed the benefits of an AI rally.

With the conclusion of the debt ceiling discussions, the market’s attention has now shifted back to central bank decisions as we enter June. The expectations of the market have undergone significant changes in the past month, with several Federal Reserve (FED) members maintaining a more hawkish stance than anticipated. Another crucial factor to monitor, which has somewhat been overshadowed recently, is the slowdown in the global manufacturing sector.

Macro View

The debt ceiling negotiations were tough, particularly for the bond markets. The fluctuating positive and negative talks resulted in significant market swings for gold and bonds. The US Credit Default Swaps (CDS) experienced a sharp increase, the US credit rating fell under at risk. The US 1-year CDS rose to nearly 180, but with the deal reached just days before default, it quickly fell to 24 within three days.

Now that the deal is done, new questions arise regarding how the markets will react to the declining liquidity as the treasury replenishes its empty coffers. There are expectations that the treasury will issue bonds worth as much as $1 trillion in the coming months.

Fears of a recession have somewhat eased due to strong jobs reports and the alleviation of the bank crisis, along with the resolution of the debt ceiling risks. However, the manufacturing sector is raising alarming signals. Manufacturing Purchasing Managers’ Index (PMI) figures worldwide have been on a downtrend since early 2021, and many major economies have fallen below the key level of 50, indicating a contraction in activity. The European Union (EU) has been hit the hardest, with its PMI falling as low as 44.8, and within the EU, Germany, a manufacturing giant, has been particularly affected. As the services sector thrives and manufacturing suffers, Germany experienced a recession during the winter months, with two consecutive quarters of negative GDP growth.

Similar to the Eurozone, the United Kingdom (UK), United States (US), and China also have manufacturing PMIs below 50. In the latest ISM manufacturing report, the “new orders” sub-index fell from 45.7 to 42.6. This suggests that the downtrend in PMI might persist for now, especially as the Federal Reserve (FED) maintains its hawkish stance. In China, there are discussions about a potential new property support package that could potentially stimulate the struggling recovery efforts if it materializes. However, in the short term, China is not performing as well as many economists had expected after the end of the zero-COVID policy.

In May, FED rate expectations underwent significant changes. The markets initially priced in a couple of rate cuts for the year, but FED members remained hawkish. Some members, such as Mester and Bullard, even signaled the possibility of more rate hikes instead of cuts. Now, the markets are pricing in a 25 basis point hike for the next two meetings with over an 80% probability. Around 30% of this probability is attributed to the July 14th meeting.

The core Personal Consumption Expenditures (PCE) index increased from 4.6% to 4.7% YoY and 0.4% MoM, indicating persistent inflationary pressures. The majority of inflationary pressures are stemming from the services sector, which is also contributing to a resilient job market. The latest jobs report exceeded expectations by 70%, and even the previous month’s positive surprise was revised upward by 41,000 jobs. Despite job cuts in the tech sector and significant job gains in lower-paying sectors, average hourly wage growth only declined by 0.1% on a yearly basis while rising 0.3% MoM.

FED member Bowman noted that the real estate market appears to be rebounding, which has implications for combating inflation. House prices have made a comeback, with the FHFA MoM house price index showing a rebound to the 10-year average while trending upwards. Strong housing prices, a robust job market, and persistent inflation make the FED’s fight against inflation more challenging. On the other hand, after the conclusion of the debt ceiling negotiations, the treasury requires additional funds, and bank deposits have not yet fully recovered, which could further tighten financial conditions. Given the current situation, the FED may opt to hold rates at the June meeting to assess the situation more thoroughly before determining the next move.

The ECB still maintains a much lower interest rate compared to the FED and is further behind in the rate hike cycle relative to the FED. However, recent PMI data suggests further weaknesses in the economy, particularly as Germany, the largest member, has entered a recession. While core inflation showed signs of potentially reaching a peak in the latest data, Lagarde, the ECB President, believes it is too early to conclude that the core inflation has indeed peaked. Most ECB members agree that the hiking cycle is not yet over, and the ECB still has room to maneuver. A particularly hawkish member, Bundesbank Chair Nagel, expects three more hikes, whereas the markets are pricing in two more hikes for the next three meetings before expecting the ECB to hold rates, which appears to be a reasonable expectation in our view.

In addition to the rate hikes, market participants are also eagerly awaiting the new forecasts from both the ECB and the FED at their respective June meetings.

