Mondays these days usually present a confusing picture to investors, and this one is no different. Reuters reported that both Ukraine and Russia appeared to be making progress towards substantive negotiations. That gave some parts of Asia an excuse to tentatively buy equities this morning and saw oil fall, with the chance of bottom-fishing the Ukraine war just too tempting.
Offsetting that was Russian missile strikes in Western Ukraine over the weekend that were very close to the Polish border, and reports from American officials that Russia was asking China for military aid, since denied by Chinese officials.
If true, it would be a serious sign that all is not well in the Russian industrial-military complex and could explain the shift by the Russians outlined in the Reuters reporting above. China, for its part, will need to tread carefully, with the US and Europe being its largest export customers. Political doctrines or not, money talks and China is facing economic challenges of its own it may not want to exacerbate for the sake of Putin.
China itself announced a complete lockdown of 17.5 million people in its coastal city Shenzhen, a major tech-hub and port city to fight rising COVID-19 cases. Adjacent Hong Kong announced that 300,000 people were in isolation or quarantine as its COVID nightmare continues.
Foxconn Technology (TW:2354), a major Apple (NASDAQ:AAPL) supplier, has already announced factory suspensions in Shenzhen and if the port also has to close, we can throw more supply chain disruptions into the global mix. Oil’s fall this morning, may also be partly due to expectations that China's domestic consumption could temporarily fall due to COVID lockdowns.
With that in mind, oil’s drop today was even more surprising after Iranian missiles rained down on a target in Iraq. Allegedly in retaliation for an Israeli attack in Syria earlier this week on suspected Republican Guards leaders there, but also perhaps linked to frustrations about the stalled nuclear agreement. Last-minute Russian demands threatened to scuttle the entire thing, making the slide in oil prices today even more surprising.
US Consumer Confidence data was weaker than expected on Friday, suggesting that the stagflationary wave sweeping the world from the Ukraine conflict was having an immediate impact. That won’t be the last we hear on that front with cost-of-living increases rising sharply around the world, provoking disgruntlement amongst consumers. Asian currencies were under pressure today and going forward, those pressures will be amplified as Asia’s central banks will be reluctant to hike with the Fed.
As if things couldn’t get more complicated, the US Federal Reserve’s FOMC announces its latest interest rate decision this week. A 0.25% rate hike is locked and loaded, and despite the noise, I believe that the Fed was still cautious and 0.50% was off the table. What might not be, though, is a faster path of rate hikes to normalize monetary policy. The US yield curve continued to flatten and if the FOMC was hawkish, could shift higher in entirety, flatten, and head towards inversion, signaling potentially, a future recession.
Stagflation is a nasty beast, and there are no painless options for central banks when it happens. Do nothing and your currency is likely to fall exacerbating imported inflation. Hike rates and support the currency, but slow or stop growth. Each central bank will have to choose its own path, but my reading thus far will be that Europe and Asia will hold rates fast, China will attempt a targeted easing, while the US and the Commonwealth countries, including Australia, will hike.
That will be good for the US dollar, bad for the euro and Asian FX, while to say the environment for equities anywhere will be challenging in 2022, is an understatement.
The FOMC will clearly be the economic data highlight of the week, even as the short-term financial markets continue to chase their tails on Ukraine developments. But China will also announce its one-year medium-term lending facility rate (MLF) sometime this week, which could feature a cut. It releases Retail Sales and Industrial Production tomorrow.
Indonesia and Taiwan’s central banks announce policy decisions after the FOMC on Thursday. China and India release trade balances tomorrow, with Singapore releasing Non-Oil Exports. Finally, Australia releases unemployment data on Thursday as well, with strong jobs gains perhaps the last piece of the puzzle needed by the RBA to drop its ultra-dovish stance. The RBA Governor said last week that preparing for higher interest rates would be a sensible precaution. Tuesday and Thursday will be peak-data days for Asia this week.
Finally, the Bank of England announces its latest policy decision on Thursday, followed by the Bank of Japan on Friday. The Bank of Japan will hold its nerve, but the Bank of England will almost certainly follow the FOMC and hike by 0.25%.
Geopolitics will continue to dominate the market and the list of headlines from around the world today made me not even want to get out of bed. One thing I am sure of is that the algo and retail fast-money gnomes of the financial markets are going to buy risk heavily at the first concrete signs of Ukraine-Russia settlement progress.
