The US session was dominated by comments from Fed Governor Lael Brainard, who set the cat amongst the pigeons of the equity and bond markets with some very hawkish comments. Ms Brainard suggested that a reduction of the Federal Reserve’s balance sheet, so-called quantitative tightening, could begin as early as next month and at a much faster pace than previous efforts. Additionally, Ms Brainard suggested the 0.50% hike was on the table as the Fed was prepared to take “strong action” to reign in inflationary pressures.
What makes the comments overnight so significant is that Ms Brainard is typically one of the most dovish of the FOMC members. If she has swung into the uber hawk camp, then markets need to take notice and that they did. Equity markets moved sharply lower while US yields across the curve, notably at the long end, rose notably. The 2's-10's inversion reversed into positive territory. At least the noise around that will thankfully die down for a while. The FOMC Minutes, released later today, will now make interesting reading.
Those of you who can remember the 80s and 90s, I know you are out there, will remember a time when the cost of capital was not zero per cent. Anyone who has been working since just 2000 probably doesn’t. The globalization deflation, the QE honeypot looks close to being empty now as we return back to the future. The readjustment will be painful but is thankfully happening during an economic boom in parts of the world, softening the blow. I’m not sure we will get a soft landing, especially when Jerome Powell says we will, and nor am I sure the FOMO gnomes of the equity market will be able to continue ignoring reality, particularly if US yields continue to rise. Fed funds futures are already priced above the FOMC dot plot, and I’m not sure that process is over.
Turning to Guns and Roses, the Reserve Bank of Australia decided it no longer needed a little patience on inflation in its post rate decision statement. As predicted—correctly for once—the Australian dollar quickly rallied over 1.0% and local equity markets gave back all the day’s winnings. If an uber dovish central bank like the RBA is shifting its stance, we should all take note. Especially as Australia is about as insulated from the stagflation wave sweeping the world as any. Thanks to Lael Brainard, AUD/USD gave back nearly all its gains as the US dollar surged on higher US yields, but AUD remains a nice catchup interest rates play, after starting from out of the pit lane. Add in its resource base, a booming domestic economy and its distance from Eastern Europe, there’s a lot to like.
China returned from holiday today with things looking as nervous as ever. The South China Post did an excellent piece on the details of concessions by China over auditing audits. The executive summary is that individual companies have plenty of wiggle room on information disclosures, so the delisting threat hasn’t gone away. China’s Global Times is reporting that 60 Chinese cities have now loosened property restrictions to support the market. There is no sign of a resolution to the leverage woes of Evergrande et al either. The World Bank has cut its 2022 China growth forecast to 5.0%.
More pressingly, China’s COVID-zero policy leaves Shanghai still locked down with cases rising still, and nerves fraying about further spreads and more sweeping lockdowns. China’s Caixin Non-Manufacturing PMI slumped to 42.0 in March from 50.1 in February. COVID-zero restrictions and fears, along with downstream impacts from Eastern Europe appear to be sapping consumer confidence. Unsurprisingly, China equities have opened lower today and it seems that LPR and RRR cuts can’t arrive soon enough. It will be interesting to see if China reverts to Plan A and hastens the weakening of the yuan, something that will have spillover effects across Asia.
The Asian calendar is quiet today with the Caixin Services PMI already out. German Factory Orders for February have definite downside risks now and may deepen the malaise of the euro. On the geopolitical front, the European Union and the United States are expected to widen Russian sanctions this afternoon. Most of it seems to have been leaked already, and I still believe that Russian energy will remain untouched by the Europeans. The force of TINA (there is no alternative) is strong with the Europeans.
Keep an eye on France as well which holds its first round of presidential elections this weekend. Marine Le-Pen, a far-right candidate, has been making hay with the cost of living and has made serious inroads into President Macron’s lead. That will be decided at the runoff election of course, but French banking stocks and government bonds have already taken a hit. It’s taken Trump and Brexit to shake financial markets out of their complacency around elections. Angry people vote, and fringe candidates are good at getting angry people to vote. A Le Pen victory on April 24th, would shake the foundations of Europe. It's easy to dismiss that Macron will win the runoff, but we’ve been here before, haven’t we?
Asian equities slump
Hawkish comments around the Fed’s balance sheet runoff and 0.50% rate hikes threw a bucket of cold reality onto equity markets overnight. US yields firmed across the curve and Wall Street retreated on Tuesday. The S&P retreated by 1.25%, the NASDAQ, home to the most interest-rate sensitive stocks, slumped by 2.26%, while the Dow Jones lost 0.80%. US index futures have moved 0.10% lower in Asia.
Fears of a faster US monetary tightening on several fronts are also forcing Asian equity markets lower today, not helped by a massive drop in China’s Caixin Non-Manufacturing PMI and continued concerns around the Shanghai COVID-19 lockdown. Japan’s Nikkei 225 has fallen by 1.80%, with South Korea’s KOSPI losing 0.90%.
In Mainland China, the return from holiday sees the Shanghai Composite down 0.40%, with the CSI 300 falling by 0.50%. In Hong Kong, the Hang Seng has lost 1.55%. Singapore is 0.60% lower, Taiwan is down 0.85%, Kuala Lumpur has gained 0.35%, but Jakarta has lost 0.40%. Australian markets are also in retreat, the ASX 200 and All Ordinaries losing 0.80%.
