Monthly Market Outlook

In July, markets started to see the light at the end of the tunnel as the Federal Reserve (FED) and the European Central Bank (ECB) became more data-dependent, raising questions about further interest rate hikes. Inflation rates in developed economies fell at a fast rate. Now that central bankers are adopting a more dovish stance, the incoming data will be crucial in determining whether July’s hike will be the last or if there are more to come.

Macro View

The manufacturing sector showed signs of life in the US, while in the Eurozone, it took a nosedive. Weak manufacturing is hitting Germany the most, as manufacturing PMI fell below 39, indicating a rapid decline in activity in the sector. The UK’s manufacturing PMI is also following the Eurozone’s path. On the other hand, the US manufacturing PMI rose to 49, but still stayed below 50, showing a slow reduction in activity. The ISM for June showed a jump in new orders for manufacturing.

In China, the Politburo issued pro-growth messages, aiming to stimulate demand, and announced possible new tools for local governments to manage debt, providing the market with mild hope.

Growth hopes from China and recovery signals from the US manufacturing sector have caused commodity prices to jump. The Bloomberg Commodity Index broke the 11-month long downtrend in July. Another factor that contributed to the breakout was the food prices. The grain corridor agreement was ended by Russia, and many grain depots were bombed near Ukraine ports. Additionally, due to the El Nino this year, food production is expected to be impacted.

The job market is still robust in developed countries. The US continuing jobless claims have been trending down since April. Eurostat’s unemployment rate has fallen to the lowest level on record, reaching 6.5%.

However, there are some signs of cooling in the job market in the US. The JOLTS open positions fell below the 10 million mark for the second time this year, and the monthly change of nonfarm payrolls is trending down, despite still being strong.

Another thing to watch is the housing sector. Despite weakness in commercial real estate and the Fed’s rapid tightening, the housing sector seems to be recovering to some extent. The FHFA (Federal Housing Finance Agency) house price index’s monthly change is now above the 10-year average.

Central Banks

In light of the macro overview, two things stand out for the US. First, the services sector, still in the driver’s seat, is experiencing a slowdown in activity growth, which is also causing job gains to decelerate. However, the process is gradual because the sector remains in very good shape, and there are no signs of significant job losses at the moment. Meanwhile, the manufacturing sector is starting to recover, and inflation might be driven more by oil and commodity price increases rather than services cost and wage growth pressure in the coming months. If the outlook remains the same, this change could occur slowly over the next 12 months, and in that scenario, the FED has a decent chance of achieving a soft landing.

The second thing to consider is inflation expectations. With the 12-month-long downward base effect now over for CPI, it could start to rise again depending on the monthly figures. If that happens, inflation expectations may increase further, which would likely be unfavorable to FED members.

The FED probably made its last hike in July, and the market expects only a 20% chance of another hike. In the Jackson Hole meeting in late August or at the September meeting, Powell might signal that. For this to happen, the next jobs and inflation reports should be mild.

But the incoming data from the US, except for inflation, has been consistently exceeding expectations for a while now. The advance US GDP for the second quarter was announced at 2.4%, surpassing the 1.8% expectation. Additionally, durable goods orders came in strong, jobless claims are falling, and the housing and manufacturing sectors are showing signs of recovery. Bloomberg’s US economic surprise index has risen significantly over the last two months.

Over the next two weeks, ISM data, along with jobs and inflation reports, will be crucial for the Fed’s decision to either hike rates one more time or to end the cycle and hold rates for a while.

ECB‘s job is a little harder than the Fed’s. Core inflation remains too hot, but in some countries, inflation has fallen almost to the target level. GDP data has been revised up from the recession level, but today it will undergo another revision, and market expectations are for an upward revision. However, overall, the economy is showing signs of fast slowdown. Credit demand is at an all-time low, according to banks’ surveys, and PMI numbers are falling rapidly. The Composite PMI fell to 48.9, and manufacturing to 42.7. The economy is giving strong signals of a slowdown while the core remains strong. The market is still expecting another hike from the ECB, with an 85% probability.

During the latest ECB press conference, one quote from Lagarde was a key hint. Lagarde said, “Do we have more ground to cover? At this point in time, I would not say so.” Now, the data from now until the September meeting will be the main driver in deciding whether to raise rates further or end the cycle.

As for the decisions of other central banks, the Bank of Japan is making changes to its 0.5% rate limit for 10-year bonds. The limit will still be in place, but it will no longer be a hard cap; instead, it will be a soft cap, and the new hard cap will be set at 1% for the rate. BOJ Chair Ueda stated that this move is not the first step to get out of the ultra-loose policy, but rather it aims to reduce the pressure in case of a surge in inflation expectations and provides flexibility to address the need for urgent major action.

In the early August meeting, the Bank of England is expected to hike rates once again. The markets anticipate a 25 basis point hike, and there is only a 13% probability priced in for a 50 basis point hike. At the swap markets, the expectation is for the BOE to raise rates three more times until the end of 2023.

The first meeting in August will be from the Reserve Bank of Australia. Traders expect no change from the bank, while a Bloomberg analyst survey is showing a 25 basis point hike.

Central Bank Meeting Calendar

Technical View

The US 10-year government bonds faced another round of selling, and the rate is now testing 4%. Despite the slightly dovish tone change, the FED is still refusing to close the door to further hikes. The recent BOJ decision to raise the 0.50% cap may add more pressure by prompting some Japanese bond investors to return home, leading to additional selling pressure while quantitative tightening (QT) is still ongoing.

The downtrend that started in October appears to be over, and a new, tighter uptrend is taking hold as the 4% level is being tested. The upcoming jobs and inflation reports, along with FED members’ speeches, will be the key drivers for the rates.

