Jerome Powell sparked more volatility in markets overnight, as if we needed more, by quite clearly stating that the Federal Reserve would not be deterred from hiking at this month's FOMC meeting, despite uncertainty surrounding the Ukraine situation. His remarks suggested a 25 basis point hike was coming, taking 50 bps of the table.
His remarks sparked more tumult in bond markets, which this week, have been behaving like the caffeine-addled tail-chasing fast-money gnomes of the equity market. US yields plummeted on Tuesday as markets removed rate hike expectations, only to fully reverse that move overnight, US 10 and 30-year treasuries adding a whopping 17 basis points.
Additionally, the Bank of Canada also hiked by 0.25% overnight with more hikes to come. Additionally, the clutching-at-straws equity rally was given renewed momentum as a 0.50% hike in March became 0.25%.
Confusingly, for those programmed to more mechanical movements by asset classes, that fit nicely into that finance textbook from the first year of university, bond yields plummeted on Tuesday, but so did equities. Yesterday, US bond yields rocketed higher, but so did equities. Meanwhile, oil and commodity prices kept reaching through the sky through the whole thing.
So, what’s going on? I believe it’s best to look at them in isolation as those lovely mechanical connections, like so many things in the world right now, are either broken or severely worn out.
Looking at equities, it is clear the perpetual mega-bulls of the past two years are continuing to fight a rear-guard action, using their previously successful buy-the-dip playbook, refusing to accept that the central bank cookie jar is near empty and that Ukraine-Russia has changed everything.
With that in mind, a massive amount of peak-Ukraine FOMO is going on. At the first sign of any glimmer of resolution, investors pile into equities. Yesterday, that cue was another meeting to be apparently held by Ukraine and Russian officials on the Belarus border today. Mr. Powell further justified their worldview by saying only a 0.25% hike was on the table this month. 0.25% is less than 0.50% equals lower rate hike equals already long peak-Ukraine FOMO equals buy equities. Simple, isn’t it?
Now bond markets. Bond investors have been pricing in substantial rate hikes by global central banks, most especially the Fed, over the past few weeks. Yields have risen across the curves and bond investors have probably gone quite underweight in anticipation of this fact.
With inflation skyrocketing everywhere, it is quite reasonable to assume that the world's central banks have mostly made a complete dog’s breakfast of actual inflation outlook. The Russian invasion of Ukraine saw some haven inflows into US bond markets, but bond markets overall didn’t respond aggressively initially.
That changed this week, as the weekend sanction frenzy showed the West meant business and bond markets scrambled to reprice rate hike expectations around the world, most especially in the US, the Dark Tower of global monetary policy.
Having pushed yields sharply lower in the assumption the Fed would blink on hiking, Mr. Powell blindsided the street by saying in fact they would hike. Cue a mad rush for the exit door to reprice the Fed not hitting the W for Wimp button at the first sign of trouble. If anything comes of today’s meeting on the Belarus border, you can guarantee yields will rise again, and equities too.
The key to this whole puzzle that is being overlooked is what shape the US yield curve, and others, will look like as the Ukraine situation evolves. There is little doubt that a stagflationary wave is on the way to the world, it’s really just how big it will be. Only a complete loss of nerve by the West will change that.
If central banks prioritize fighting inflation in 2022, having failed the world on that front in 2021, then hiking into a stagflationary environment likely means they are accepting some sort of recession is necessary to sort the whole mess out. Before everyone panics, there are recessions.
Recessions can be a mild headache, or a vicious migraine, and everything in between. But in this case yield curves, including the US, are likely to turn NEGATIVE. The pain of higher reference rates will lift short-end rates, while longer-dated yields, pricing in recessions, and slower growth and future inflation, will fall.
A glance at oil prices and commodity prices in Asia today, tells me the bond markets and equity markets are both running around like headless chickens at the moment. The underlying trend is there for all to see.
Some sort of recession is on the way, it's just how deep it's going to be. And that dear readers, is why bond yields can fall, (in parts of the curve), and equities can fall at the same time. In the meantime, unless the meeting today produces a miracle, the day in the sun for equities looks like yet another sucker’s rally. As I have stated before, volatility will be the winner in 2022.
