Firm risk appetite supports global equity rally; US dollar depreciates

Lufthansa’s 9-billion-euro aid was approved.

By Ipek Ozkardeskaya,

Chinese services PMI printed the first extension since January and the fastest since October 2010, the Australian GDP contracted 0.3% in the first quarter, slightly less than -0.4% penciled in by analysts and the US oil inventories fell 500’000 barrels last week according to the API data.

The more official EIA data due Wednesday should confirm the unexpected decline in US stockpiles versus a consensus of analyst expectations pointing at a 3-million-barrel rise.

Else, Germany announced a 100-billion-euro rescue package and Lufthansa’s 9-billion-euro aid was approved, pushing the DAX 3.75% higher on Tuesday. Better-than-expected economic data, combined with the optimism on business reopening and unprecedented fiscal and monetary support continue boosting the investor appetite and attracting capital to risk assets and currencies.

Hence, the global stock rally gives no signs of fading. The US stock markets gained following a strong European session on Tuesday. Asian stocks extended gains. The Nikkei and ASX 200 advanced 0.86% and 1.59% respectively, Shanghai’s Composite (+0.51%) and Hang Seng (+1.20%) gained despite the social unrest in Hong Kong.

Activity in FTSE (+1.0%) and DAX futures (+1.33%) hint at a bullish start on Wednesday, as well. Steep recovery in energy and commodity stocks should continue giving a decent support to the British blue-chip index, as financials recover.

The US dollar continues its journey south pushing its major counterparts to three-month highs. The US 10-year yield is now above the critical 0.70% resistance as investors chase higher risk assets for better revenues.

The EURUSD cleared the 1.12 resistance, Cable hit 1.2610, and the USDJPY finally gave in to US dollar shorts, broke the 108.00 resistance and rallied on stops above this level to trade at 108.84 for the first time since April.

Swiss franc and gold however hold on to their gains, despite the resilient risk appetite. The yellow metal lies in ambush in case of a sudden reversal in global risk appetite, as some investors believe that the current market rally seems overrated and a correction should be around the corner sooner rather than later.

Moving forward, important economic data and events should either boost or abate the risk appetite. On the data deck, investors will be watching the May final services PMI figures Wednesday. Released earlier this week, the manufacturing PMI numbers mostly surprised to the upside, especially in most hit European economies such as France, Italy, and Spain. A similar positive read could boost the expectation that the recovery may be better than earlier expected as the economies enter the normalization period.

Across the Channel, however, the British services PMI which is expected to have jumped from 13.4 to 28.0 in May, may remain short of analyst expectations given that the UK follows mainland Europe with a couple of weeks delay on the COVID lockdown and investors should show some more patience before seeing the data improving in the coming weeks.

In the US, the ADP employment figure is expected to reveal an additional 9.5 million job losses during last month — much better compared to April’s 20 million decline, but still very much worrying for the health of the US labor market.

Because it is all about expectations, a better than expected read should support the presently building idea that the post-COVID recovery would be stronger than previously thought, however a negative surprise could have the opposite effect of denting the investor mood, remind that the crisis is not over yet and bring investors back on earth.

Else, the Bank of Canada (BoC) is expected to maintain its overnight rate unchanged at the historical low of 0.25%. With the support of improved oil prices, the BoC could wait and see the impact of near zero rates before taking further action.

The USDCAD pulls lower on the mix of a broadly softer US dollar and steady recovery in oil prices. The pair is testing the 200-day moving average (1.3490) to the downside. Technical indicators point at oversold market conditions, meaning that some correction would be health at the current levels.

However, we revise our medium-term Loonie outlook from negative to neutral, conditional to the continuation of steady recovery in oil prices as economies reopen.

WTI crude is testing the $38 per barrel. OPEC and Russia are expected to announce further production cuts this week, up to 9.7-million-barrels which equals roughly 10% of the global oil output.

But, with the prospects of lower production and improved global demand being broadly priced in, the upside potential could soon be exhausted. Hence the announcement of further production cuts itself may lead to some profit taking before the critical $40 level. Support is seen near $35/33 pb area.

— The writer is senior analyst at Swissquote Bank