Summary: The market mood is souring further to start the week after a downbeat session to close last week, as oil prices have shot skyward again to over 130 dollars per barrel on US discussion of a ban on Russian oil imports and as wheat futures are again limit up in Chicago on fears for the wheat supply this year as planting season approaches in Ukraine. Gold touched 2,000 dollars per ounce briefly overnight and the euro continues its downward spiral against major currencies.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - US equity futures are responding negatively to the potential prospect of an import ban on Russian oil with Nasdaq 100 futures leading the declines down 1.6%. Financial conditions in the US have tightened the most since the euro crisis in 2011, but the numbers are not including the last two weeks covering the Russian invasion in Ukraine. It is quite likely that financial conditions are now tightening at the fastest pace since the great financial crisis which will continue to put downward pressure on equities.
Hong Kong’s Hang Seng Index (HSI.I) & China’ CSI300 (000300.I) - down over 3% with selling across the board except mainly oil, coal, gold, fertilizer and Chinese property stocks. Oil and coal producers benefited from the surge in oil prices and coal prices. Chinese property stocks rose amid Chinese Premier Li adopted a moderate tone about the property sector and remarked that the Government would satisfy reasonable housing demand and implement city-specific policies and did not mention any property tax in his report to the National People's Congress.
European equity markets – European equity futures are down 2.5% in early trading as there are now active talks about a Russia oil import ban in the US pushing Brent crude futures as high as almost $140/brl but coming down to around $130/brl ahead of European cash equity trading. The galloping commodity prices will naturally put downward pressure on the economy and increase operational volatility for many companies already struggling with inflationary pressures. An import ban on Russian oil and gas would immediately put Europe into a rationing mode to preserve and allocate oil and gas to the most important sectors of the economy first.
EUR crosses – the euro continues to absorb the most pressure of major currencies on the fallout from the war in Ukraine, although the Japanese yen is also somewhat weak as it is so reliant on energy imports. EURUSD traded down to 1.0822, although it rebounded back close to Friday lows near 1.0885 as of this writing as a considerable portion of the shock move higher in crude oil was erased overnight. Any financial crisis stemming from the current commodity situation will not be limited to Europe, which however does risk the most direct exposure to the sudden detonation of Russian assets after Russia invaded Ukraine. It may be too early to detect this, but this could be the first modest sign of “relative resilience” in the euro as its momentum lower failed to match the the momentum in other markets. EURCHF deserves watching around the parity level, which it traded below briefly overnight as the Swiss National Bank needs to balance currency considerations for exporters versus inflation considerations. Recent weekly sight deposit readings suggest that the SNB has not leaned against the move higher in CHF with intervention.
AUD crosses – The Aussie continues to serve as an odd kind of “safe haven” in the recent situation due to Australia’s remarkable portfolio of commodities that are precisely those for which supplies are most at risk in relation to Russia’s assault on Ukraine, particularly LNG (Australia is the world’s largest supplier and wheat (a major exporter). AUD jumped higher again overnight as AUDUSD now may be focusing on the 0.7500+ area after breaking important resistance last week, but will also be the most headline-prone currency among G10 to any change in the situation in Ukraine and commodity prices, together with the EUR. EURAUD is down a stunning 10% from its February highs.
Crude oil (OILUSAPR22 & OILUKMAY22) jumped almost 18% to just shy of $140 on the Asian opening driven by shortages and the risk of a US and European ban on Russian crude imports, currently estimated to be around 5 million barrels per day through pipelines and seaborne cargoes. Russian produced products and commodities have become increasingly toxic with self-sanctioning by oil energy buyers already being felt. Brent crude around $130 has by now reached a level where demand destruction will start to set in with consumers self-rationing their needs while heavy fuel consuming industries may also start. Whether the drop will happen fast enough to prevent an even bigger jump remains to be seen.
Gold (XAUUSD) touched $2000/oz in Asia with Goldmans calling it the currency of last resort, while copper (COPPERUSMCH22) and palladium (PAc1) both hit fresh records at $5.03/lb and $3174/oz as investors responding to Russia's intensified war in Ukraine by seeking shelter in gold while worrying about supply disruptions in the others. Commodities derived from Russia and Ukraine have surged higher with sanctions and port closures shaking up the industry with buyers scrambling to find and right now failing to find alternative sources of supply. Nickel being another metal, currently up 22%, while even more worryingly Chicago wheat (WHEATMAY22) trades limit up bid for a second day at $12.94/bu, up 60% since the start of the Russian war.
