I mentioned yesterday that even the slightest hint of any good news emerging from the Ukraine-Russia talks would spark a relief rally. So, it came to pass as Russia offered to “reduce operations” in the North of Ukraine around the area near Kyiv. The effects were immediate, European equities rallied aggressively, oil and gold fell and so did the US dollar. The fact that a reduction in operations is not a ceasefire was a concept too far for the street to grasp, nobody wants to miss out on selling “peak Ukraine.”
Notably, both oil and gold retraced all their losses in double quick time, helped along by lower US API Crude Inventories in oil’s case, and a lower US dollar and US yields in gold’s case. Asian equities are also jumping on board today as well, rallying across the region. The fact that Russia is redeploying its forces to the East and South to concentrate operations there, while digging in around Kyiv is not much of an olive branch, assuming you can take Russia at its words. I have long given up smacking my head against the wall over the intellectual banality of the equity markets. The “peak-Ukraine” FOMO rally could well carry on into the end of the week.
Although the fact that nothing has actually changed was lost on the equity space, it certainly hasn’t been in the energy space. OPEC+ are unlikely to spring any surprises today on production. US data yesterday was impressive. Case-Shiller House Prices rose more than expected, and the JOLTS Job Openings for February stayed elevated at 11.266 million. No signs there regarding the doom and gloom recession we’ll talk about in the next paragraph. Data is indicating Americans are moving around again (in fossil fuel-powered vehicles) at pre-pandemic levels. Taken in totality, there is no reason to be getting bearish on oil right now.
The fun and games continue in the US yield curve as well, with my inbox filled today with questions along the lines of what time tomorrow will the recession start? The culprit was a momentary inversion of the 2’s-10’s yield curve. I am tempted to say 11:45 New York time but a more reasoned discourse is warranted.
First of all, there are recessions and then there are recessions. Some are mild, some are not. We have no idea if a recession in the US will be mild or ugly if the yield curve moves to inversion. The data released overnight isn’t screaming recession, the opposite in fact. A strong Nonfarm Payrolls on Friday won’t back up the recession argument either. Markets also try to price in the future, and not the present. If you trade equities, that is a perpetually bullish nirvana forever.
Forecasters have been falling over themselves as to who can price the most 50 bps hikes from the Fed this year. As recently as December, hardly any of them were, like the Fed themselves. So perhaps they’re not as clever as everyone thinks they are. I suspect it has caused a lot of herd-like stampeding in the bond market, though, which may, or may not, be a large part of the reason for the moves in bond yields we are seeing now, not economic Armageddon. There is no doubt the Fed is now behind the inflation curve and faces a credibility issue, and fears that they will repeat the mistake the other way are valid, I grant you.
One thing to note is that the Fed, along with other central banks, has been quantitatively easing on and off for over a decade. They will start selling those holdings in the next couple of months, and depending on what they sell, it could start pushing 10 to 30-year rates higher, going some way to pushing the curve back to positive. All those years of quantitative easing might also change the mechanical linkage between inverted yield curves and recessions as well, we just don’t know yet.
Unfortunately, the by-product of near-constant quantitative easing over the last decade or so (forever if you’re the Bank of Japan) in the United States and Europe is whole generations of financial people who believe the cost of capital is zero, the risk free rate of return is near zero, and that central banks will ease and QE at the first sign of trouble, making investing risk free. I’m sorry to say that the return of structural inflation after a 20-year holiday means some sort of reality check is upon the world. The swing from globalization to national supply chain resilience will nudge that process even more.
In an inflationary environment, central banks cannot use QE to net present value the wealth of our children to pimp up asset prices today anymore. The moves in the US yield curve may be part of those new reality growing pains. Look on the bright side, the Fed, ECB, and BOJ have been QE-ing for over a decade and have managed to meander through. The Reserve Bank of New Zealand did it for less than two years and made a complete mess of it, engineering Norwegian prices and Nigerian wages. A few years of juicy inflation will also have the benefit of deflating the huge pandemic debts that governments around the world have accumulated in real terms. Much like the Fed did with hapless war bond buyers after WW2. In the meantime, take a deep breath, and calm down.
In other news, Australia’s federal budget overnight contained the expected pre-election goodies. It wasn’t market moving, and likely isn’t going to be enough to move the needle on a defeat in May for Scott Morrison’s government. I am told there is no truth to the rumor that ScoMo will be holidaying in Hawaii on election day.
