Goldilocks and the three equity bears.
The Goldilocks economy and global equity investors mojo are under threat from the emergence of three bearish narratives.
Federal Reserve Chairman Powell erred to the hawkish side and had speculation running rampant that the Feds will trigger quicker pace of interest rate increases as the economy accelerates. But with the staggering amount of fiscal stimulus entering the marketplace, the risk for the economy to overcook could lead to even higher interest rates. Notwithstanding the fact it opens another can of worms as the Fed starts to withdraw policy accommodation adding more policy constraint.
Libor-OIS spread is a favourite topic of conversation again this morning as renewed tightness is forming in the dollar funding markets. Ignoring unhatched signs of stress in the financial apparatus can be dangerous. But this too appears to be another fall out from tax amnesty as opposed to credit stress in the financial markets. Money markets are losing a massive chunk of short end funding due to US firms’ cash repatriations. Also, the staggering amounts of 3-month treasury paper coming to market is not helping matters either. But regardless of cause and effect, it’s still pressuring dollar funding rates, and therein lies the issue.
Yesterday’s sharp drop in China PMI was nothing short of horrific for commodity markets.China’s official manufacturing PMI fell by 1.0pts to 50.3, its lowest level since mid-2016 and. More to the point, the 2.1pt decline in the China PMI over the past five months is the most significant decline in 6 years. Predictably we’ve seen a sell-off in industrial metals which is negatively impacting commodity sentiment in general. However, given that much of the PMI drop can be explained away by seasonal factors and the Chinese New Year, it may present some tasty levels to re-enter copper and iron ore positions ahead of a likely PMI recovering in March and April.
Oil Markets
The fall in oil prices had their usual far-reaching consequence on a broader basket of assets as a sense of risk reduction grips markets
Dispirited signs the DoE inventory report sent oil prices plummeting as WTI prices dumped one large figure to trade deep in the $ 61.00’s per barrel handle on the inventories gusher.
Traders are hypersensitive to crucial inventories data especially top side builds given the markets refocusing on shale production output as the US remains on course to be the worlds largest oil producer has prices convincingly moving lower.
Also, yesterday’s economic data from Japan and China also weighed on sentiment as the massive misses on Japan’s industrial data and China have dented the global growth outlook.
Oil prices are staring at a very greasy poll higher today
Equity Markets
Waves of risk aversion are running through investors heads as they prepare for round two of Jay Powell’s testimony probably hoping that he dials back on some of those hawkish overtones he delivered to Congress on Tuesday.
But at the heart of the overnight equity sell-off is tumbling oil prices that have tanked the energy sector as investors are not only growing concerned about increasing shale production weighing on oil prices but also the tepid industrial data out of both Japan and China which could dent the rosy global growth narrative and weigh on oil demand.
Gold Markets
Not an overly exciting 24 hours in the gold markets as traders sit tight awaiting round two of Jay Powell testimony to the Senate which tends to more telling. Of course, there’s the chance he dials back his hawkish rhetoric, but if he stays the course, there’s always a chance we could see higher repricing of US interest rates and a slightly firmer DXY which could trigger another leg lower in Gold prices. The balance of risks suggest Gold prices will move lower on day 2 of Powell’s testimony
Currency Markets
The dollar rose to five-week highs on Wednesday, buttressed by a cheery assessment of the U.S. economy from the Federal Reserve’s new chairman, which has raised the spectre of a faster pace of interest rate normalisation through 2019. While the dollar continues to bask in the afterglow from Powell’s day one testimony, but it could get interesting if Powell gears back the hawkish retort as the dollar bears are trying to decide when and where to pick their spots.
The Japanese Yen
Traders don’t have to make sense out of currency markets; they just have to be right. While yield differential suggests a higher USDJPY, with month end exporter flow dominating the landscape while JPY crosses feeling the pressure from a halt in the equity market rebound we should expect downside pressure to remain. Also with the BoJ reducing purchases yesterday, it always creates an air of policy uncertainty warranted or otherwise.
The Euro
It was always going to be a stressful week for the Euro ahead of the Italian election, but a combination of month end USD demand and a general dollar bid has driven the EURUSD below the critical 1.2200 level. While the Italian polls weigh on sentiment, its been more of a dollar storyline than anything else the past 48 hours as it now becomes a USD trend follower as opposed to the leader. The break of 1.22000 could trigger a more profound move lower as the EURUSD market is still long and was not positioned correctly for a stronger USD and we could unleash some stops on the way down
The Australian Dollar
The weaker China PMI and the commodity knockdown effect is weighing on regional sentiment, but the Aussie is also feeling the brunt of a hawkish fed’s positive impact on USD sentiment. Adding to the Aussie woes today’s CAPEX came in soft 0.2% QoQ expected 1%. This should put further pressure on AUD which is already the go-to currency fro establish near-term USD longs.
Asia EM FX
The pace of play will likely remain directed by broader market USD sentiment through weeks end.
The Malaysian Ringgit
With the headline CPI coming in below market expectations at 2.7% YoY (Consensus: 2.8%, Dec: 3.5%), it means the BNM will stay on hold through March which will weigh on near-term MYR sentiment. However, it has not put to rest another rate hike in 2018. Although the stronger MYR likely impacted the CPI reading, we should expect the BNM to prefer a gradual pace of MYR appreciation to complement the OPR hikes while attempting to bring overall monetary conditions back into equilibrium.
But adding to the Ringgit negative tone, this morning’s manufacturing PMI fell below the expansionary level 50 coming in at 49.9 vs 50.5 prior, definitely a bearish Ringgit setup today.
Hong Kong Dollar
USDHKD is at the highest level since 2007 as the broader interest discount gap is causing some concern amongst investors who are looking to park funds under the relative safety of the USD.
