Fed Chairman Jerome Powell set the cat amongst the pigeons overnight stating that the Federal Reserve could raise interest rates more aggressively to tame inflation if needed, not ruling out 0.50% increases if necessary. That is quite the volte-face from three months ago and really isn’t helping the feeling that the Fed is well behind the curve vis-à-vis inflation.
US yields across the curve rose sharply, equities eased, and currency markets saw the US dollar rise sharply, notably against the Japanese yen which is a window into the fate of Asian FX in general in H1 of 2022.
Lost in the noise is another reality—the Fed is looking to start tapering its balance sheet by mid-year, a one-two combination on the tightening front. We are not at taper tantrum yet, but I, like others, do wonder about the Fed’s growth projections in this environment. The abrupt change by the Fed from dove to hawk even as the Ukraine conflict sends another cost-push inflation wave across the world isn’t inspiring confidence. The flattening move higher by the yield curve suggests others share my concerns.
We haven’t even got into the full effects yet on the price of staples such as wheat that the Ukraine conflict will inspire. Even if the conflict stopped tomorrow, those full effects and rises by other key commodities have yet to be fully felt.
Oil also spiked higher in an emotional session overnight after stories circulated that the EU was considering a full oil embargo on Russia. Unsurprisingly, there was no agreement on that which is completely logical, as large parts of the EU cannot just flick a switch and substitute Russian energy. The acute vulnerability of Europe’s energy security looks increasingly likely to be Angela Merkel’s legacy.
In Ukraine, fighting continues to rage with no signs forthcoming since Turkish comments over the weekend that either side is any closer to reaching a peace agreement. Markets have been putting much store in this outcome, somewhat naively in my opinion, and the chickens appear to be coming home to roost.
That reality, I believe, was the main reason oil prices moved sharply higher overnight, even as the EU declined a Russian oil embargo. That said, I fully agree that any headlines suggesting negotiation progress will see a sharp reversal by oil and a rise by equities in the short term. We are all slaves to the hews headline ticker now.
Asia’s data calendar was dead today, but two notable headlines caught my eye. Firstly, Bank of Japan Governor Kuroda said it was premature for the BOJ to speak about exiting its easy monetary policy, and that it would continue buying ETFs as needed. Secondly, RBA Governor Lowe said something along the lines of the RBA wouldn’t respond with monetary tightening unless there was widespread evidence of price pressures. Both governors’ comments sent their currencies lower and their stock markets higher.
Both could be considered a microcosm of the Asia-Pacific as a whole, where, thankfully, most of the region is starting from a much lower inflation base than the Northern hemisphere. That has spared regional currencies the worst of the ravages of a hawkish Fed, for now. But it looks like the dam is cracking on the Japanese yen.
China is also in an easing mood, but significantly in my mind, has refused thus far to show the color of its money. If the Fed throws in a couple of 0.50% rate hikes over the next few months, it is hard to see there being no fallout in Asian FX, with the region clearly more interested in supporting growth, inflation be damned.
As for the RBA, it is in danger of the same complacency that the RBNZ is guilty of and may find itself in a monetary box canyon like its South Pacific neighbor. With all of this in mind, I am struggling to make a bullish case for equities in the region in 2022.
Fitch has downgraded world GDP growth by 0.70% to 3.50% overnight, and it won’t be the last. In my opinion, the upcoming US quarterly earnings session now has significant downside risks. Not so much from performance in Q1, but in negatively revised forward outlooks by companies. Thanks to the QE addiction as a normal monetary policy tool by the world's central banks since 2008, markets are programmed to buy the dip. With interest rates rising, rampant inflation and war-time economics, dusting off some old trading and economics textbooks, written on paper, may be required. Or follow Warren Buffet.
Tuesday is the quietest day of the data calendar globally this week, which only has global PMIs to get excited about anyway. China’s Caligula of leverage, Evergrande (HK:3333), suspended trading in its stock yesterday pending a meeting with international creditors. There could be some headline risk associated with this today. Otherwise watching the price of oil and wheat has become a market favorite to go alongside the usual Ukraine watching. Watching from the sidelines in this sort of market isn’t such a silly strategy.
Another mixed day for Asian equities
Ukraine peace hopes after comments from Turkey over the weekend were quickly extinguished by the Fed’s Jerome Powell, who came out swinging on inflation flighting and potential rate hikes. That shifted the entire US yield curve higher and nipped any recovery by equities in the bud. US markets closed slightly lower.
The S&P 500 edged 0.04% lower, while the interest rate sensitive NASDAQ fell 0.38%, with the Dow Jones having a bout of growth nerves, falling 0.58%. In Asia, US futures continued falling, led by the NASDAQ which was 0.40% lower, followed by the S&P 500 and Dow, which have fallen 0.20%.
