Returning from 10 days away in Eastern Indonesia, it seemed like my uncanny ability to head off on holiday just before market inflexion points was alive and well. I still have five days holiday left for this year, so I will let readers know when I intend to take them so that you can all buy volatility.
A few things have played out in my absence, some expected, some not; such is the way of the world’s capital markets. The US dollar has been finally on its way higher, although the rally has been driven by a flattening of the US yield curve and Euro-virus nerves, and not by a rise in longer-dated US yields. It was clear that longer-term inflation expectation remains anchored capping long-dated yields, helped along by the Fed. Short-dated yields were rising, flattening the curve, and, for now, that was where the stress of the US inflation picture was being felt.
Energy and base metal prices have continued to ease. The first was driven by President Biden & Co’s threats to release strategic reserves, soggy data from Europe, along with its new wave of virus restrictions as infections sore in wave number four. Industrial commodities, such as, coal and iron ore have been crushed thanks to China talking them down, increased domestic coal production and its power crunch restricting industrial demand.
Stock markets continued to trade at or near record highs in the US, and who can blame them? US data remained strong although the inflation noise got louder by the day. And markets there knew that the Fed has an even weaker appetite for negative price action than someone who bought Bitcoin at $67,000.00.
Interestingly, the Dow Jones retreated since the Biden infrastructure package was passed, perhaps warning that even the perpetual mega-bulls of Wall Street, back-stopped by the Fed, could be in for some two-way price action into the year-end.
European equities were still holding up but in Asia, the picture was far murkier, thanks in no small part to China’s shared prosperity policies, clampdowns, property sector nerves, power crunch, stagflationary environment, insert China risk here………
If Europe faces a winter of virus lockdowns and discontent, and a cold winter with challenged gas supplies, even the ECB, in its permanent role as the European governments’ chief-debt-monetizer, will struggle to keep the recovery going. That’s what happens when you lack the imagination to do anything by QE forever, you get declining marginal utility for your efforts, just ask Japan.
Gold finally cracked its mega-resistance at $1835.00 an ounce, despite a very much stronger US dollar. It seemed that with long-dated US yields in a permanent state of suppression, short-dated US yields were rising in response to inflationary noise and strong US data; and that is what gold is responding to.
If the Fed bows to reality and hastens the taper, something the Vice-Chairman suggested last week, gold could yet find itself in another false dawn. But a move towards $2000.00 an ounce before the December FOMC can’t be ruled out.
On the Fed, President Biden will announce whether Jerome Powell retains his job after my birthday in February next year or whether he decides to go with Lael Brainard. If Ms. Brainard, an über dove, gets the nod this week, expect US stocks to jump higher and to see some temporary US dollar weakness.
The US data calendar is relatively thin this week, so the Fed Chair news could have an outsized effect. US data is front-loaded to the front half of the week, with Markit PMIs tomorrow, and Durable Goods, and October PCE on Wednesday. Thanksgiving, the annual silence of the turkeys, is on Thursday with a partial holiday I expect many Americans to turn into a long weekend, on Friday. That will notably impact volatility in the second half of the week.
European and Australian Markit PMIs are released tomorrow and with growth nerves frayed this week, I am hearing the term stagflation used a lot these days as the world catches up to me, markets will be more sensitive to weaker prints. Australia should outperform as the reopening peace dividend grows.
Europe, on the other hand, has been going backwards. New restrictions were sweeping the continent as cases surge, as were protests against them. A run of weaker data, notably from Germany, and with Russia showing more proclivity to mass armies on the Ukrainian border, rather than pump natural gas through it, made it hard to construct a bullish case for the Eurozone at the moment. Weak PMIs will make that negative noise louder although I expect the euro to take the brunt of the pain. The United Kingdom has, by contrast, performed fairly well recently, but risks guilt by association with the Eurozone.
In Asia, China left its one and five-year Loan Prime Rates unchanged as expected today, with the PBOC adding liquidity to the system via the repo market once again. The latter appeared to be its favored method of quiet support. Capturing the headlines were government officials over the weekend telling banks to limit speculation in the yuan, i.e., stop buying it.
