The more things change, the more things stay the same. That harsh reality was dished out in spades to markets trying to price in “Peak Ukraine” by buying the dip yesterday. That light at the end of the tunnel turned out to be the train coming the other way. An apparent change of tactics by Russia in the Ukraine towards wholesale urban destruction, and a procession of giant Western companies announcing exits from Russia eroded sentiment, as did the slowly dawning reality that the world outside of Russia will also endure economic pain as the price of Russia’s invasion of Ukraine.
All of that equals an inflationary wave and supply chain disruption set to wash once again, across the world economy. As opposed to anytime else this century, it will occur in an already inflationary environment caused by the global COVID-19 pandemic. Oil and energy were perhaps the biggest drivers though, with crude prices spiking once again. The International Energy Administration announcement of a strategic reserve release of 60 million barrels was swept aside as what it was, window dressing. Additionally, talk emerging from the OPEC+ meeting being held at the moment seems to indicate that the grouping will not look to increase production above its previously agreed schedule.
Oil prices leaped nearly 10% higher overnight and have jumped another 3.0% in Asia this morning. There is definitely a sense of fear in the air. Asia, of course, is acutely sensitive to higher energy prices, most of Asia being huge net energy importers. But disruptions to Russian metals exports and most certainly, Ukrainian food exports, are quickly combining to create a perfect storm in financial markets. I am still not ruling out a stagflationary shock to the world as the price it pays to bring Russia to heel.
Government bond yields are in full retreat now and not all of it can be attributed to haven flows out of equity and other asset classes. Bond markets appear to be pricing in that the Ukraine situation will be enough for central banks to postpone the normalization path for interest rates. Certainly, countries such as India and the Philippines have been doing just this as growth suffered and inflation exploded due to the pandemic. There are no good choices for central banks in these environments, which makes this month's Federal Reserve FOMC decision all the more important. If the Fed blinks, we can assume the rest of the world will as well. Equity markets will remain challenged in this environment.
One man’s loss is another man’s gain and if I were to look at the Asia-Pacific, three names pop up as potential winners. Australia of course, is a massive energy, industrial ore, and agricultural exporter. Not for nothing is it known as the lucky country. Malaysia with oil and palm oil. But the big winner could be Indonesia with palm oil, metals, coal and oil and gas. Malaysia and especially Indonesia, have been in the too hard basket for international energy companies for well over a decade. The world will be scrambling for new sources of energy now, and Indonesia has lots of that and other stuff the world needs. To be sure though, Indonesia is very much in the “value-added” side of the equation and if the world comes calling, they will be expected to be building a lot of tertiary refining and processing infrastructure now. We can expect phones to be ringing in many parts of Africa right now as well.
Switching to US President Biden’s State of the Union address, something I usually try to avoid, no matter who the President is. I find watching it tiring as politicians jump up and down constantly to clap, like an aerobics class gone wrong. He lost a big part of the audience early on gun control, but one thing stuck out to me—children and social media. President Biden was vociferous in his condemnation of social media giants and their targeting of children and wanted to “bring them to heel.” I have always believed that big tech would face a Standard Oil moment, and this may be the start of it. You can guarantee it will have bi-partisan support as well. Meta (NASDAQ:FB), Alphabet (NASDAQ:GOOGL) and Twitter (NYSE:TWTR) may be less FAANG and more door-MAT when they open for trading this evening.
Back in the real world, data releases in Asia, although light, have been mostly positive. South Korean data was with Construction and Industrial Production rising by 6.80% and 4.0% YoY respectively in January, while Manufacturing YoY grew by 4.40%, with Retail Sales slowing MoM by -0.20%. Some Omicron effects appear to be in that data, but overall South Korea’s economy remains robust with most attention on the impending Presidential election.
Australian Q4 GDP outperformed, rising 3.40% QoQ, and by 4.20% YoY, consumption rising by 4.20% YoY, and only capital expenditure letting the team down, falling by 1.50% in Q4. Australia has shrugged off Omicron and its rapid border reopening should maintain momentum into 2022, with the terrible flooding likely to lead to a further reconstruction boom this year. It is well placed to benefit from the world’s Russian woes as well, even if domestic inflation also explodes. The lucky country remains as lucky as ever.
Looking ahead, Eurozone Inflation will likely print at near 5.50%, especially with national indicators on the high side overnight. With developments in the markets elsewhere, upside risks persist and will likely be yet another drag on Eurozone equities. The US releases ADP Employment which will be used to extrapolate this Friday’s Nonfarm Payroll estimates, even though it has been a poor indicator. Federal Reserve Chairman Powell begins two days of testimony on the Hill, with markets hanging on every world for hints of FOMC rate hikes this month, futures have already pulled back from a 0.50% hike. Finally, official US Crude Inventories will have a higher impact than normal after a surprise fall in API Inventories overnight, and with oil prices on fire over Russian supply shocks this morning.
Asian equities follow US markets south
Surging oil prices yesterday sparked global growth fears as the Ukraine-Russia situation intensified and oil supply chains were thrown into chaos over sanctions. That reversed the peak-Ukraine rally of the day before and sent US markets tumbling on Tuesday. The S&P 500 fell 1.55%, the NASDAQ fell 1.59%, and the Dow Jones tumbled by 1.78%.
