China Markets Tank into the NPC, "Who Blinks First"?
China equities are taking a hit in the Asia morning, with the CSI 300 down around 2.8% and ChiNext down over 4%. This comes ahead of the annual National People’s Congress (NPC) starting on March 5, where China will outline its key policy objectives for the year.
Any focus on the authorities leaning against leverage via policy tightening will be closely watched in the context of the banking regulator’s comments earlier this week, commenting that “the first step is the reduce the high leverage within the financial system” and “very dangerous” speculation in the property market.
Deleveraging was postponed after the huge monetary and fiscal expansion following the 2008/09 global financial crisis. If the government directs policy to avoid that mistake again, the implications for China-dependent exporters of hard commodities are negative.
The global equity markets continue to dive headlong into the plunge pool as high flyer tech stock remains significantly vulnerable to Higher Yields. Likewise, at the Index level, we are brushing up against some sharp technical points.
And in the absence of a convincing Fed pushback, short sellers continue to press the envelope lower, looking to test the pain threshold for profitable day traders and stimmy check recipients who need cash to pay for April 15 tax obligations.
FOREX
I think EUR will underperform from here on because the global reflation story does not feed through to EU rates the way it feeds through to fixed income markets run by more permissive central banks like the Fed.
I think EUR, which tends to be neither a cyclical nor a funding currency, will fall under almost any rates or risk regime this month.
Furthermore, the post-COVID economic boom will be driven by services. The USA is the most services-heavy economy globally and will provide the icing on the cake.
And the cherries on top will unquestionably be the $1.9T of stimulus passed in the next week or two and then a massive US infrastructure package from Mayor Pete.
And this is the perfect environment to remain long the Loonie as Canada should benefit from the massive US growth spurt as the Great White North remains firmly tied to the hip of the US of A.
Strong global growth led by US services should continue to benefit all commodity currencies but may also lead to a rotation out of Asia and into North America in the coming months. So short EURCAD looks inviting.
Stocks and EM currencies experiencing the re-run of higher yields
US economic data was weaker Wednesday, but the selling in fixed income continues. It feels like when Bund/Gilts are rallying, USTs are unchanged, and when Europe is selling off, USTs keep pace. Gilts led the selloff on the day, but late afternoon selling had Treasuries a close second.
Ominously, despite this week's calm, there has been little in the way of meaningful outright buying since month-end, and while 5y5y OIS is noticeably creeping towards the Fed's terminal rate, it's not quite there yet. Still, I don't see a reason to step in and turn bullish duration, at least in the 10-year part of the curve.
Markets are largely ignoring what the central banks have to say, though. The larger flows continue to be skewed to a further increase in yields, especially in USTs. So the Fed will need to fabricate a more convincing scenario to keep rate hike fever in check and avoid a colossal meltdown. Since March 2020, the free and easy money principle has bankrolled speculators, and that liquidity-supported house of cards could easily topple at the first sign of a Fed blink.
EM currencies are experiencing a re-run, albeit a smaller magnitude so far, of the negative impact of higher US real yields.
In Asia, the underperformance of IDR should not come as a surprise as a high yielder, while KRW and tech-heavy KOSPI weakness are very much consistent with US big tech downside.
There seems little risk of early tightening from the US. The more immediate risk is from China, which will hold its annual National People’s Congress (NPC) starting on March 5, outlining its key policy objectives for the year, so the focus is on Asia's risk bellwether the yuan, as usual.
Any focus on the authorities leaning against leverage via policy tightening will be closely watched in the context of the banking regulator’s remarks earlier this week, commenting that “the first step is to reduce the high leverage within the financial system” and “very dangerous” speculation in the property market.
Meanwhile, the probability of verbal intervention from Fed Chair Powell on Thursday to slow the rise in US yields appears less likely following another set of sanguine comments from his peers. Chicago Fed President Evans did not sound perturbed by rising yields.
RISK MARKETS
The bond market vigilantes return triggered a jump in 10-year yields to 1.47 % though still lower than the recent highs of around 1.51% seen last Thursday. The S&P 500 closed down 1.3%, but it is more than double that in the NASDAQ.
Equities got hit with the inflation stick Wednesday as technology shares felt the bond market vigilante's wrath after another spike towards 1.5 % in US 10-year bond yields.
The selloff in global fixed income markets is revving up again, spilling over to unseat equities and other relatively heavily positioned risk-sensitive assets. Leaving investors agog at just how soon the market is already testing the central bank policy thesis.
Chicago Federal Reserve Bank President Evans yesterday did not push back on the rise in yields. He said he does not see a risk of inflation rising too quickly and does not think the Fed will need to change the duration of QE purchases. To my mind, the only thing left that might influence the Fed's decision-making process would be whether financial conditions were to tighten or markets were deemed dysfunctional.