The PBOC also set a weaker yuan fix versus the US dollar today. Despite US dollar strength elsewhere, the yuan continued to appreciate as well, thanks to strong export performance and domestic bond market inflows. The PBOC may finally have been signaling that its tolerance for a stronger yuan, particularly on a TWI basis, was waning. A situation exacerbated by the fall of the euro and the yen.
The Bank of Korea has a policy announcement on Thursday with a 0.25% rate increase to 1.0% tentatively penciled in by markets. I’m 50/50 on this as despite inflation being well North of 3.0%, the Bank of Korea may be watching developments internationally and erring to the side of caution. Notably, the won was not trading like the BOK was going to hike this week.
Japan may announce a petroleum reserve release this week, and possibly more supplementary budget number 39459549409 details. It is a short week in Japan with a national holiday tomorrow.
Speaking of central banks that have dropped the ball from their ivory towers and let the country down, the Reserve Bank of New Zealand announces its latest policy decision this Wednesday. Having postponed a previous rate hike due to the arrival and subsequent embedding of the Delta-variant in New Zealand, the question on Wednesday was whether it will be 0.25% or 0.50%.
As a Kiwi, I can tell you it needs to be 0.50%, but markets appeared to be pricing 0.25% if the NZD/USD rate was anything to go by. New Zealand releases Retail Sales tomorrow and if the QoQ Q3 number is positive, despite the Auckland lockdown, expect a 0.50% hike to get rapidly priced into the Kiwi. Of course, the ambivalent economic inequality over heaters of the RBNZ may choose the global central bank strategy de rigueur and go for a fence-sitting hawkishly dovish 0.25% hike. The New Zealand Dollar could be in for a wild ride this week.
As for Asia today, I think it could best be described as nervously unchanged, and I don’t blame them for feeling that way one bit.
Equities mixed in Asia
Asia had plenty of risk points to deconstruct today, some positive, some not so, and it was hardly surprising that regional equities were trading each side of unchanged across the region. On Friday, Wall Street finished mixed as the yield curve continued flattening. The S&P 500 edged 0.14% lower, with tech outperforming and lifting the NASDAQ by 0.40%. The possibility of a faster Fed taper weighed on the Dow Jones which fell by 0.75%. In Asia, US futures were following China, all three indices added0.30% in subdued trading.
In Japan, the Nikkei 225 was quiet ahead of a public holiday tomorrow and government budget announcements, the Nikkei 225 crept 0.05% lower. The KOSPI surged, thanks to a 5.0% surge by Samsung Electronics (OTC:SSNLF). China markets rose as the PBOC signaled it may have seen enough yuan strengthening for now and added liquidity today, as well as leaving the one and five-year LPR’s unchanged. The Shanghai Composite rose by 0.65%, with the CSI 300 climbed by 0.30%. In Hong Kong, a series of small fines levied on China tech giants over the weekend pushed the Hang Seng lower by 0.35%.
The cautious mood was prevalent across ASEAN and Australia, especially after the resource and manufacturing-centric Dow Jones fell heavily on Wall Street on Friday. Singapore rose by 0.25% with Taipei and Kuala Lumpur unchanged. Jakarta was 0.20% lower while Bangkok dropped by 0.50% and Manilla by 0.25%. Soft commodity prices were weighing on Australia today, with the All Ordinaries falling by 0.35%, and the ASX 200 tumbling by 0.50%.
With anti-lockdown riots sweeping Europe over the weekend, along with increasing restrictions and surging cases, Eurozone equities were likely to open lower this afternoon. Fears of a fourth wave in Europe eroding the global recovery have played their part in Asia’s cautious mood today, and that reality will definitely weigh on the Europeans themselves this afternoon.
Europe COVID situation keeps US dollar firm
The US dollar rally continued on Friday after Austria announced a full national lockdown due to spiraling COVID-19 cases. Fears that new virus restrictions across the Eurozone would derail its recovery saw the US dollar rise against the euro, but it was also evident that haven-related buying also boosted the greenback generally. The dollar index rose 0.57% to 96.06, edging higher to 96.11 in Asia.
The deteriorating risk sentiment weighed on the Australian and New Zealand Dollars, which gave up over 0.60^ to 0.7250 and 0.7000, respectively. With commodity prices also softening still, AUD/USD was likely to remain under pressure with a failure of 0.7220 opening further falls to 0.7150 initially. NZD/USD may find some support ahead of Retail Sales data and the RBNZ policy decision on Wednesday, With 0.25% priced in, if the RBNZ does not go 0.50%, NZD/USD could fall below 0.6900 this week.
