Bracing for a whole new world in June – Fed begins QT and China’s mini-steps towards reopening
APAC Strategy Team
Summary: How far this bear market rally will last is anyone’s guess, but commodities remain poised for another week (or more) of gains even as bonds slip again. China PMIs remain in contraction, but stakes are high on China’s reopening and oil and industrial metals stand to benefit. But fresh inflation fears are stoking the markets, which means more pain is to come in equities.
What’s happening in markets?
US and European markets. US markets were closed for Memorial Day holiday on Monday. But the futures are trading and suggesting a small advance on Tuesday. As mentioned, we are seeing a ‘technical rally’ in downbeat names of 2022 in the Nasdaq and S&P500. But we are cautious of the rally, thinking it will likely be short lived before a bearish pull back resumes, with the Fed starting QT this week and most S&P500 companies are guiding for profit growth to slow. In European markets, most were higher with the Euro Stoxx 50 up 0.9%; with Hermes International (RMS) rising the most in anticipation of luxury goods demand picking up with some key-tier one Chinese cities reopening.
Asia Pacific equities ride the commodity wave but inflation fears are biting again. Asian equities remained mostly bid on Tuesday after a quiet overnight session due to the US holiday. China’s manufacturing PMI was better than expected for May, but still remained in contraction, dragging down the ASX. Australia’s ASX200 is trading lower 0.6% after rising for two days. Today the tech names that have been fuelling the recent rally, have been seeing profit taking with Zip (ZIP) down 5%, Tyro (TYR) down ~5%. Meanwhile, the commodity theme continues to dominate; with metals, energy and grain stocks hitting higher levels because, 1- manufacturing kicks off Wednesday in Shanghai, China. 2-Hong Kong has decreased some travel restrictions, and 3- China has a 33 point plan to boost eco’ growth with Shanghai itself having 50 point plan to drive economic activity. This is why oil stocks like Beach Energy (BPT) are up 2.7% and metals companies like Fortescue Metals (FMG) are up 1.7%. Other stocks doing well today ahead of China’s reopening include coal companies like Whitehaven Coal (WHC) up 2.2% as the coal price is likely to push up, as over 70% of China’s electricity comes from Coal. Meanwhile, meat, grain and real estate business Elders (ELD) is trading up about 3% after going ex-dividend yesterday (transferring the dividend right to shareholders). Singapore’s STI index (ES3) was up close to 0.5% as Singtel returned to gains and REITs continued to advance. Japan’s Nikkei (NI225.I) was up 0.1% as well as Softbank gained.
Chinese equities continued to rally on reopening and recovery prospects. CSI300(000300.I) gained about 1% in morning trading. Shanghai reported 31 new local cases for yesterday and announced to lift the lockdown tomorrow except for high/medium risk areas. The opening includes orderly resumption of public transport as well as private vehicle transport and allowing movements in and out of residential compounds from tomorrow June 1. Residents are required to do regular PCR tests every 72 hours. Hang Seng Index(HSI.I) gained modestly and Hang Seng TECH Index (HSTECH.I) climbed 1.2%. The National Development & Reform Commission (NDRC) and National Energy Administration released an action plan on new energy development yesterday. Chinese new energy and electric utility names listed in Hong Kong surged 4% to 13%.
Oil price rose 2.3% to $117.73 (highest level since March 9) after EU leaders agreed to pursue a partial ban on Russian oil – paving the way for more sanctions on Moscow. We’ve also got China resuming manufacturing and relaxing on some travel restrictions in HK - pushing up expectations that oil demand will increase. This is expected to support US oil giants Occidental Petroleum (OXY) and Marathon Oil (MRO) which are already this year’s best performing stocks in the S&P500 up 144% and 90% this year respectively.
