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Equities Shift Higher Despite Default Risk

Stocks in developed markets moved higher following several weeks of range-bound trading. The Nasdaq Composite index gained 3% on the week, the S&P 500 added 1.6% while Germany’s Dax (2.3%) and Japan’s Topix indexes (3.1%) reached multi-decade highs. The main driver was the outperformance of technology stocks, mostly the IT and Communications Services sectors with the semiconductor sub-sector as the notable mover.

The US regional bank crisis eased with stocks posting a partial recovery. On the earnings front, three large retailers, Walmart, Home Depot and Target reported mixed results.

Bond yields edged higher across tenors, and the $ index appreciated and maintains its upward trend. Commodities were little changed on average with the grains complex (corn, soybeans, wheat) posting a sharp decline.

There were few economic data updates but most came in weaker than anticipated. US retail sales, €-zone industrial production, China retail sales, production and urban investment, all signal a slowdown ahead.

The focus remains on the political stand-off in Washington regarding the debt ceiling. The latest update on Friday was an unsuccessful negotiation session between the White House and Republican policymakers that ended with no progress and no scheduled follow-up meeting. Members of Congress did not meet on Saturday and declared no progress from meetings last week. Both sides claim the other's demands as too extreme.

Today, Biden said he plans to speak with top congressional Republican House Speaker McCarthy in a last-minute effort to try and raise the federal $31.4tn debt ceiling and avoid falling into default in the coming weeks. Biden shortened his trip to Asia to focus on this issue. Republicans voted to increase the debt ceiling three times, without budget cut pre-conditions, when Trump was President. 

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Fed on a Wait & See Mode

There were no monetary policy meetings by central banks in developed countries. Economic data updates were limited with inflation in the €zone, Japan and Canada as the highlight.

At a Fed research conference on Friday, Chair Jerome Powell said it was still unclear whether interest rates will need to be increased further as the Fed waits to see the impact of the ten consecutive hikes.

"We face uncertainty about the lagged effects of our tightening so far, and about the extent of credit tightening from recent banking stresses," Powell said.

"So today, our guidance is limited to identifying the factors we'll be monitoring as we assess the extent to which additional policy firming may be appropriate to return inflation to 2%," Powell added.

Atlanta’s Fed President Bostic also left the door open to more tightening.

"I would say it was a pause, but a pause could be a 'skip,' or it could be a hold,"

"There's a lot of uncertainty in the world. We will just have to see how things play out and get a sense of what's true signal and what's noise, and that is going to be a week-to-week thing," Atlanta Fed President Bostic.

The FOMC meets on June 14 and markets are currently pricing in an 87% probability of leaving rates unchanged.

The European Central Bank signalled more rate hikes ahead.

"We still have to have sustainably high interest rates, so it's a time when we have to really buckle up and look at this target that we have and deliver on it," ECB Chief Lagarde said.

"Our goal is simple and straightforward: price stability. And we have to be totally determined to deliver that."

ECB board member Isabel Schnabel said the central bank should go on "raising rates to a sufficiently restrictive level and keeping them at that level for as long as necessary".

Traders expect the ECB to increase borrowing costs two more times by the end of the summer, taking the deposit rate to 3.75%.

$ Interest Rates

Interest rate markets are being driven by the debt ceiling situation. The last time the US got this close to defaulting due to a similar conflict was in 2011, also under a Democratic government but Congress avoided the event by raising the ceiling. The US lost its AAA credit rating and stocks sold-off sharply following that near-default incident.

"I still believe we'll be able to avoid a default and we'll get something decent done," President Biden said at the G7 Summit in Japan.

Bond yields in advanced economies shifted 15-25 basis points higher across curves last week with the 10-year US Treasury closing at 3.69% (highest in 2 months), Bunds at 2.42% and Gilts at 4% (highest in 7 months).

The debt ceiling talks are being mentioned as the main reason for the dollar appreciation as investors seek safe havens. The ¥ was the main loser last week with a >1.5% fall despite the strong rally in Japanese stocks and remains the worst-performing currency among majors this year.



In credit rating changes, Ireland was upgraded one notch by S&P to AA while Portugal had its outlook upgraded to positive (Baa2) by Moody’s. Ireland’s 10-year bonds tightened 4bp against Bunds to +46bp or 2.9% yield. Portugal’s spread also narrowed 4bp on the week to +80bp or a 3.22% yield.


Weak economic data in China triggered a risk-off tone across commodity markets. A stronger $ and concerns over the US debt ceiling also weighed on sentiment. The biggest movers US natural gas and grain markets, mainly corn and soybeans.

Natural Gas prices rose sharply on increased demand to fill the gap left by the lack of wind power last week which fell from supplying almost 17% of the total energy needs to just 7%. Front-month contracts gas rallied 14% WTD to $2.58/MMBtu, the best week in more than two months.

Grains are seeing favourable weather conditions in the US Midwest region that helped improve crops while the Ukraine Black Sea export deal was extended for two more months last Wednesday, increasing supply. The result was a steep sell-off in corn, soybeans and wheat futures. Soybeans dropped to a 10-month low, also impacted by lower Chinese demand. 

Risk On Mode for Stocks

Stocks managed to break out of a tight range after weeks of sideways trading and ended higher. The S&P 500 gained 1.6%, closed at 4,192 and even traded above 4,200 for the first time since August. Nasdaq indexes outperformed on the back of solid returns for mega-cap technology stocks while the weakest sector was Utilities.

This year’s rally in technology stocks was driven by robust balance sheets, predictable cash flows and strong Q1 earnings reports by mega-caps including Microsoft, Alphabet, Apple and Amazon (see table).

Japanese equities reached a 33-year high driven by expectations of stronger governance standards, inflation finally accelerating and the economy showing signs of recovery. The Topix index rallied >14% YTD in ¥ terms, and 9% in $, in line with the average for developed indexes. 

The US regional bank sector saw some relief last week after encouraging updates regarding deposit levels at a few banks that triggered a partial recovery. However, stocks fell on Friday after US Treasury Secretary Yellen said that the sector needed further consolidation and expected more mergers to take place. The KBW Regional Bank index recovered 6.2% on the week. 


Earnings Reports: Retailers

Walmart (mcap $404bn, P/E 36x) beat sales ($152bn, +8% YoY) and earnings ($1.6bn, -18% YoY) estimates and raised its full-year guidance. Strong grocery sales, which account for 60% of revenues, offset weak demand for clothes and electronics, a sign of lower retail demand for discretionary items.

Target (Discount retailer, mcap $70bn, P/E 26x) reported sales ($25bn, 0%) and profits ($950mn, -6%) in line with expectations and maintained its full-year outlook unchanged.

Home Depot (Home improvement retailer, mcap $295bn, P/E 18x) missed revenue ($37.2bn, -4%) but beat earnings ($3.9bn, -7%) estimates. This was Home Depot’s worst sales miss in two decades and it lowered full-year revenue forecast. Falling lumber prices and poor weather conditions were the catalysts for the surprise.