New Zealand Building Permits surprised to the upside today, with February permits rising by 10.50%. More tellingly, ANZ Business Confidence remained at the bottom of the Kermadec Trench at -41.90. You literally can’t buy plasterboard in New Zealand to build those permitted buildings, and the builders will all move to Australia anyway soon. That, along with massive prices rises, the financing squeeze and higher rates from the RBNZ will shortly squash consumer confidence as well. It's not hard to see why Australian equities and AUD/NZD are outperforming.
Japan Retail Sales fell by -0.80%, the third month of losses. Omicron restrictions continue to dampen consumption, with the imported price rises and geopolitics will make the BOJ’s job even more difficult. The BOJ has extended its JGB bid right along the curve today, to cap 10-year rates at 0.25%. It is working well, and USD/JPY has collapsed to 122.00 in the last 24 hours. Beware of central banks bearing gifts though, much of the yen rally could be due to repatriation ahead of the financial year-end tomorrow. Helped along by a fall in US yields overnight. Come Friday, or early next week, though, the new financial year could see those repatriation flows reverse and head back offshore once again.
The rest of the day’s calendar is quiet, with only German Inflation to distract Europe from geopolitical developments. Things get more exciting in the US where ADP Employment is released. A number well above 450K will see markets repricing Friday’s Nonfarms higher, along with some more Fed hikes I suppose. It also releases Corporate Profits, Final Q4 GDP and Real and Core PCE Prices. All of it has upside risks that could see US yields move higher. Equities will likely construct a bullish case no matter what the data says.
Tomorrow in Asia, things get much more interesting as South Korean Industrial Production and Retail Sales, Japan Industrial Production, and official China Manufacturing and Non-Manufacturing PMIs are released. The China data will have a very binary outcome. Strong numbers equal lower risk of China slowdown equals buy Asian equities. Weak numbers equal panic over China's slowdown and COVID-zero equals sell Asian equities, especially China. Only a surprise from OPEC+ or developments in Eastern Europe will trump that.
Asia equities are mostly higher
The first sign of good news, no matter how tenuous, from the Ukraine-Russia talks resulted in a mass stampede into equities with the FOMO gnomes pricing in “peak-Ukraine.” European markets soared and the rally continued into New York, where excellent data and lower US yields boosted sentiment. The S&P 500 closed 1.23% higher, the NASDAQ jumped by 1.84%, and the Dow Jones finished 0.97% higher. Some short-term long covering sees futures on all three indexes ease around 0.20% in Asia.
Asian markets, as desperate for any good news from the Eastern front as anyone else, have reacted by rallying strongly today. The exception is Japan where the Nikkei 225 has slumped by 1.27%. Part of the reason could be the yen rally overnight, but I believe that financial year-end flows ahead of tomorrow are distorting trading in Tokyo today.
Elsewhere, the news is positive. Mainland China’s Shanghai Composite has jumped 1.50% higher, while the CSI 300 has soared by 2.15%. Hong Kong has rallied by 1.50%. South Korea’s KOSPI has posted a much more sedate gain of 0.25%, perhaps with one eye on Tokyo and heavyweight local data due tomorrow.
Singapore is unchanged, pausing for breath after a few days of gains as domestic virus curbs were relaxed. Kuala Lumpur is 0.25% higher, with Jakarta climbing 0.35%, while Taipei has leapt 1.20% higher. Bangkok has gained 0.65% with Manila rising 0.20%. There is a defiant North Asia heavyweight/ ASEAN split today, perhaps reflective of improved risk sentiment internationally. With that in mind, India’s Sensex has also posted a healthy 1.0% gain in early trading.
European markets posted a banner day of gains yesterday on Ukraine hopes. A dig into the fine print, and a closer look at the reality of the Russian comments, may temper that enthusiasm this afternoon.
US dollar falls on higher risk sentiment
The US dollar retreated overnight, led by USD/JPY which collapsed to 122.00. Hopes of an improvement in the Ukraine situation, after comments by Russia also lifted market sentiment, reducing the US dollars haven bid. Slightly lower US yields also eroded some support. The Dollar Index fell 0.70% to 98.40, falling again in Asia to 98.17. The index has traced out a double bottom at 98.00 overnight and has support there and at 97.75. Sustained failure of the latter will signal a deeper correction lower, however much will depend on whether USD/JPY continues falling aggressively.