In Asia today, the pre-Ukraine data releases continued to show a positive picture, though. South Korean GDP outperformed, continuing a strong week of data, but gains may be limited ahead of the 9th of March elections, and an electorate angry at the cost of living and housing. A familiar tale globally.
In China, Caixin Services PMI disappointed, printing at 50.2. Omicron fears, a soft property market, and a weak run for equities could be crimping consumer confidence. However, an official commenting that he could see the end of the COVID-zero policy may limit any negative fallout.
Australia may be underwater at the moment, but it remains the lucky country. Market Service PMI leapt to 57.4 in February and January’s Balance of Trade exploded higher to AUD 12.90 bio, with exports leading the way. If there is one country standing to benefit from the global mess now, it is Australia. It’s got lots of the things that everybody wants to buy with Russia out of the picture, even coal.
China may yet rue its diplomatic petulance over Australian import bans. Pop in a post-flooding construction boom and even the RBA may need to throw in the towel on its über-dovish outlook and start hiking. The Australian dollar could be a winner in 2022. The Wallabies might even win the Bledisloe Cup. Strange times indeed.
European markets will continue to be buffeted by Ukraine headlines, while the US sees the second day of Powell testimony and the release of ISM Non-Manufacturing PMIs and Factory Orders. The PMI sub-indexes will tell the real story, which will likely be one of Omicron being omigone in American eyes. That sets us up for US Non-Farm Payrolls tomorrow, with the risks skewed to the topside and potentially more bond market volatility.
Asian equities are cautiously higher
Overnight, news that a second Ukraine-Russia meeting in sunny Belarus sparked a relief rally in equities markets, which was given more momentum at Jerome Powell signally the Fed would only hike 0.25% this month, instead of 0.50%. As I said previously, peak-Ukraine FOMO is strong in equity markets right now, and the outcome of today’s meeting will dictate entirely whether this is yet another sucker’s rally. I am in the latter camp but hope that I am completely wrong.
Overnight, European equities surged, and that continued into New York. The S&P 500 leapt 1.86% higher, the NASDAQ rallied by 1.62%, and the Dow Jones rose an impressive 1.78%. Futures rallied initially in Asia, but comments from Treasury Secretary Yellen about "addressing potential gaps in Russia sanctions" quickly sent futures on all three indexes back to unchanged.
Asian markets were mostly higher, in line with price action overnight, but more cautiously so. Having been bitten on Ukraine FOMO rallies already in the past week, local investors were wary of being caught out again. Secondly, oil prices have jumped higher in Asia once again today, adding another note of caution.
The Nikkei 225 rose by 0.90%, with the South Korean KOSPI rallying 1.55% after another trance of strong economic data. In China, caution pervades Mainland markets, the Shanghai Composite up just 0.10%, while the CSI 300 was 0.30% lower. Hong Kong eked out a modest 0.25% gain.
Singapore was 0.50% higher, while Taipei added 0.35%, with Bangkok climbing 0.55% and Kuala Lumpur rising 0.70%. Manilla was 0.15% in the green, while Jakarta’s market was closed once again this week for a national holiday. Australian markets were also rallying, without displaying the animal spirits of the retail armies of Tokyo and Seoul. The ASX 200 was 0.65% higher, while the All Ordinaries gained 0.75%.
As I have stated, Asia was once burnt and twice bitten and looking at oil prices today, I don’t blame them. Similarly, European markets were unlikely to continue the rebound of yesterday and will likely open slightly higher only. Any sign of progress at the Ukraine-Russia meeting will spark a bigger relief rally, but an inconclusive meeting will see yet another scramble for the exit doors.
Currency markets mixed
The US dollar mostly retreated overnight as Fed rate hike expectations were pared for March and investors hoped for progress in the Ukraine-Russia meeting expected today. The dollar index eased slightly by 0.04% to 97.36, but with oil prices on fire in Asia today, resumed its ascent, climbing 0.16% to 97.51. Its short-term direction continued to be at the mercy of Ukraine developments although I note that whispers of positive news did not severely dent US dollar strength.