Bitcoin and Ethereum both fell around 9 % over the weekend, with Bitcoin breaking below the 50-day moving average on Friday. This morning Bitcoin dipped below USD 38k before bouncing slightly back.
US Treasuries (TLT, IEF). The yield curve continues to bear-flatten as the market expects a more aggressive Federal Reserve, but long-term yields remain compressed amid the war in Ukraine. The 2s10s spread closed around 25bps on Friday while the 2s5s spread dropped to 15bps signaling that the US economy is losing momentum and that it may not be far off from a recession. This week, the US CPI figures for February are going to be in the spotlight while there will be no speeches from Fed officials as they enter a blackout period before next week’s FOMC meeting. Markets are still pricing six rate hikes for this year. Everything is pointing to more bear-flattening of the yield curve.
European Sovereigns (VGEA, BTP10). The world will be looking for any sign of hawkishness at the ECB meeting this week as the Eurozone inflation is at a record high level. The war in Ukraine caused markets to pare back on interest rate hike expectations in the euro area despite inflation is likely to remain high for a longer period. Investors will be particularly interested in revisions of the ECB’s economic projections as speculation of a early end of QE is increasing.
US Corporate space (HYG, USIG). The primary high yield bond market resumed its activity without problems. The Move index is at the highest level since March 2020. Yet, the corporate bond space is facing serious headwinds that could provoke a tantrum. We remain concerned that inflation and interest rate hikes might weigh negatively on credit spreads going forward.
What is going on?
US discussed a Russian oil import ban with Europe, according to US Secretary of State Antony Blinken, and Japan said it is in talks on similar measures with the US and Europe. This triggered the enormous further rise in global oil prices overnight on fears of a disruption of even more of the approximately 5 million barrels of oil that Russia exported daily before its invasion of Ukraine.
China sets new GDP target. The around 5.5% GDP growth target in Li’s report was at the high end of economist expectations (5% to 5.5%) and in line with provincial targets released last month. CPI target is set at around 3%. M2 money supply growth and aggregate financing growth is targeted to be in line with nominal GDP growth. The official budget deficit target of 2.8% of GDP may look larger once we include the RMB2.3 trillion transfers from SOE profits and the fiscal stabilization (which will bring the number to 4.6%).
US making overtures to Venezuela in desperation to boost crude oil imports. The Biden administration could look to ease oil sanctions against the country and US officials held face-to-face meetings with Venezuelan officials in Caracas at the weekend. A lifting of sanctions and allowing the last US major, Chevron, to pump at full capacity could increase production by several hundred thousand barrels per day within many months, according to a Venezuelan official quoted in a WSJ article (paywall).
Strong U.S. job report for February. Nonfarm payrolls growth turned out to be 678K last month, which is much higher than the expected 400K. The unemployment rate decreased to 3.8% versus prior 4.0%. Wage growth was slower at 5.1% year-on-year versus 5.8% expected (0.0% month-on-month in February!). But this is not really worrying. It is mostly explained by the return of lower-paying jobs. We doubt the report changes anything for the U.S. Federal Reserve.
Global supply chain pressures decreased in February. The index created by the Federal Reserve of New York fell for the second consecutive month at 3.31. A back-to-back decline hasn’t happened since September-October 2020. However, it remains at a very elevated level. Expect it to sharply increase in March due to the global trade disruptions related to the Ukrainian conflict. The index is based on two sets of data : global transportation costs (e.g. Baltic dry index, Harpex index etc.) and supply chain-related components from the PMI surveys (e.g. delivery times, backlogs etc.). See the full report.
What are we watching next?
Oil (and other commodity) prices indicating real growth recession incoming, risk of financial crisis. On the real growth front, oil prices have reached levels that force governments, especially local governments on fixed budgets to curtail some portion of their operations and companies and even individuals to do the same. In the financial system, companies and operators exposed to commodities prices for their operations may need to raise capital to meet margin calls or tap credit lines. One measure of stress in the US financial system, the FRA/OIS spread, spiked to its highest since April of 2020 last week at 36 basis points. US financial stocks have hung on to their range, with the XLF closing near the range low since last September on Friday, but European banking stocks (the EURO STOXX Banks Index) has plunged 30% from a multi-year high in February.
Earnings Watch. The Q4 earnings season is grinding to a halt with the upcoming week being the lightest since the earnings season started. The key earnings to watch this week are XPeng, Adidas, JD Logistics, Oracle and JD.com.
Economic calendar highlights for today (times GMT)
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