USD/JPY was trading at 114.00 this morning and looked to have settled into a 113.50 to 115.00 trading range for now. Haven buying will support the yen, limiting USD/JPY gains unless long-dated US yields start moving higher across the curve again. With anti-lockdown riots sweeping Europe over the weekend, the environment for the single currency was challenging, without also pricing in a potential economic slowdown because of them.
EUR/USD could test 1.1160 this week and that in turn sets up a potential retest of 1.1000. GBP/USD continued to find support due to its more impressive data of late but will remain guilty by geographic association with the euro. GBP/USD was steady at 1.3445 today and looked likely to trade in a choppy 1.3400 to 1.3500 range through the start of the week.
The US dollar strength story was confirmed mostly to the G-10 space so far with Asian currencies remaining firm, mostly due to a constantly appreciating Chinese yuan. The PBOC set a weaker yuan fixing this morning, and noises were made from China officials over the weekend about speculation in the yuan by banks, which meant buying yuan.
Taken together, it seemed that the PBOC may have felt yuan strength had gone far enough for now and thus regional Asian currencies were likely to struggle this week. I expected them to cautiously mark time for now unless the yuan weakens rapidly—unlikely—or US data does not impress this week. Any signs of a slowing in the US would be the catalyst for further Asian FX weakness, as would more Fed officials jumping on the Fed Vice-Chairman’s faster taper narrative.
Oil remained on the defensive
Oil prices tumbled on Friday thanks to fears over the European economic recovery and the ongoing threats by President Biden and other leaders to release strategic reserves onto the markets to push down prices. Brent crude tumbled 3.23% to $78.45 a barrel, and WTI collapsed by 4.05 to $75.65 a barrel.
In Asia, both Brent and WTI added 25 cents to $78.70 and $75.90 a barrel on modest short-covering. Brent had resistance at $77.00 a barrel, with the 100-day moving average (DMA) at $74.00 providing support. WTI had resistance at $80.00 a barrel, with the 100-DMA at $76.70 the next major support.
The threat of coordinated SPR releases from various economies was more noise than substance, with President Biden unable to release a material amount from the SPR unless the situation could be legally defined as a material supply disruption. That would be a tenuous connection to make, as supplies continued to flow globally, albeit at higher prices. Europe was a rather more sobering situation, and if the Eurozone countries move back into more strict lockdowns into the holiday season, the knock-on effects on consumption will be noticeable.
Until the European situation clarifies one way or the other, oil rallies were likely to struggle for momentum above $82.00 and $80.00, respectively. Nevertheless, with oil prices now around 10% lower than a few weeks ago, and demand still robust in America and Asia, I do not anticipate another huge sell-off from here.
Fed taper torpedoes gold
Comments on Friday by the Fed Vice-Chairman suggesting that a fast Fed-taper could be in order, torpedoed gold’s rally, sending it 0.70% lower to $1846.00 an ounce. Once again, gold’s vulnerability to any hint of tighter US monetary policy was highlighted, with a US dollar rally on Friday also weighing on gold prices.
That said, gold’s technical picture remained constructive in the medium-term, especially as it has spent over a week above the previously formidable zone of resistance between $1832.00 and $1825.00 an ounce. Gold’s Relative Strength Index (RSI) also hit extreme overbought levels last week, but Friday’s retreat moved it back to neutral, another supportive technical factor.
Gold rose to $1847.50 in quiet Asian trading and further losses could not be ruled out as fast-money longs were culled. They should be limited to $1830.00 an ounce though, with a return to $1800.00 unlikely at this stage. Gold topped out a number of times between $1870.00 and $1880.00 last week, and this denoted its next major barrier to further gains.
In the bigger picture, the repression of rates in the long-end of the US yield curve, along with US data showing that inflationary pressures were rising, finally seemed to bring the inflation hedging trade back. With inflationary pressures reflected only in short-dated rates, for now, only more officials jumping on to a faster-taper narrative, or a sudden move higher in longer-term US yields, would be likely to derail gold’s rally. Gold will likely consolidate in a $1830.00 to $1860.00 an ounce range over the first half of this week.