That is likely to be a sucker’s rally, though, because behind the scenes, the stagflationary wave sweeping the world, and the new cold war, are quietly eroding the foundations of the global recovery. The pain will be felt unevenly, and I’d hate to be a politician fighting an election this year, although resource-heavy countries should fare better than most. You could almost construct a case for getting bullish Latin America again on that basis. Almost…
As I have stated ad nauseam, volatility will be the winner in H1 2022, not market direction. Although I expect more last stands from the "buy-everything" HODL gnomes. Alas, after 14 years of central banks creating inequality in the world, all good things must come to an end. Given the risk profile of this week, a sensible investor with a longer-term view, and without a need to get spanked by Mistress Whip-Saw, might choose to watch the fun and games from the sidelines.
A very mixed day for Asian equities
There were some serious divergences in Asian equity markets this morning as China concerns buffeted some markets, while others rose on lower oil and Ukraine negotiation hopes. On Friday, US markets finished on a soft note as Michigan Consumer Confidence fell, and investors reduced risk into the weekend.
The S&P 500 fell by 1.30%, the NASDAQ retreated by 2.18%, and the Dow Jones slipped by 0.69%. Hopes that Ukraine-Russia negotiations were moving in the right direction saw US futures rise today. S&P 500 and NASDAQ futures rising 0.50%, while Dow futures edged 0.25% higher.
Negotiation hopes led to lower oil prices as well today, which lifted Japan’s Nikkei 225 0.95% higher, with the other main beneficiary being the perpetual optimists in Australia. The All Ordinaries and ASX 200 climbing 1.0%, while New Zealand climbed back to unchanged after the government cut fuel taxes.
Elsewhere though, Asia was a sea of red after China announced a full lockdown of Shenzhen over the week for at least a month. That was followed by a procession of multinational companies announcing halts to production at facilities located in the region. Fears of further supply chain disruptions if the port closes, or lockdowns spread, combined to weigh heavily on Asian markets. The evolution of China’s Omicron situation will potentially have more weighting on Asian sentiment this week than the FOMC.
Mainland China saw the Shanghai Composite falling 1.35% with the CSI down 1.70%. Hong Kong is in full retreat as it grappled with its own virus nightmare, the Hang Seng plummeting by 3.75%. South Korea’s KOSPI was 0.75% lower, and Singapore fell 0.70%. Taipei was down 0.60%, with Kuala Lumpur falling by 0.45%.
Jakarta was bucking the trend as more and more investors looked at commodity prices and picked Indonesia as a winner. Jakarta was 0.50% higher today. Bangkok was up 0.15%, but Manilla plummeted by 3.55% on a combination of currency weakness, mounting government debt repayments, pre-election nerves, weaker Asian growth and stagflationary pressures that have only mounted through the pandemic.
As ever, the rallies seen today in Asia and on US futures were just one headline away from disappearing. European markets tentatively dipped their toes in the water on Friday and will likely do the same again today on Ukraine-Russia negotiation hopes. But sentiment will remain fragile in European equities for the foreseeable future for reasons I don’t have to explain.
The US dollar rallies strongly
The US dollar’s rapid recovery continued Friday as investors turned to how hawkish the FOMC will be, the US yield curve continued flattening, and investors loaded up on weekend risk protection. The dollar index rallied 0.60% to 99.12 on Friday, rising to 99.17 in Asia. A sustained break above 99.50 will signal another leg higher for the greenback. Progress by Ukrainian and Russian negotiators left the potential for a sharp correction to 98.50, but only a close below 97.50 changes the overall bullish outlook.
Selling pressure returned to the euro after the ECB signaled little interest in hiking rates in this environment last week. EUR/USD retreated 0.69% to 1.0912 on Friday, where it remained in Asia. That brought the multi-year support line back into sight once again. A sustained fall through 1.0800 will signal a very bearish technical outlook, targeting a move back below parity in the months ahead.
A divergence in US/Europe monetary policy, Eastern Europe woes and soaring commodity prices meant that long-term resistance at 1.1400 will remain out of reach. GBP/USD was also looking vulnerable, falling to 1.3019 in Asia. If the Bank of England fails to hike by 0.25% on Thursday and is not hawkish enough, Sterling is set to retest 1.2700.
