Summary: Soaring crude oil prices are lowering the outlook for real economic growth and central banks can do little to address the situation, just as a coordinated release of strategic reserves failed to halt the ramp up in prices yesterday. Prices rose another six dollars per barrel overnight, with no credible response to the supply pinch from US President Biden indicated in his first State of the Union address. Today, market focus remains on the risk of contagion risk in the global financial system stemming from sanctions against Russia, and on Fed Chair Powell testimony before Congress.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - US equity futures are following European equity futures lower with S&P 500 futures trading around the 4,285 level after being rejected at the 4,400 level in yesterday’s session. The market continues to prefer crypto-related assets, cyber security, defence, logistics, commodities, and mega caps stocks. If risk-off takes hold today the 4,200 is a big psychological level to watch but the previous trading sessions’ lows are on the way to 4,200 the natural support levels to watch. Biden’s State of the Union speech last night could positively impact energy and defence stocks going forward.
Hong Kong’s Hang Seng Index (HSI.I) & China’ CSI300 (000300.I) - Both Hang Seng and CSI300 fell about 1%. Baidu (09888) surged over 8% after reporting results yesterday. Baidu’s Q4 revenues rose 12% YoY and EPS declined 42%, beating analyst estimates. Meituan (03690) rose 3%. Oil stocks did well while banks were sold. CNOOC (00883) rose 3%. HSBC declined 5%. In February, Li Auto (2015) delivered 8,414 vehicles (+265.8% YoY), better than expectations and peers. XPeng (09868) and Nio (NIO) delivered 6,225 (+180% YoY) and 6,131 (+9.9% YoY) vehicles respectively. Li Auto was up 0.7% while XPeng was down 4%. With more tightening in COVID-19 measures to come in Hong Kong, reportedly including potential restriction on people to leave their residence, HKEX (00388) fell around 3%.
European equity markets – more pressure in European equities with Euro STOXX 50 futures trading at the 3,730 level as tightening commodity prices will squeeze Europe’s economy and the companies. Even lower interest rates at this point are insignificant for equities as the range of outcomes and the uncertainty from the war in Ukraine are just too big hence why we remain defensive.
EURUSD, EURJPY and EURCHF – Europe is bearing the brunt of the impact from Russia’s assault on Ukraine, as energy and power prices soar, and its financial system deals with the fallout. German Bund yields plummeted below 0% yesterday and all thoughts of ECB tightening have been kicked down the road even as inflation risks soaring further on the latest rise in energy prices. Watching the 1.1100 area lows in EURUSD, 127.50-128.00 zone in EURJPY and EURCHF for further downside risk - to perhaps as low as 1.07-1.08 in EURUSD on any new round of widespread deleveraging.
AUDUSD and USDNOK – recent market action has seen considerable resilience in commodity-linked currencies like the Aussie and NOK, which have held their own against traditional safe havens like the US dollar even as market volatility has spiked. Traders are clearly considering the robust fundamental support for these currencies on soaring energy (NOK and AUD – Australia is the world’s leading LNG exporter) and food (Australia a top-six global wheat exporter). But can this resilience continue should markets switch into a proper deleveraging moment that sees indiscriminate selling of risky assets as investors head for safety? Watching the key resistance zone in AUDUSD at 0.7250-0.7300 as a key indicator for answering this question.
The European Carbon Emissions trading system (CFIZ2) has tumbled by 30% during the past month and yesterday’s 16% drop was the worst in almost a decade. The system was originally put in place to speed up the green transformation by acting as a tax on higher polluting fuels such as coal and gas, and in recent months, the contract attracted an army of speculators, believing this was a one-way bet with the price only expected to go up. The Russian conflict and with that punitively high gas prices has started to kill industrial demand for power thereby reducing demand for pollution offsets. In addition, the general rise in margin cost on other positions potentially also a source of selling while Italian business lobby has called for a suspension of the EU carbon market. The slump was arrested after the price found support at the 200-day moving average at €67/tons.
Crude oil (OILUSAPR22 & OILUKMAY22) has surged higher with a drop in Russian supply highlighting the fact the global oil market has moved to a more dangerous stage. Yesterday, a major independent oil company offered Russian Urals $18.6/b below Brent with no takers, and it highlights how potentially up towards 2 million barrels per day of Russian crude may struggle to find a buyer amid sanctions and rising shipping costs. IEA warned that global energy security is under threat while a decision by the US and other major consuming nations to release 60 million barrels from SPR underwhelmed the market. Futures buying is concentrated at the front resulting in spreads blowing out. Examples being the Brent prompt spread trading close to five dollars per barrels while the one-year spread has reached $21.5/b, a level not seen since the Gulf war several decades ago.
Gold (XAUUSD) reached its highest closing level in 13 months yesterday in response to increased haven demand and a sharp reversal in US inflation adjusted yields. The US 10-year real yield has collapsed to –0.97% in response to rising inflation expectations (breakeven) and falling nominal yields as investors seek shelter from the unfolding turmoil across global markets. The number of expected US rate hikes continues to collapse and with inflation expected to remain elevated as growth slows, the risk of stagflation is rising, a development that will support demand for hard assets such as gold and silver.