In Asia, some short-covering has lifted futures on all three indexes by around 0.30%, but Asian markets have followed New York’s lead and headed south as oil prices jumped once again this morning. Japan’s Nikkei 225 is down by 2.0%, but South Korea’s KOSPI is holding its own after returning from a holiday yesterday, rising just 0.10%.
The good news ends there with China’s Shanghai Composite down 0.40% and the CSI 300 falling by 1.05% after the PBOC also drained liquidity today. Hong Kong is also 1.0% lower. Singapore is down 0.50%, with Taipei 0.40% lower. Jakarta is down by 0.50% and Kuala Lumpur by 0.20%, Bangkok is unchanged, and Manila is 0.80% in the red. Australian markets, boosted by surges in commodity and energy prices, are marginally higher. The ASX 200 is 0.05% in the green, and the All Ordinaries has risen by 0.25%.
Asian markets have been aided by the slight rise in US futures today, but it is likely to be a temporary situation. Brent crude above $110.00 a barrel is not good news for regional markets. European equities never passed go yesterday and headed directly south. That state of affairs is likely to persist today and even the buy-the-dip gnomes of New York will struggle to construct a bullish case later this evening.
US dollar rallies on higher energy and deepening Ukraine crisis
Overnight, saw another flight to safety that benefited the US dollar as the Dollar Index surged 0.67% to 97.39, edging slightly higher to 97.42 in Asia. The flight to safety was more uneven this time, EUR/USD and GBP/USD sank, AUD, NZD and Asian EM currencies held their own, although the reasons for that are not immediately obvious to me.
EUR/USD sank 0.86% to 1.1120, where it remains this morning. Notably, it once again held the 1.1100 support region and although there are not many reasons to be long of Euros at the moment, from a technical perspective, the potential seems to be building for a short-squeeze. A new Ukraine-Russia meeting or progress by China in brokering some sort of ceasefire would be enough to spark a 200 point rally in my option. The fall in US yields is also a supportive factor.
Notably, AUD/USD, NZD/USD, Asian EM and the JPY are all holding their own, suggesting that the potential for a short-squeeze is developing in currency markets as they become temporarily overlong US dollars. Any sell-off of the US dollar is likely to be temporary though. A wavering Jerome Powell later today, or any glimmers of Ukrainian hope, could be enough to spark a washout of US dollar positions. That is likely to be an opportunity to load up on greenbacks once again, as one theme that has pervaded recent developments is that relief rallies have been short-lived in nature, nothing has changed on that front.
Oil prices explode higher on Russian supply shock
Oil prices exploded higher in New York overnight, and have continued higher in Asia today as well, with Brent crude topping $110.00. My inbox is filled with pieces outlining supply disruptions from Russian oil today. The underlying theme is that even if one could theoretically buy Russian oil and gas without breaking sanctions, no one wants to take the risk and won’t touch them with a 10-foot barge pool. Assisting the rally along was the feeling that the IEA SPR release was a drop in the ocean, and a surprise fall in US API Crude Inventories by 6.10 million barrels.
Overnight, Brent crude leapt an eyewatering 9.45% to $107.55 a barrel, and WTI rose a quite incredible 10.95% to $106.35 a barrel. In Asia, the panic has continued as buyers scramble for supplies. Brent crude has risen 2.60% to $110.05, and WTI by 2.05% to 108.50, although both are off intraday highs.
Asia’s rally was assisted by comments coming from the OPEC+ meeting that the grouping would not be increasing supplies by more than the 400,000 bpd previously agreed. The Iran nuclear deal has also gone quiet, and that is about the only thing that could give temporary relief to oil prices now. The uncomfortable fact is that OPEC compliance is well above 100% anyway, meaning they are pumping as much as they can, so even an announcement theoretically larger increase would not materially impact markets for more than the short-term.
As the realities of the Ukraine-Russia situation bite once again, I intend to stick to my view that Brent crude will top $120.00 a barrel and could trade near to $130.00 a barrel. That will be the price of the world holding its nerve to cripple Russia’s economy.
Brent crude has theoretical technical resistance at $119.00 with support at $98.00 and $96.00 a barrel. WTI will have resistance at $110.00 and 112.00, with support at $100.00 a barrel. The Relative Strength Indicators (RSIs) on both are at extreme overbought levels, so I am not ruling out potentially substantial short-term pullbacks from here. However, they are likely to be dips to buy for the brave, and not a structural turn in market direction.
Gold leaps higher but price action is unimpressive
Gold prices leapt higher overnight in lockstep with the ratcheting plummet in investor sentiment, sparking safe-haven inflows. Gold rose 1.90% to $1945.50 an ounce. The price action remains unconvincing, however, notably because gold prices have immediately fallen by 0.50% to $1936.50 in Asia as US futures staged the most minimal of rallies.
The case for higher gold is strong in this environment and needs no explanation from me. Much of the rally still seems to be being driven by fast money based on the price action in Asia. That says two things to me, real investor flows are still underweight in gold, and gold is vulnerable to further rapid retreats as the fast money hits the exit at the first sign of trouble.
Gold should continue to move higher in the bigger picture, short of a sudden change in the Ukraine situation, but it is likely to be an emotionally draining series of zig-zags up and down along the way. Being patient and waiting for dips could spare gold investors’ a few heart murmurs.
Gold has support at $1902.00 with critical support now at $1880.00 an ounce. Resistance is at $1950.00 and $1975.00 an ounce. I note that the gold RSI is also in overbought territory, raising the specter of the next short-term move being down, and not up.