Geopolitical and economic nerves have eroded sentiment amongst investors, and as a result, both AUD and NZD retreated over the past two sessions to 0.7255 and 0.6795, respectively. That reversed the bullish technical picture for both, with the relative strength indicator (RSI), now in neutral territory from overbought. That left both vulnerable to resuming their declines once again, although an improvement in the Ukraine theatre could see them stage a sharp sentiment rally. It was a coin toss at these levels.
Asian currencies spent Friday retreating and that continued today after China’s Shenzhen lockdown and with the PBOC setting a very weak yuan fixing at 6.3506 today. The fixing may be signaling that the PBOC reached its limit on yuan appreciation now and Asian currencies will struggle to rally if the PBOC started applying more aggressive countercyclical factors to the USD/CNY fix.
I also believed the monetary policy divergence was also starting to weigh more heavily on Asian currencies with the FOMC expected to hike this week, with hawkish forward guidance. With Asia, a huge net importer of energy and commodities, unwilling to hike interest rates despite stagflationary pressures and tighter US monetary policy, combined with slower China growth, the macro environment was negative for Asian currencies.
USD/JPY exploded higher to 117.35 on Friday after resistance at 116.50 failed, rising to 117.75 today. The Korean won, Philippine Peso and New Taiwan dollar were also under pressure with USD/CNY breaking out of the topside and rising to 3.3650, trading above the fix. The question will be, how much of the foreign reserves will Asian central banks want to spend in H1 2022 to defend their currencies? Possible winners in Asia remained the Malaysian ringgit and most especially, the Indonesian rupiah, thanks to their resource bases.
Oil prices ease on Ukraine hopes
Oil markets in Asia staged an unconvincing pullback today in hopes that Ukraine-Russia negotiations were moving to a constructive stage, despite the weekend widening of the Russian bombing. Additionally, the Shenzhen lockdown may have tempered China's growth expectations and thus, its energy consumption.
All of that was a most ambitious reason to price in peak oil in my opinion, but I do acknowledge that any improvement in Eastern Europe could provoke a very sharp and deep sell-off. Despite Iran’s missile launches into Iraq over the weekend, it and the nuclear deal appeared to be off the market's radar for now.
Oil traded sideways on Friday, rallying modestly as investors hedged weekend risk. Brent crude rose 2.95% to $112.95 a barrel, while WTI rose 3.15% to $109.15 a barrel. In Asia, both contracts reversed most of those gains. Brent crude was 2.0% lower at 110.20, and WTI was 2.35% lower at 106.70 a barrel.
Any progress, no matter how tentative, could see support for Brent at $106.00 a barrel, and WTI at 104.00, quickly tested. In this scenario, both would then probably move back below $100.00 a barrel, although with the stagflation pressures in the world here to stay, Ukraine settlement or not, that was likely to be the lows for the next few months.
Brent and WTI have probably seen their multi-month highs for now last week as markets appeared to be getting more comfortable with the new normal. That said, I do not believe the oil at $100 a barrel will spur OPEC to pump more, supporting prices, even if Iran comes in from the cold. Oil could yet return to $130.00+ a barrel, but talk of $200 a barrel is needless scaremongering.
Gold has burned too many fingers once again
Gold’s price action on Friday and today suggested that its safe-haven status has waned once again. The primary reason for this is the aggressive nature of the pullbacks, last week’s one was a classic, that put gold in the too hard box for many investors and traders. In the bigger picture, gold was doing exactly what it should do in a war and stagflation environment, remaining near all-time highs. That was cold comfort, though, if you bought gold above $2050.00 an ounce last week and were looking at a $100 an ounce loss already.
As gold continued to burn the hand that feeds it, prices fell on Friday. Gold finished 0.40% lower at $1988.50 an ounce and was retreating once again in Asia, falling 0.75% to $1973.50 an ounce. Support/resistance came in at $1960.00 and $2010.00 an ounce. A failure of $1960 could spur capitulation trades, taking it back to $1920.00 and possibly $1880.00 an ounce.
If anything. silver prices continued to trade much more constructively after the longer-term breakout above $24.1000. It remains to be seen, though, if silver can retain its luster if gold continues losing its shine.