USDJPY exposed again as US yields rise. Risk sentiment stayed firm as China is getting ready to reopen. But US bonds slumped again as inflation fears failed to recede. Comments from Fed’s Waller also brought faster rate hikes back to the table after some expectations of a September pause had started to build in. Yields went up across the curve after falling for three weeks in a row, and that sparked a selloff in the yen. USDJPY has shot up to 128+ levels, peaking at 128.95 in Asia. AUDJPY has shot up above 91.500 to its highest levels since earlier in the month.
AUDUSD is continuing to bounce off its low and set higher levels and is up 5% since May 13. The next catalyst to watch for the AUD is the Australian GDP data out tomorrow (Wednesday) which could push the AUDUSD up if the data is stronger than expected. Also on Wednesday Chinese manufacturing in Shanghai is expected to resume.
Bitcoin has seen its biggest gain in two weeks, rising above $31,000 for the first time since May 16. This is starting to look interesting for Block (SQ).
What to consider?
Fed’s Waller hints at more than a couple of 50bps rate hikes. Fed Governor Christopher Waller said he “supports tightening policy by another 50bps for several meetings”. In particular, his remarks hinted that he is not taking 50bps hikes off the table until inflation comes down closer to the 2% target, which suggests more than two 50bps rate hikes. Fed also begins QT tomorrow which adds another layer of uncertainty to the markets. Meanwhile, President Biden will hold a rare meeting with Fed Chair Powell to discuss the state of the US and global economy, especially as inflation remains a key concerns ahead of the mid-term elections.
China’s May PMIs bounced from their April lows. Official manufacturing PMI came at 49.6 in May, beating street consensus (Bloomberg survey 49) and bouncing 2.2 points from April’s 47.4. Non-manufacturing PMI rose to 47.8 in May, well exceeding the market expectation at 45.5 and 41.9 in April. Although both are still in contractionary zone, the rebound was broad based, benefiting from relaxation of lockdowns. Large enterprises led the recovery in manufacturing PMI and was back to expansionary zone with a 51.0 print. Among non-manufacturing activities, the construction sub-index moderated to 52.2 from 52.7 in previous month while the services sub-index bounced to 47.1 in May from 40.0 in April.
Higher EU inflation may boost ECB tightening expectations. May inflation prints in Germany and Spain have come in above expectations. Germany’s May HICP inflation jumped to 8.7%, beating consensus forecast of an 8.1% increase mainly as food prices jumped higher. Spanish inflation was also higher at 8.5% vs. a consensus estimate of 8.3%. This adds upside risk to the outlook for euro-area inflation of 7.6% in May and will likely reinforce the European Central Bank's resolve to lift rates, possibly at a more aggressive pace than previously hinted.
Port congestion remains a major issue partially due to China’s zero covid policy. Due to Shanghai’s lockdown which started from late March onwards, up to 260,000 twenty foot equivalent units (twenty-foot long containers) could not leave the port of the city in April. This will take weeks to ship, perhaps between eight to ten weeks. Neighboring ports are congested too. This is the case of the port of Ningbo-Zhoushan (busiest port in the world in terms of cargo tonnage) where a large number of containerships have been diverted away from Shanghai in recent weeks. Expect the situation to worsen in the short-term as a new wave of Chinese exports looms with the reopening of the economy.
Potential trading and investing ideas to consider?
Consider investing in Australian mining companies with high exposure to China, that will likely benefit from the reopening. As mentioned above, with China slowly reopening its economy, and resuming manufacturing activity in Shanghai tomorrow (Wednesday), it could be worth investing in companies that will likely benefit from this. So, think about Rio Tinto (RIO) earning 57% of its revenue from China (selling iron ore, aluminium and copper), BHP (BHP) earning 65% of its revenue from China (from iron ore, copper, and coal), and Fortescue (FMG) earning 88% of revenue from China (from iron ore). Other smaller companies to look at include Mineral Resources (MIN) that earns 9% of its revenue from China (iron ore and lithium). And even smaller companies like Iluka Resources (ILU) earning 34% of revenue from China. Syrah Resources (SYR), which earns 45% of revenue from China.
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