MARKET WRAPS

Watch For:

E.U. Long-term interest rates statistics; U.K. Bank of England publishes stress testing results, Bank of England's financial stability report, RICS residential market survey; trading updates from Galp Energia, Tullow Oil

Opening Call:

European futures are seen higher as investors await a U.S. Labor Department report that will take the temperature of the economy. In Asia, stock benchmarks were mixed; the dollar weakened; Treasurys were broadly lower; while oil and gold futures advanced.

Equities:

European stocks may open higher early Wednesday ahead of a key U.S. inflation report.

The inflation results, coupled with the kickoff of corporate earnings season, could dictate whether stocks will continue a 2023 rally that has defied many investors' expectations.

The June consumer-price index report is expected to show headline annual inflation falling to 3.1%, having hit a multi-decade peak of 9.1% a year before.

However, annual core inflation, which strips out volatile items like energy and food prices, is expected to be more elevated at 5%.

Still, "I think there's some optimism about CPI coming in lower [than expected] this week," said Phillip Colmar, managing partner and global strategist at MRB Partners.

"A weaker than forecast figure could signal that inflation is moving tellingly towards the Fed's [2%] target, which could result in a brief rally if the consensus then changes to one more hike this year as opposed to the two currently in place," said Interactive Investor.

Traders are pricing in an over 90% chance that the Fed will raise its benchmark interest rate in July, and an over 30% likelihood that the central bank will raise it by one more time by year-end.

Analysts expect second-quarter profits to drop 7.2% from the same period a year earlier, according to analysts polled by FactSet. That drop would result in a third-consecutive decline in quarterly earnings.

At the same time, however, strong hiring and low unemployment in the U.S. have made some investors more confident that the Fed can achieve a so-called soft landing, slowing inflation without sparking a recession.

"That will be a strong buffer for markets," Adrian Helfert, chief investment officer of multiasset at Westwood Group said.

Forex:

The dollar weakened early Wednesday.

Markets were betting on U.S. headline inflation to slow to +3.1% in June, which would be its lowest level since March 2021, from +4.0% in May, DBS Group Research said.

However, the Fed will probably focus more on core inflation remaining firm at +5.0% in June versus +5.3% in May, it added.

Interest-rate differentials aren't moving sharply in favor or against the U.S. dollar, Jefferies said.

"A lot of these rate moves have been in lock step with each other and global in nature with maybe a very slight U.S. underperformance," it said.

From an interest-rate perspective, the Federal Reserve should deliver one or maybe two interest-rate rises this year, similar to the European Central Bank and central banks in Australia, Canada, Norway, Sweden and others.

"Only the UK's Bank of England may outpace the Fed and likely only by one or two, 25 basis-point increments."

Improving global growth would be one factor that could work against the dollar, it added.

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JPY strengthened against most other G-10 and Asian currencies on speculation of unwinding of carry trades, where investors borrow funds in a low-yielding currency such as JPY and invest the proceeds in a high-yielding currency such as USD.

USD/JPY has witnessed good activity, with JPY shorts covering, Chris Weston, head of Research at Pepperstone said.

Also, USD/JPY's 1-month implied volatility has risen to 11.42%, the highest since mid-April, which is weighing on carry positioning, Weston added.

Bonds:

Treasury yields were broadly lower as traders await Wednesday's consumer-price index report for June, which may seal the deal on another interest-rate rise by the Federal Reserve later this month.

Markets are pricing in a 92.4% probability that the Fed will raise its main interest-rate target by 25 basis points to a range of 5.25%-5.5% on July 26, according to the CME FedWatch Tool.

The central bank is expected to take its fed-funds rate target back down to around 5% or lower next year.

"Taking a step back, we'll offer the observation that throughout 2022, trading direction in the U.S. rates market wasn't particularly concerned with the distinction between headline and core inflation," said BMO Capital Markets.

"The simple fact that both measures of consumer prices were running so hot made any comparison a moot point. With headline inflation poised to print at 3.1% on a yearly basis, it's worth noting that the average from 2000 to 2019 for this measure was 2.2%."

A greater-than-3% CPI rate "is still consistent with the FOMC having more work to do on the inflation front; however, there is a compelling argument that following July's hike, this 'work' may take the form of avoiding cuts," BMO Capital Markets said.