USD/JPY traded in a 200-point range overnight, breaking support at 123.00 to finish 0.83% lower at 122.90 in New York. It has continued falling in Asian trading, dropping another 0.80% to 121.95 today. Although the yen rally is being blamed on the BOJ extending its JGB bid across the curve, I am struggling to see how that is immediately bullish for the yen. A more likely reason is lower US yields overnight, and most especially, yen repatriation ahead of the financial year-end tomorrow. No doubt there are a number of fresh long USD/JPY positions put on above 124.00 that have been squeezed as well.
A new financial year on Friday could see those flows reverse, especially if US Nonfarms are strong, pushing up yields. Readers should be cautious about getting too negative USD/JPY at these levels, as the underlying drivers of Yen weakness have not changed. I suspect only a plunge in oil prices or US yields would change that narrative. USD/JPY has support between 121.00 and 121.25 which looks attractive, with resistance at 123.00 initially.
EUR/USD soared 0.90% higher to 1.1085 overnight on the Russian comments about the Ukraine strategy. It has gained another 0.20% to 1.1110 this morning but heavy 1.1100 option expiries should keep it pinned near present levels until the New York cut. EUR/USD also faces triple-top resistance at 1.1135 and I remain skeptical of its ability to maintain gains around here. More seemingly positive news from the East could extend gains over 1.1200, but a harsh dose of reality from the news wires could just as easily send it back below 1.1000.
AUD/USD and NZD/USD edged higher overnight but remain in a range, consolidating recent gains. Notably, neither picked up the Russian tailwind seen elsewhere. AUD/USD has resistance at 0.7550, while NZD/USD has resistance at 0.7000.
Asian currencies rallied sharply overnight, led by the Korean won, Thai baht and New Taiwan dollar. Once again, the difference between reduced operations and ceasefire has passed over the heads of regional markets, who it seems, are as keen as anyone else to price in hopes of a Ukraine settlement. China’s PBOC set a weaker yuan today at the USD/CNY fixing, hinting they are not interested in seeing material yuan appreciation from these levels still. That has taken the heat out of the Asia FX rally this morning although USD/THB and USD/NTD has fallen 0.40% today, while other pairs like USD/CNY and USD/SGD are 0.20% lower, suggesting Asian currencies remain bid. The longevity of the Asia FX rally is directly proportional to how long the market believes “reduced operations” is a sign of a Ukraine peace deal.
Lots of noise, little substance for oil
Oil prices did the Neville Chamberlain's “peace in our time” gag reflex overnight after Russia’s “reduced operations” comments. Oil prices traded in a 10-dollar range and initially tumbled after the announcement, Brent crude touching $105.00, and WTI $98.50 a barrel. A lower than expected API Crude Inventory number along with no signs of OPEC+ largesse quickly saw fundamentals reassert themselves, Brent crude rising to finish 1.70% higher at $111.10, and WTI rising 1.60% to close at 105.10 a barrel.
In Asia, oil is having a relatively quiet session with Brent crude and WTI rising just 0.30% to $111.40 and $105.45 a barrel. It seems that Asia’s usual buy-the-dip reflex is taking a temporary back seat. Regional buyers may be hoping further Ukraine developments will give them better levels to buy. As outlined above, they are likely to be disappointed.
Oil markets will be watching for announcements from OPEC+ over the next 48 hours regarding production hikes. Realistically, the best they can expect from the rhetoric seen so far, is the pre-agreed 400,000 bpd increase. US official Crude Inventories will be closely watched as well after the API number was lower than expected. If official inventories also disappoint, that may put a floor on prices. I still expect Brent to trade in a choppy $100.00 to $120.00 range, with WTI bouncing around in a $95.00 to $115.00 a barrel range.
Gold cleans out speculative long positions
Gold prices tumbled after the Russia announcement yesterday, falling $30 an ounce at one stage to $1890.00 an ounce, before reversing all those losses as US yields and the US dollar fell. Gold finished just 0.17% lower at $1919.50 an ounce. The price action looked very much like a culling of nervous long positions, with fast money exiting after support at $1915.00 failed.
Despite the recovery overnight, gold’s price action remains soft. In Asia it has risen by 0.40% to $1927.50 an ounce, presumably as fast money chases the market higher once again. Gold could maintain these gains if the US dollar remains soft, otherwise, failure of $1915.00 likely sees a wash, rinse, repeat price action of yesterday. A sustained break of the $1880.00 region will probably trigger a capitulation trade, potentially pushing gold down to $1800.00 an ounce.