Brent oil has broken out from its tight range of 70 to 79 and is trending towards 90, as the hiking cycle is coming to an end and expectations for China stimulus are rising. It appears to be forming a dip after a downtrend, but for further upward moves, 90 will be a major resistance to watch. Exxon’s CEO expects robust demand for oil in 2023 and 2024. If this expectation comes to fruition, we could see 90 being tested in the coming weeks.

Precious metals enjoyed positive returns after last month’s declines. Silver was the best performer, surging close to 8%, while Palladium was the worst performer among the precious metals, similar to June. Gold, on the other hand, moved relatively calmly with significant upward and downward jumps.

The gold/silver ratio, which serves as a useful indicator for gold prices and typically exhibits a negative correlation, worked well in July too. However, the trends seem to be shorter and less certain.

Despite the high negative correlation between real rates and gold, the rising real rates did not cause a significant drop in the gold price over the long term. The US 10-year real rate rose from below -1% to below 1.6%, and the FED hiked rates to over 5% and reduced its balance sheet, but gold remained just below $2000 throughout the entire three-year period.

The question is, once the dynamics change in favor of gold, will gold continue to stay unaffected by these changes, or will there be a breakout for the long term? Although the long-term correlation has diverged, the one-month correlation is still below -80%.

Gold ended its uptrend in June and has been moving flat below the 1985 resistance. The 1985 level might determine whether gold will remain flat or push higher. As long as it holds, any upward moves could create selling opportunities. On the downside, the support levels to watch are 1937 and the zone between 1892 and 1900 (please refer to our short-term gold outlook). If the 1985 resistance breaks, gold might attempt to push past earlier tops above 2000.

Silver jumped again in July after the big drop in June. It still looks undecided between the two trends. The longer downtrend now does not appear too strong anymore. On the other hand, silver is having difficulty making new highs in the new uptrend channel. For the short term, the 200-hour moving average is still working relatively well.

After trying and failing to push up, the dollar index fell below 100 in July but later made a comeback. The next targets could be 102.60 and 104.13 if the upward momentum continues. Depending on the data in the first two weeks of August, there could be a move towards 105.75 or below 100 in play.

The stock markets enjoyed another strong month, with the MSCI World index rising by 4.23%. The Nasdaq rose 4.94% but remained subdued after the middle of July, while the Dow Jones enjoyed a rally in the second half of the month. The Dax rose 3.03% with a month-ending rally, influenced by the dovish ECB, but it remained weaker relative to US indices.

The VIX remained low throughout the month. After falling below 14.25, it showed no significant jumps, supporting the stock market rally. In August, as long as the VIX stays below 16.30, upward pressure on stocks might continue.

The S&P 500 enjoyed another very solid month. However, the upward moves are contracting, and the index has reached the upper line of the trend channel. A correction seemed due at the start of July and still appears likely. But, as most traders know, stock market rallies can extend much longer than expected. S&P traders are walking a thin line, as any good economic data from jobs reports or PMIs can affect the index positively or negatively in the short term due to conflicting FED expectations and recession fears.

As long as the 21-day moving average holds and there are no sell signals from the relative momentum index, staying long could be safer. Nevertheless, there could be a sudden sell-off as lots of earnings reports are set to pour in the next weeks.

With the massive AI and tech rally alongside a slowed-down manufacturing sector, the Dow/Nasdaq ratio has fallen more than 25% since the start of this year. A falling wedge formation has been observed. If the manufacturing sector recovers as expected in the coming months, the Dow might have an advantage over the Nasdaq for a while. A potential trigger to watch for such a change could be around the 2.35 level.

The FX market experienced different trends in the first and second halves of the month. As the dollar started to appreciate more in the second half, EURUSD and GBPUSD gave away some of their positive returns. AUD diverged more negatively after the weak CPI data and lost value against the dollar, unlike most of the other FX pairs. On the other hand, CHF had a very strong month.

EURUSD is still trending up despite the latest drop. The Eurozone is experiencing a slowdown, and economic data surprises are in favor of the US. The FED’s interest rate is significantly higher than the ECB’s, but the trader’s sentiment and momentum are still on the side of EUR for the moment. As long as it holds above the 200-day moving average, downward moves could create buying opportunities.

Key support levels to watch during August are the Fibonacci 23.6% level at 1.0865 and the lower line of the trend channel at 1.0760, which is about to converge with the 200-day moving average.

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 long squeeze. However, before making a major downward move, EURUSD sometimes enjoys one last big push, and that could happen in this instance as well.

EURUSD is currently close to its long-term downtrend from 2008, by nearly 4%. On the other hand, many previous reversals did not reach the trend line at all. As long as the positions stay this high and the trend holds, there is a chance of a long squeeze.

GBP has demonstrated resilience against the dollar in the last few months as the uptrend continues. The three-year downtrend was broken and then tested from the other side in June. After the pullback, GBPUSD enjoyed a good run, getting close to the 1.3187 resistance level before making another pullback. As long as the trend holds (currently at 1.2660), upward moves can be expected to continue in August as well. In case of a breakdown, possible support levels to watch are 1.2618, 1.25, and 1.2294.

USDJPY had a roller coaster month in July. First, speculation about the BOJ increasing the bond rate limit caused a sharp sell-off in the first half of the month. Then, Ueda signaled that the BOJ would continue its extra loose policy for a while. After testing 137.50, USDJPY jumped to the 142.50 resistance level. However, the BOJ’s decision to change the 0.50% hard limit to a soft one and implementing a hard limit of 1% confused the markets, leading to two big waves between 137.50 and 142.50. These two levels could be key in the coming weeks. An upward breakout may lead the price near 146. On the other hand, a head and shoulders pattern has formed with 137.50 as the neckline support. A downward break could lead the price first to the trendline and, if the selloff continues, to the lowest levels of the year.