• US equities were a touch weaker Friday, with S&P down 0.1% but still up 2.4% over the week, where the dominant economic narrative was softer than expected inflation reports. 
• Another beat on US Michigan consumer sentiment, up 8.2pts in July to the highest since September 2021. Still well below pre-covid levels but moving in the wrong direction for the US recession camp. Expectations rose the most, but current conditions went up as well. From the presser, the rise was attributable to the "continued slowdown in inflation along with stability in labour markets."
• In contrast to the softer-than-expected US inflation prints last week, the 5-10yr inflation expectations series in the Michigan survey rose 0.1ppts to 3.1%: back to the top of its post-covid range.

Markets

US stocks closed slightly lower on Friday. Still, investors painted the tape green amidst signs that disinflation may finally be here to stay and as investors contemplate the implications for rates, stocks, and the Fed.

It felt like investors were beginning to believe that a soft landing was possible. Yields were precipitously lower- most of it over the week's final days- and the decline is happening for the 'right' reasons as people remove inflation premiums from their estimates vs. assuming the Fed will cut rates.

Lower rates were also spilling into the stock market, with longer-duration stocks like Tech and Communication Services among last week's best-performing subsectors. While a soft landing with normalizing inflation remains in play, late-cycle risks could limit risk appetite after a week in which the low-hanging fruit was harvested. 

Though Fed officials will be silent this week ahead of next Wednesday's FOMC meeting, this week's data docket will provide updates on the latest trends in consumer spending, manufacturing and housing. The main focus will be Tuesday's retail sales report for June, which will sharpen forecasters' expectations for Q2 real GDP growth.

Still, despite the weaker near-term inflation outlook, the US policymakers might want to remain vigilant because inflation remains above target, and the economy has been firmer than Fed officials expected. Last week, the NFIB and The University of Michigan surveys served as reminders that underlying momentum remains strong, which could have inflationary implications.

On balance, the Fed will welcome the progress evident in last week's CPI report, particularly the softening of super-core inflation. Indeed, prices for core services ex-shelter (and ex-health care) were flat in June; that being said, as subsequent Fedspeak indicated, this progress is too tentative to prevent the Fed from raising rates by 25bps at their July 26th meeting.

Earnings

If one positive theme seems to be emerging across earnings, it is a confident US consumer. However, with earnings season ramping up, the strong rally and overweight positioning heading into this season argue for a muted rally. However, there is a widespread narrative that an earnings recession is underway or imminent, and if that starts to show up in the data, it could be a showstopper.

Asia

Last week US Treasury yields eased, loosening local financial conditions and coaxing buyers back to the markets as the return on local currency against the USD improved.

Still, China remains a question mark as the negative data surprises indicate significant payback in China's growth after the Q1 surge.

And as China will likely dominate the news flow this week, hot or cold investors will primarily view the releases through the lens of how they will influence the policy decisions made at the upcoming Politburo meeting in late July. (i.e. bad news is good for policy input)

Forex

The market reaction to the downside surprise in US CPI compressed US-EU front-end rate spreads as US front-end inversion deepened. But with inflation relief signalling progress towards a soft landing, and thus a Fed that is likely to be on hold over the next 12 months, the Dollar might not be trending freefall. 

The rates outlook is not that divergent for a big part of the broad Dollar index Policymakers across much of EM are already responding to lower inflation. The Euro area should not be far behind. US rates mostly moved in isolation, but Euro area rates started to respond late last the week. 

CNY will need to participate for the broad Dollar to move much lower. But policymakers there are dealing with low inflation of a different order of magnitude and are still in easing mode.

If the Fed stays higher for longer in fear of inflation returning and even if a soft landing ends up being the running narrative, neither outcome is positive for gold, especially when forgoing a 5 % APY opportunity cost via money market funds for the next 12 months

Oil

If there was one thing that the oil markets clearly underestimated, it was the impact of the unabated rise in interest rates which had a more marked effect on crude than any other commodity as it is the most widely speculated by investors. In the trading world, higher carry cost simply raises the cost of speculation.

Meanwhile, monetary policy tightening has fed fears that the global economy is heading for a major downturn, which would weaken oil demand if that comes to fruition. Nonetheless, it also explains why typical holders of crude inventories carry less than normal.

However, the recession narrative now seems to be giving way to an economic soft landing which is a favourable outcome for oil markets in a late-cycle economy.

The fundamentals for higher prices in the coming months appear more encouraging: declining supply, the likelihood of rising demand and, as mentioned, relatively low global inventories complete the theoretical bullish thesis.

Saudi Arabia extended its voluntary production cut of 1.0 mb/d in August, while Russia announced it would curtail its crude oil exports by 500 kb/d in August. Even Algeria chipped in with a small voluntary cut of 20 kb/d.

However, the fact that the cartel has been forced to trim production is not necessarily an imminent positive development. In October and April, recall OPEC+ also made big cuts totalling 2.0 mb/d and 1.7 mb/d, respectively.

The accumulation of such cuts suggests that the recovery in global oil demand is proving much softer than initially anticipated, likely reflecting the slow return to in-person work, still-sluggish overseas tourism and increasing EV adoption.

Given how heavily intervened oil markets have been, it's only time before the next political shoe drops.

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