The Fed "created a lot of movement in the bond market, which is attractive," said John Augustine, chief investment officer for Huntington National Bank.

"We're inclined to be a little bit more cautious now."

In Augustine's eyes, the potential threats to debtholders are twofold. If the Fed holds tight later this month-an outcome few investors anticipate-bond prices could rebound and send yields lower.

Stronger-than-expected earnings and improved corporate outlooks, meanwhile, may entice investors back toward stocks.

Energy:

Oil futures advanced in Asia, supported by weakness of USD, which typically has an inverse correlation with oil.

Also, oil prices have been boosted by hopes for stronger demand in the developing world and supply reductions by the world's largest oil exporters, Phillip Securities Research team said.

However, gains in oil prices may be limited after the American Petroleum Institute reported Tuesday that U.S. commercial inventories of crude oil rose by a rather large 3 million barrels last week.

Investors were looking ahead to U.S. weekly inventory data from the U.S. Energy Information Administration due Wednesday.

Metals:

Gold futures rose, ahead of Wednesday's release of U.S. inflation data, which are expected to help guide the Fed's decision on path for interest rates.

"We have seen bond yields decline at the start of this week, with investors potentially anticipating a weaker inflation report on Wednesday," Fawad Razaqzada, market analyst at StoneX said.

"This has reduced the opportunity cost of holding gold over bonds slightly."

"Should the report show further signs of slowing inflation, this could fuel speculation around the Fed's hiking cycle nearing an end," said FXTM.

"Such a development could boost attraction for zero-yielding gold, potentially pushing prices beyond the $1,940 region and higher towards $1,960," it said.

However, "should prices remain trapped below $1,932, this could open a path back to $1,910 and $1,900, respectively."

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Iron ore prices rose in China trade amid expectations of higher demand after Beijing announced a series of supportive policies to revive the property sector.

"Although market sentiment has picked up today, traders are still cautious in their operation, and some steel mills replenish their stocks based on demand," Donghai Futures analysts said.

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Aluminum gained in the Asian session on prospects of reduced production of the base metal.

Power consumption in China's Sichuan province reached a record high earlier this week amid high temperatures, which was exacerbating low hydro dam levels, ANZ Research said.

Hence, aluminum smelters near the provincial capital of Chengdu have been ordered to curtail power consumption, which puts at risk about 50 kilotons of the base metal, it added.


TODAY'S TOP HEADLINES

Here's how Wednesday's inflation report could push U.S. stocks even higher

Expectations for the Federal Reserve to push interest rates even higher this year have helped to put a lid on U.S. stocks' rebound rally in 2023, but the outlook for interest rates, and with it stocks, could shift once again if Wednesday's consumer-price index for June shows inflation has ebbed more quickly than economists had expected.

It is a notion that's some analysts are embracing, especially after Tuesday's reading on used-car prices via the Manheim Used Car Index declined 10.3% over the past year, the 10th straight monthly decline and the biggest on record for June.


Measure It Differently, and Inflation Is Behind Us

If core inflation came in just below 3%, the Federal Reserve would breathe a huge sigh of relief, stocks would head to the races and consumers could relax about the rising cost of living.

It isn't merely a dream: Measure U.S. price changes the way Europe does, and inflation was already there in May. Measure them as the U.S. does, and on Wednesday new figures are predicted by economists to show core inflation far higher, at 5% for June.


Inflation Expectations Return to Fed's 2% Target, Cleveland Fed Research Finds

Expectations of where U.S. inflation will be over the next five years have moved back down to around 2% after surging last year, according to a new measurement tool from the Federal Reserve Bank of Cleveland.

Last year, inflation expectations for the five-year horizon jumped to levels well above the central bank's 2% target, as actual inflation climbed amid supply-chain upheavals, a labor shortage and the effect of Russia's invasion of Ukraine on energy and food prices.


Oil supplies are set to tighten, but concern over weak demand growth limits price gains: EIA

Global crude oil inventories are set to decline over the next 15 months, but worries about the global economy and prospects for weaker energy demand are likely to limit any price gains for oil, according to the U.S. Energy Information Administration's monthly Short-term Energy Outlook report released on Tuesday.

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07-12-23 0015ET