In Japan, the new BOJ chair, Ueda, disappointed Yen bulls by affirming commitment to an ultra-loose monetary policy and curve control. Ueda stated that the current easing measures contribute to productivity. The BOJ remains focused on achieving 2% inflation, but Ueda acknowledged that reaching this target will take time.

In Australia, the minimum wage was increased, which could potentially prompt the RBA to consider another interest rate hike. However, the market expects the RBA to maintain rates at the June meeting and assess the situation, as the impact of the minimum wage increase may be minimal unless it significantly affects higher tier wages.

Central Bank Meeting Calendar

Technical View

The US 10-year yield experienced a rebound from the 3.15 – 3.30 zone due to concerns surrounding the debt ceiling. With the resolution of the issue, the yield fell to the 3.50 support level but failed to break below it. The primary downtrend is still ongoing. As long as the resistance zone of 3.90 – 4 holds, any upward moves present buying opportunities for bonds. The expectations of increased auctions and a hawkish stance from the FED may keep yields elevated for some time, but a continuation of the downtrend can be anticipated in June.

Brent oil prices are currently trading in a range without much movement, but they have extended the downward trend to reach around 70 instead of 75, influenced by the impact of the slowing manufacturing sector. If OPEC decides to implement another 1 million barrel cut, it could potentially trigger a move towards the resistance level of 90. However, the demand for oil remains weak at present. A key level to monitor in the first week of June is around 76.80.

Precious metals had a volatile month in May, resembling a rollercoaster ride. As debt ceiling risks escalated, metals saw a promising first half of the month. However, as the Federal Reserve turned hawkish and progress was made on the debt ceiling deal, precious metals ended May in negative territory. Among them, gold remained relatively steady with a negative 0.5% return. On the other hand, platinum and palladium experienced larger declines, falling over 6%.

The gold/silver ratio, which serves as a useful indicator for gold prices and typically exhibits a negative correlation, appears to have halted its current downtrend, thus increasing pressure on gold. In May, silver experienced a decline of more than 4%, while gold is striving to maintain its current uptrend.

Gold has been following an upward trend since October, but the recent decline has led it to test the 9-month long uptrend. With the diminishing debt ceiling risks and market expectations of a rate hike from the FED, downward pressure on gold has significantly increased. If the current trend fails, the 144 and 233-day moving averages could become potential targets in the coming days. Particularly, the midpoint of the November-May surge at 1840, which aligns with the 233-day moving average considering the time factor, could present an excellent buying opportunity if the price drops by as much as $100. However, if the trend remains intact, gold bulls will continue to be in play, and there is a possibility of a reversal in the recent downward movement.

Silver had a challenging month after forming a double top around the $26 level. Following the break of the $24.50 support, the price fell to the 38.2% retracement level. Currently, silver is attempting a comeback, and the key level to monitor is once again $24.50, but now as a resistance. If it fails to surpass this level, the $22.86 support may come under pressure once again. A downside break could potentially lead to a test of the lower trendline of the uptrend channel, which is currently around $21. However, it’s worth noting that the downtrend that started in 2020 has been breached and is not as strong as before. Therefore, the uptrend may potentially overcome the long-term downtrend in the coming months.

The dollar index has strengthened due to the increased possibility of a rate hike, with some members adopting a hawkish stance and many others showing no indication of any cuts this year. The index has formed a falling wedge pattern and is currently attempting an upward breakout. However, the key level to monitor is not the upper boundary of the wedge, but rather 105.75, which has acted as both resistance and support multiple times over the past year. Additionally, this level is currently supported by the 200-day moving average. If the dollar index manages to break out above this level, the recent rally may continue in the short to medium term. Conversely, if the resistance level and the moving average hold, dollar bears might seek to take advantage of the recent surge.

The stock markets enjoyed another positive month, with the MSCI World index rising by 2.05% since the beginning of May. The Nasdaq stood out as the clear winner, delivering a return of over 10%, driven by the surge in AI and AI-related stocks. However, the Dow Jones index ended the month in negative territory due to the impact of the slowing manufacturing sector. As we enter June, traders will closely monitor whether the Nasdaq can sustain its positive divergence or not.

The VIX experienced a significant drop, reaching a level near 14.10, which is close to its lowest point since the shock of the COVID-19 pandemic. Despite the downtrend in the VIX, the S&P 500 has not yet shown a clear uptrend. However, it has begun to display early signs of an uptrend taking shape.

