The extent of the impact of China’s Covid-zero policies on the domestic economy was highlighted this morning as the Caixin Services PMI for April recorded its second-largest fall on record. Caixin Services PMI fell from 42 to 36.2. It is likely to be one of several headwinds facing China markets in today’s session, as they return from the Labour Day holiday break.
China is tightening Covid-19 restrictions in Beijing and extending them elsewhere as its Covid-zero policy continues to weigh on the domestic economy and exacerbate supply-chain issues internationally. Reuters is also reporting that the US SEC has expanded its list of US-listed Chinese entities that face delisting over audit transparency. Another 80 companies were added today including heavyweights such as JD.Com and Pinduoduo. The massive post-FOMC relief rally staged by US stock markets overnight could pass Chinese markets by today.
Perhaps the only silver lining for the rest of the world around the China slowdown is in the energy space. The EU announced overnight it was moving to enact a ban on Russian oil imports by the end of the year, with exceptions for Hungary and Slovakia. That was enough to torpedo European equities yesterday, but Brent crude finished the day over 5.0% higher. Although I believe the world continues to materially under-price Ukraine/Russia risks in the energy space, the slowdown in China is acting as a brake on rising oil prices.
In the EM space, India surprised markets yesterday with an unscheduled 40bp interest rate hike. That send the SENSEX tumbling, while the Indian rupee surged higher. Having held steady at the recent meeting, it speaks volumes about the inflation stresses that central bankers are facing now that India has shifted its policy bias. India’s RBI has tolerated stagflationary monetary conditions throughout the entire pandemic to keep the lights on in the economy. Its shift is an important one, and it will be interesting to see if other Asian central banks start blinking on inflation as the year progresses. I would expect more rate hikes from South Korea, the picture is muddier for the rest of the region. Especially given that many Asia-bloc countries have a high beta to China, and it continues to face serious downside risks to growth. The post-FOMC rally in Asia FX will be temporary, I believe.
Turning to the FOMC policy decision which has been analysed to death already, it was a case of sell the rumour, buy the fact. The FOMC hiked by 0.50% as expected, with Chairman Jerome Powell signalling that another 0.50% hike is pencilled in for the next two meetings. That sparked a huge relief rally in equity and currency markets, with gold also rallying as the street breathed a collective sigh of relief that 0.75% hikes were unlikely to happen. In fact, Mr Powell didn’t specifically rule out a 0.75% hike next month, citing the need to be “nimble.”
Markets are geniuses at picking out the bits of a story that fit their preferred narrative though. And naturally, we saw the US dollar plummet versus DM and EM currencies, equities rallied aggressively, bond yields eased, although mostly at the short end, and gold and silver posted handsome gains. The FOMC also saved bitcoin’s bacon, which rallied 5.0% higher after threatening a major downside technical breakout earlier in the day. The price action overnight is suggestive of positioning, something I have been telegraphing the last few days, as opposed to a structural change in sentiment.
Lost in the noise, the Fed also announced a start to balance sheet reduction, or quantitative tightening if you want to use a couple of buzzwords that make you sound clever. From June the Fed will start selling USD 45 billion of bonds and MBS’ a month, ramping up to USD 95 billion a month by September. It will be interesting to see if we can avoid a “taper-tantrum” this time. In 2013, the previous exercise was quickly halted as EM started to meltdown, and that was in a low inflationary environment. I would argue that QT could have a far more important downstream impact on markets than Fed Funds rate hikes and has, until now, had its risks discounted like those from the Ukraine/Russia war. The Fed believes it can get away with aggressively tightening and reducing its balance sheet and a soft landing will prevail. Given their track record on “transitory inflation,” I am as nervous as a fat steer at a BBQ festival or using a pedestrian crossing here in Jakarta.
Australia’s trade surplus expanded to AUD 9.314 billion this morning. But it was driven by bloated demand for everything the lucky country grows, pumps, or digs out of the ground. Instead, the headline number was flattered by a 5.0% slump in imports even as exports were almost unchanged. Building Permits also slumped by 18.50% in March. Perhaps we are seeing the first signs that a lower Australian dollar, making imported goodies more expensive, a surging cost of living, and rising financing costs, are starting to drag on the domestic economy, just as the RBA starts to hike rates. Australia will be as insulated as any country from the Ukraine/Russia resource inflation surge that is yet to be fully felt by the global economy, but it won’t be fully immune to those downstream impacts.
Japan, South Korea, and Indonesia are on holiday today, but we have Inflation releases from Thailand, Philippines RPI, India Services PMI and Singapore Retail Sales. The RBI hike yesterday will drown out any noise around the India PMI, but Singapore Retail Sales has definite downside risks as rising costs squeeze discretionary spending on the Red Dot. The MoM for March number is expected to fall by 0.50%, but a much larger fall will weigh on stocks, particularly banks, and may unwind some of the impressive gains the Singapore dollar made overnight.
Later today, we have German Factory Orders although I expect developments around the Europe/Russia oil ban to drown that out. UK Services PMI has downside risks and could weigh on sterling. Later this evening, also from the UK, we will have the results from the Northern Ireland election and a policy decision from the Bank of England. Markets have priced in a 0.25% hike to 1.0% from the BOE. The BOE have been using the Ukraine situation as a reason to reel in hawkish expectation and rightly so. They, like Europe, face least-worst choices in this respect. They should also announce their own plans for balance sheet reduction. A hike of less than 0.25%, a soft approach to QT, and/or a dovish outlook, should stop sterling’s overnight rally in its tracks and resume the downside pressure. The Northern Ireland election could also be sterling negative if Sinn Fein sweeps the vote.
Finally, don’t forget that we also have the US Non-Farm Payrolls data due out tomorrow. Markets are pricing in around 400,000 jobs, steady from last month. We had a very soft ADP Employment print overnight. Although the two are not strongly correlated, and the JOLTS data suggests the labour market remains impressively robust, there is a downside risk to this month’s print now. Perversely, a soft print could be fuel for the fire for the market’s peak rates narrative, sparking another big rally in equities, US bonds, EM, and gold, while punishing the US dollar. To paraphrase the musical Chess, this week really is the show with everything but Yul Brunner.