US Treasuries (TLT, IEF). The market pared back on rate hike expectations aggressively yesterday. The Fed’s peak rate is expected to be at 1.7% versus 2.5% the central bank’s long-term estimate. Such change of sentiment caused a deep rally in US Treasuries which saw 10-year yields falling to 1.7%. There starts to be fear that a less aggressive Fed will not be able to curtail inflation, driving the economy to a stagflation army state. The focus continues to be on Fed’s officials and what the market can expect from the FOMC meeting this month as inflationary pressures soar, but the economic outlook remains uncertain. Jerome Powell will testify before the House Committee on Financial Services today and before the Senate Banking Committee tomorrow. On Friday, the market will be waiting for the non-farm payrolls and average hourly earnings. Volatility will remain high as the market continues to weigh whether inflation or growth is going to be at the forefront of monetary policies.
European Sovereigns (VGEA, BTP10). The bid for safe-havens continues to compress yields in the euro-area as the ECB looks to prepare for a dovish March monetary meeting. Now the market expects the ECB to hike interest rates by 25bps in March 2023 instead of December this year. The biggest gainers were Italian BTPS with the BTPS/Bund spread falling below 150bps. Today’s focus will be on the eurozone CPI numbers and ECB’s official speakers before the blackout period on Thursday.
UK Gilts (IGLT). Gilt yields dropped the most since the Brexit Referendum in June 2016. Markets are paring back rate hike expectations, now pricing only 25bps hike in March and a total of 100bps hikes watching December versus August previously. The yield curve will continue to shift lower as investors fly to safety and markets expect less aggressive monetary policies.
US Corporate space (HYG, USIG). Corporate bond spreads continue to widen, the primary market resumed issuing high yield bonds although the pipeline remains light. The CDX HY spread soared to 380bps the highest since October 2020. Credit spreads look poised to widen even more.
What is going on?
US President Biden’s first State of the Union address underwhelms. President Biden opened the speech with a broadside against Russian president Putin and Russia’s invasion of Ukraine, but saw no specific warnings on how the US would escalate its efforts based on Russian behaviour in Ukraine outside of further sanctions against the Russian regime’s leadership and the Russian economy. Much of the address was aimed at addressing inflationary pressures and initiatives he claimed would address the rise in prices, including the rather odd combination of rising social spending and climate change-related spending, essentially doubling down on the previous legislation plan that failed to pass the Senate.
Russian assault on Ukraine intensifies, as does scale of disengagement with assets and operations in Russia by foreign companies and investors. US oil giant Exxon has halted its operations at a project in far eastern Russia and is looking for a way to exit the project entirely, many companies are unwilling to take on loads of Russian crude for export, and major US companies are entirely halting product sales to Russia, including Apple, Nike and Ford. Elsewhere, major equity indices are eliminating Russian equities from their indices and clearing companies are making it difficult to even liquidate existing Russian assets, much less buy new ones. South Korea and Japan have joined in sanctions against Russia’s central bank. The USDRUB exchange rate has “stabilized” in the 105-110 area after dropping about 25% to start the week in the wake of the announcement of sanctions over the weekend.
German CPI for February continues to rise. It was out at 5.1 % year-on-year versus prior 4.9 % - aligned with consensus. The two main factors pushing prices higher are energy (+22.5 % year-on-year) and, to a lesser extent, goods (+7,9 % year-on-year). Expect that today’s eurozone CPI for February to be painfully high. According to the economist consensus, it could reach 5.3 % versus prior 5.1 %. The report will cover the period before the recent increase in energy prices related to the invasion of Ukraine by Russia. It is likely that inflation will jump more substantially in March. We estimate that the ongoing events in Eastern Europe could add one percentage point to inflation this year.
Earnings recap. Zalando disappointed yesterday with only a 12-19% revenue growth range this year and little uplift in operating margin. Salesforce delivered in line with estimates and shares were up in the extended trading indicating that the market was clearing prepared for bad news. Sea’s operating loss widened in Q4 despite strong revenue growth, and the market was able to look past that due to a much better than expected revenue guidance for 2022.
Supply disruptions continue to weigh on U.S. manufacturing activity. The ISM manufacturing index rose to 58.6 in February. The main drivers were new orders and production. This reflects solid demand. But the inadequate amount of supply continues to have a negative effect on the overall activity.
What are we watching next?
Fed Chair Powell testimony today and tomorrow after Biden State-of-the-Union address. With energy prices soaring and US President Biden strangely talking up climate spending and social spending as a way to fight inflation in his first State of the Union address, what can the Fed offer to do as the rise in energy, food and other prices is rapidly tightening financial and economic growth conditions even before the Powell Fed has had the chance to kick off its rate tightening cycle. Its tools have no sway over the current drivers of the rise in commodities prices, even if they can perhaps slow other areas of the economy. We’ll watch Powell’s testimony closely for how the Fed interprets the current backdrop and whether more caution is creeping into the outlook due to the impact on the growth outlook. The market has shifted to pricing less than 100% odds of a rate hike at the FOMC meeting in two weeks.
Bank of Canada decision today – the rate decision today comes at a difficult time for the BoC, as galloping energy and commodity prices are lowering the outlook for real economic growth. The market is pricing near certainty that the bank hikes the policy rate today for the first time for the cycle by 25 basis points to take the rate to 0.50%, and traders will focus on guidance from the bank today.
Earnings Watch. Today’s key focus is on Kuehne + Nagel and Snowflake that represent logistics and speculative growth stocks respectively.
Economic calendar highlights for today (times GMT)
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2024: The wasted year
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