Wall Street's overnight losses will weigh on European equities, as will the detail of the new sanctions to be announced. How well European equities hold up will depend on the detail of those sanctions. Today’s FOMC Minutes, giving an insight into just how hawkish the committee might actually be, will be the main driver of Wall Street’s direction later Wednesday.
Higher US yields lift the US dollar
The US dollar rose overnight as US long-dated yields spiked higher after very hawkish comments from the Fed’s Brainard, previously one of its most dovish officials. A robust ISM Non-Manufacturing PMI and ISM Non-Manufacturing Employment, new orders and business activity served as an additional tailwinds. The Dollar Index rose 0.50% to 99.48, gaining another 0.10% to 99.58 in Asia.
The dollar index has now moved through resistance at 99.50, which technically, suggests the rally should extend to the 100.50/101.00 region for starters. I would prefer to see a more sustained break of 99.50 before making that call, but with interest rate differentials widening, and the situation darkening in Eastern Europe, dips should be well supported now. The longevity of the US dollar rally from here really depends on whether you believe markets have fully priced in the Fed’s tightening cycle. The FOMC Minutes may help answer that, but looking around the world right now, the US dollar is definitely one of the least ugly horses in the glue factory.
EUR/USD slumped again with more Russian sanctions on the way, French election nerves and timing US yields. It fell 0.60% to 1.0905 and is now within shouting distance of multi-year, and multi-decade support, if your charts go back to the '90s. A sustained break would target 1.0600 and 1.0300 initially. Resistance is now at 1.1200, with longer-term resistance at 1.1320. If the sanctions to be announced today are softer than expected, EUR/USD could stage a relief rally above 1.1000, but I suspect any gains will be hard to maintain.
The moves higher in US yields saw USD/JPY rally through resistance at 123.25, climbing 0.68% to 123.60. It has added another 0.13% to 123.77 in Asia. Rather surprisingly, there has been no “watching FX markets closely” noise from the Bank of Japan or Ministry of Finance today, emboldening USD/JPY bulls and powered by an ever-widening US/Japan rate differential. The late March highs at 125.10 are now in sight again, followed by 125.80. Unless the FOMC Minutes are less hawkish tonight, allowing markets to assume they have price the worst in for the FOMC on monetary tightening, USD/JPY should find plenty of support into 122.50.
AUD/USD surged 200 points higher at one stage yesterday after the RBA changed its statement language to a slightly hawkish tone. Brainard’s comments in the US saw the fast money retreat just as quickly, pushing AUD/USD all the way back from 0.7660 to 0.7580, where it remains in Asia. Nevertheless, AUD/USD has held above its breakout point at 0.7550, a bullish technical development. With markets playing catchup to RBA tightening, support on the crosses against low yields like the Yen, and robust commodity prices, AUD/USD should find its way back to 0.7660, sooner rather than later.
The PBOC set a neutral USD/CNY fixing at 6.3799 today after the holiday break. Nonetheless, both USD/CNY and USD/CNH are trading much lower at 6.3630 and 6.3760. The persistent yuan strength is anchoring regional Asian currencies, which only made small losses versus the US dollar overnight. The Philippines peso has been unusually strong the past week and I am wondering if the BSP, and other regional central banks, might be quietly “smoothing” markets by selling US dollars. A very hawkish FOMC Minutes this evening will likely see more US dollar strength and renew downward pressure on Asian currencies. However, unless China steps up its efforts to weaken the Yuan, regional currencies should be spared the worst of the greenback strength.
Oil prices are steady
Oil prices eased overnight in the face of a stronger US dollar, a slow news ticker from Eastern Europe, and continuing concerns over China’s growth as the Shanghai clock down continued. Brent crude fell by 2.15% to $104.60 a barrel, with WTI falling 2.45% to 101.15 a barrel. With China returning today, it was business as usual with Asia walking in and buying. Brent crude has risen 1.10% to $106.70, and WTI has gained 0.80% to $101.90 a barrel.
Despite the back and forth markets, oil is range trading this week. The extent of the new Russian sanctions to be announced by Europe and the US today will have a more immediate impact on short term direction. It is my base case is that Europe will leave Russian oil alone for now, although if they surprise and target this sector, prices should move sharply higher. In the meantime, China's growth concerns seem to be tempering gains in oil markets.
I expect Brent to remain in a choppy $100.00 to $120.00 range in coming weeks, with WTI confined to a $95.00 to $115.00 a barrel range.
Gold’s consolidation continues
In another wax on, wax off session, a stronger US dollar pushed gold 0.48% lower to $1923.25 an ounce overnight. In Asia, moribund trading sees it slightly lower to $1922.50. Gold remains confined to a narrow but noisy $1915.00 to $1945.00 an ounce range.
The risks are still skewed to the downside for gold, especially if US yields and the US dollar keep climbing. Only a rally through $1970.00 changes that outlook temporarily. Failure of $1915.00 an ounce will signal a retest of important support at $1880.00.