After two months of struggling just below it, the S&P 500 has finally made a breakout above the infamous 4200 resistance level at the beginning of June. This breakout signals that the previous downtrend is now officially over, and the S&P 500 may be on the verge of a long-term uptrend. In the medium term, the index has already formed an uptrend channel and is currently moving towards the upper boundary of that channel. The upper boundary is currently around 4500 and is projected to be at 4560 by the end of June. As long as the price remains above the previous resistance level of 4200, which can now be considered as support, it is expected to continue rising towards the upper boundary in the coming weeks. However, there are two main risks to consider: a potential hawkish surprise from the Federal Reserve and a possible liquidity shortage due to the cash needs of the treasury.

The FX volatility has increased in response to the surge in the dollar index. EURUSD experienced a decline of more than 3%, while JPY performed even worse due to the Federal Reserve’s growing hawkish stance, disappointing Yen bulls with Ueda’s support for ultra-loose policies. On the other hand, GBP remained remarkably strong, with only a minor decline of 0.27% against the dollar. Notably, rate hike expectations for the Bank of England (BOE) saw a significant increase in May.

EURUSD has broken both the short and medium-term uptrend channels, experiencing a significant sell-off. Now the trend is over, there is a possibility of a pullback or rebound towards the broken trend. The level to watch is 1.0760, which acts as the major resistance before a re-test can occur. If this resistance is surpassed, EURUSD may attempt to make a comeback towards the lower boundary of the trend, currently around 1.0850. However, it is important to note that the previous trend is no longer in place, and upward moves may be considered selling opportunities, particularly given the accumulation of long bets. On the downside, the key levels to monitor are the 1.048 – 1.050 zone. This zone is significant as it aligns with the 200-day moving average and Fibonacci 38.2% retracement, which has served as major support during the 2015-2016 period and has provided support multiple times this year as well. If EURUSD falls to this zone, bulls may be inclined to increase their bets from this key support level.

According to the COT report, net non-commercial Euro positions are currently at their highs, which could have negative implications for EURUSD. It has been observed that whenever Euro longs accumulate to excessive levels, EURUSD tends to experience significant losses. Since the 2008 crisis, there have been four instances where EURUSD made such moves, resulting in an average retreat of 19.35%. This raises the possibility of a short squeeze. With the uptrend now concluded, if EURUSD continues to deliver weak returns, the likelihood of a short squeeze may increase. However, it is important to note that, except for the peak during the COVID-19 pandemic, EURUSD has been overvalued at those times based on our real yield model. Currently, it is not far from its expected value. If a short squeeze is not triggered, it is possible that there may not be a significant decline in the near future.

GBP has demonstrated resilience against the dollar compared to other currencies such as EUR, AUD, and JPY. There are two key factors contributing to its strength: the upward revision of GDP and the market’s expectation of additional rate hikes by the Bank of England (BOE) following the revision. At the beginning of May, the market anticipated three rate hikes and one already implemented. Starting June, the likelihood of two more rate hikes on top of the previously expected one (total of 4) is currently estimated at 70%. However, it is worth noting that GBPUSD is currently nearing a two-year downtrend and is just above the 61.8% retracement level of that decline. The range of 1.2630 to 1.2760 represents a significant resistance zone. Additionally, there is a potential rising wedge formation, with its upper line falling within that zone. If GBPUSD breaks out above 1.2760, there is potential for the price to reach 1.35 in the coming weeks. However, until a breakout occurs, upward moves could present selling opportunities.

USDJPY continues its upward trend as Yen bulls were disappointed with the new chair Ueda’s decision to maintain a “no change” policy. Prior to Kuroda’s succession, there were speculations that Ueda’s appointment would lead to a policy review and potential reversal of the ultra-loose monetary policy. Although the BOJ has initiated a policy review, it is expected to take more than a year, and recent statements from Ueda and the BOJ suggest that there will be no significant policy changes in the near future. As a result, USDJPY has surged toward the upper line of the trend channel. If the dollar index remains strong, the upward movement could extend toward the resistance level at 142.50 in the coming weeks. Unless any signals of rate cuts from the FED or a change in policy from the BOJ occurs, USDJPY could potentially resume to fell upward pressure, while any downward correction may present buying opportunities. Key support levels to monitor are 137.50 and 135.