EUR/USD remained anchored around support at 1.1100 today, despite spiking lower to 1.1050 in the overnight session. There appeared to have been large EUR/GBP selling flows that went through the market as GBP/USD rallied to 1.3400, where it remained today. As long as EUR/USD clings to 1.1100, there was still potential for a decent short-squeeze. Long-term support was at 1.0800.
AUD, NZD and CAD all rallied strongly as global sentiment took a tentative step higher, with CAD’s rally aided by a 0.25% hike by the Bank of Canada. AUD/USD and NZD/USD were nearing resistance at 0.7300 and 0.6800, respectively, while USD/CAD was flirting with support at 1.2830. Positive developments from Eastern Europe could spark a potentially aggressive rally by all three sentiment indicators, but I would prefer to wait for absolute confirmation.
Asian currencies also staged modest rallies overnight, but the continuing rise in oil prices will cap gains in most regional currencies. USD/CNH and USD/CNY remained anchored between 6.3100 and 6.3200 as basket component currencies elsewhere remained weak. Yuan strength will likely only weaken if the PBOC decides to raise the counter-cyclical factor at the fixing.
With most international transactions for energy and commodities being priced in US dollars, demand for greenbacks from the real economy should remain robust, softening any short-term retreats.
Oil rises once again in Asia
Despite the noise in equity and bond markets overnight, the panic in oil markets continued with prices rallying aggressively once again. Brent crude leapt 6.80% higher to $114.50 a barrel overnight, while WTI rallied 4.75% to $111.40 a barrel. The sense of panic continued once again in Asia, with Brent climbing 1.70% to $116.50, and WTI rising 2.20% to 113.95 a barrel.
Comments by Janet Yellen about plugging gaps in sanctions this morning gave no comfort to Asian physical buyers scrambling for supplies. Nor will stories circulating that China has instructed State buyers to secure supplies of key commodities from energy to metals to food, and to not worry about the price.
I believe the bigger part of the squeeze though is from OPEC+ showing no interest in ramping up production, and most especially, international financial institutions refusing to finance any commodity purchase with Russia written in the paperwork, as well as international shippers avoiding Russia.
Even if Western sanctions appear to be allowing energy payments to continue, Western financial institutions were taking no chances. In this respect, the private sector appeared to be doing the heavy lifting on Russian sanctions on several fronts right now.
Although the relative strength index indicators (RSI) are grossly overbought on both contracts right now, geopolitics was driving markets and not traders. Brent crude was in shouting distance of my initial $120 a barrel target and with markets unable to magically replace $5 million bpd of Russian oil exports, it seemed when and not if it will hit this level. WTI could also potentially move to $120.00 in the sessions ahead.
What would change the dynamic would be any signs of progress at the Belarus border meeting today. I struggle to remember when asset markets were so keen to clutch at straws as they were now, but if we do see a glimmer of hope, a $10 a barrel fall by both contracts is not out of the question. The real question then is, do you buy the dip?
Gold maintains gains, but silver looks more golden
Gold probed $1950.00 an ounce in the early part of yesterday, only to fall from grace on Ukraine hopes and a surge higher by US yields, finishing the day 0.88% lower at $1928.50 an ounce. In Asia today, despite the rally in oil prices, haven flows were absent as gold eased another 0.20% lower to $1924.70 an ounce.
Gold’s price action remains concerning, even if it was still consolidating near the top of its recent range. Although the RSI has fallen back from overbought territory, lessening the downside correction potential, gold’s inability to retest $1975.00 leaves nagging doubts. One thing is for sure, any sign of progress from the Belarus border meeting today likely sees gold plummet quickly back towards support at $1880.00 an ounce.
Conversely, the silver upside breakout I telegraphed last week continued to develop very nicely. Silver broke out of long-term resistance at $24.2000 an ounce, rose then fell and retested the breakout line and then rallied powerfully; a technical analyst's dream. Silver remained very near to its Ukraine highs at $25.2000 an ounce. A rise through $25.5000 signals a new leg higher in the greater rally targeting $31.0000, which only a fall through $24.0000 an ounce signals failure.
Silver might be a better risk hedge right now, even with its greater volatility and lower liquidity. Or a more esoteric route could be to sell the XAU/XAG ratio. Precious metals require nerves of steel and deep pockets at the moment, perhaps silver is the least worst choice to hedge risk?