That was enough to weigh on Asian markets, which were digesting soaring oil prices and a very hawkish Jerome Powell overnight. The exceptions were Japan, which has returned from holiday, and Australia. Both markets can thank their still very dovish central bank heads for the rallies. The Nikkei 225 jumped 1.50% higher, while Australia’s All Ordinaries and ASX 200 were 1.10% higher.
Elsewhere, the price action was unexceptional. The KOSPI traced out a 0.64% gain, but Mainland China’s Shanghai Composite and CSI 300 were flat. The Hang Seng rose by 1.0% after Alibaba (NYSE:BABA) increased its share buyback total to $25 billion. Singapore fell by 0.15%, with Taipei down 0.20%, Kuala Lumpur by 0.15%, while Jakarta edged 0.35% higher on pumped-up commodity prices and the ending of visitor quarantine, in a boost to the tourism industry.
European markets were mostly negative overnight. None of the developments outlined above were likely to be supportive, and the Eurozone probably needs a sliver of good news on the Ukraine news ticker to prevent equities from heading south again today.
Powell lifts the US dollar
A very Jerome Powell overnight lifted US yields across the curve and sent the US dollar higher, aided by some Ukraine tailwinds as negotiations between the warring states went quiet. The dollar index rose 0.25% to 98.47, adding another 0.31% to 98.79 in Asia as the Japanese yen slumped. The last 24 hours appeared to be one of those days where uncomfortable truths were finally confronted, and that uncomfortable truth was that the US Federal Reserve was in inflation-hunting mode, and that US rates could move higher faster. Add in oil prices soaring and no progress in ending the Ukraine war and all the ingredients were there for a US dollar rally.
USD/JPY rose sharply by 0.70% today to 120.30 after BOJ Governor Kuroda maintained the BOJs dovish stance, adding more momentum to the US/Japan rate differential trade. With most of Asia taking much the same view as Japan, Asian currencies were also lower across the board and I expected those pressures to increase over the next few months. USD/JPY, having broken through 120.00, had 123.00 and 125.00 potentially in its sights. Any thoughts that the Ministry of Finance will intervene were complete nonsense unless moves in the yen become extremely disorderly.
USD/KRW and USD/MYR were 0.25% higher with USD/TWD 0.40% higher, while only USD/CNY was unchanged at 6.3645 after a neutral PBOC fix. If China is embarking on a steady weakening of the yuan from here, the pressure on regional currencies will also increase.
A lack of Ukraine negotiation progress, higher US rates and soaring oil prices have weighed on the euro, offsetting any gains from refusing to enact a Russian oil embargo. EUR/USD fell 0.36% to 1.1017 overnight, easing lower to 1.0990 in Asian trading. That left EUR/USD midrange between critical long-term support at 1.0800, and resistance between 1.1150 and 1.1200. Short of a peace agreement arriving between Ukraine and Russia, the single currency will struggle to maintain gains above 1.1100 now.
Oil prices soar overnight
Nerves broke in oil markets overnight, as the prospect of a European embargo on Russian oil, and reality dawning around Ukraine-Russia negotiations, sent oil prices soaring. Brent crude leapt 7.90% to 116.35 a barrel, with WTI rallying 7.0% to 112.00 a barrel. In Asia, as with the last few sessions, we saw buying from the get-go, Brent rising 2.50% to $119.20, and WTI rising 2.60% to 115.00 a barrel.
What was most significant, was that oil continued to rally aggressively even after the EU dismissed the idea of an oil embargo on Russia. It was clear that tensions were rising once again as no progress towards a Ukraine settlement has been made. I still believed that Brent crude and WTI will continue to trade in a roughly $100.00 to $120 range, however. Even the most tenuously positive Ukraine news should see both contracts quickly back below $110.00 a barrel.
Gold stuck in a range
The one positive to take out of gold’s price action overnight was that despite a rampant US dollar and much firmer US yields across the entire curve, gold still managed to eke out a modest gain, as Ukraine nerves appeared to inspire a bout of haven covering. Gold rose 0.80% to $1935.50 an ounce, where it remained in Asia.
The problem with haven buying is that it is a fickle beast and disappears as quickly as it emerges. In a global stagflation environment, gold remains one of the more attractive choices in an uninspiring list, but given its proclivity to stage sudden downside corrections, there is probably no need to chase prices at these levels.
Gold remained locked in a tight $1920.00 to $1950.00 an ounce range. A break either way should see another $30 an ounce move. The risks were still skewed to the downside, with critical support at $1880.00. Failure signals a deeper correction targeting the $1800.00 regions.