To convince the Fed that markets are dysfunctional, I suspect it will take a lot more than 4bp tail in the 7-year auction or 2013 styled velocity increase in the US 10-year bond yields. Still, with financial conditions forever too loose, Fed intervention's hurdle is high and will be higher always when activity and inflation data come in very strong through Q2.
Prospects for a rapid recovery in US consumer spending are increasing after the White House announced on Tuesday that it would have enough vaccines for every adult by the end of May, two months earlier than previously reported, which leaves the consensus forecast for 2021 US GDP growth of 4.9% much too pessimistic.
With the US economy about to shift into maximum overdrive, GDP could hit 7.5%-8.5%, buoyed by the vaccine roll-out and pent-up spending to come in Q2, so to any trained eye real yields far too low ahead of a decisive period for economic growth.
The market focus remains worryingly on higher interest rates, a by-product of market-based inflation expectations, as well as the throughput effect into the heavily owned tech sector, where alarm bells are sounding amid lofty valuations.
Navigating inflation euphoria is no easy task as commodity base effects, fiscal stimulus, and reopening coincide; it will be difficult to fight inflation enthusiasm and even more problematic for FX markets, as monetary and fiscal policy differentiation tends to be more pronounced heading out of a crisis than when during a financial emergency.
Still, until a clear top lid gets put on bond yields, rate jitters amid higher volatility are going to be the order of the day. The Fed should not be in a rush to lean against higher yields, interpreting the rise as being justified by endogenous drivers like building optimism around the economic recovery. So, the Fed could willingly leave it up to the markets self-correcting mechanism (higher bond yields) to ease sentiment back into the risk parity level where both higher bond yields and stock markets can exist in perfect harmony.
I guess we will remain in the bond market churner where rates go higher, and it is scary when it happens too fast. Still, higher rates are fundamentally good economic news and a natural by-product of a rebound out of financial crisis and into normalcy and reflation.
And while the Fed is happy to let the back end move higher, I doubt they will ignore any aggressive movement in the front end 2022 / 2023 pricing.
Whether higher rates are good for stock indexes stuffed full of long-duration higher flyer bit-tech is one question. In contrast, WFH tech plays are another as we near the selling window for profitable day traders who need money to pay for April 15 tax obligations.
OIL MARKETS
Oil prices jumped early on Wednesday, following reports that the OPEC+ group could be contemplating the possibility not to increase collective oil production from April as widely expected.
What started as a calm trading day quickly turned into the running of bulls after Reuters reported that the OPEC+ alliance is considering keeping the oil production cuts from March in place in April and given the still-fragile global demand recovery.
There was a massive build in oil stockpiles for the week ending February 26. After the freeze, a build had been expected but not entirely of this magnitude—it was the largest build since 1982. Refinery runs were still well below average as many plants struggle to restart, hence the build. Gasoline demand, however, was the star of the show with a very welcome and colossal draw as the weather improved and road traffic picked up significant gasoline demand at 8.6mbls a day was now back at mid-March 2020 levels when it touched 8.8mbld. Oil stalled for a few minutes after the data then started climbing.
But I think framing out the bullish vibe are the unambiguously positive recovery headlines around reopens and vaccines in the US after President Biden said they would be enough vaccine doses for all American adults by the end of May.
The OPEC+ meeting on Thursday hinges on the gap between Russia's preference to add 1.5mbpd of crude oil production and Saudi Arabia's choice for adding 0.5mbpd. Perhaps more interesting is the lack of response of US shale to the higher crude oil prices. Historically US shale has been the fastest to react, but some cold water was being poured on this by Occidental (NYSE:OXY), which envisages shale production never recovering to pre-covid-19 levels.
Oil bulls also bullishly point to an increase in output from OPEC+ being a reduction in spare capacity.
However, it seems likely that just as low prices were the cure to low prices in 2020, there is not much appetite from a recovering global economy for materially higher oil prices in the near term. So, the OPEC calculus is a challenging one.
FOREX
The Malaysian ringgit closed yesterday on a favourable tone after the government eased mobility restriction across most countries. Today higher oil prices should offset the climb in US yields to allow the MYR to trade withing its current range. Still, sentiment will remain prone to the broader US dollar reaction to higher US yields, especially if the US yield rise starts to outpace other countries bond yield bounce.
USDAsia has been reacting a touch negatively to higher yields and the ensuing wobble in risk sentiment. The selloff in US real yields last week breached "speed limits." where the critical risk for EM FX near term is how much higher USDCNY can go post NPC.
The US inflation reflation narrative is still alive, and the USD short unwind could continue. The Bank of Japan may surprise by stressing a commitment to cut rates further if needed. As a result, the market is going long via USD/JPY as the cleanest hedge.
GOLD MARKETS
Gold continues to struggle down over $200 since the start of 2021. If it fails to hold above $1,700 this week, the selloff may continue. Rising bond yields have been the most significant obstacle while overall economic conditions improve as the trifecta COVID vaccines roll out in the US.