Summary: Equities sold off hard yesterday late in the US session and were weaker still overnight, closing below their 100-day moving average and at the lowest level in more than two months. In Asia overnight, Chinese markets were closed, while other markets showed signs of contagion from the US, with the Nikkei 225 suffering its worst session in more than three months as yields edged lower and the JPY firmed. Energy prices surged higher on reports China's Vice Premier had ordered energy firms to secure winter supplies at all costs.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - a weak session yesterday in US equities pushing lower amid VIX rising above 23 as the global energy crunch is significantly bursting the transitory inflation narrative. The marginal cost of energy is exploding causing great damage to the global economy and inflation will stay elevated for quite some time. Equities are risking a sudden big move in interest rates and change in sentiment, so investors must be prepared for a much more volatile period with extensive declines in equities. This morning, Nasdaq 100 futures have pushed below the 100-day moving average this morning trading around the 14,570 level. The previous big local top in April around the 14,000 level is the next big support level. In S&P 500 futures the next big support level is at 4,200. The only thing that matters today for risk is where energy and power prices go.
EURUSD – EURUSD followed through to new lows well south of 1.1600 yesterday, possibly setting up a run further south toward 1.15000 and points further – even into the next key retracement level of 61.8% down at 1.1290 if this risk deleveraging continues, which tends to favour the US dollar, although the euro enjoys a degree of liquidity that makes it less vulnerable than the smaller currencies or sterling if conditions get particularly rocky.
USDJPY and JPY crosses – with this latest episode of risk deleveraging across markets, US treasuries and traditional safe havens like the JPY held firm for now, such that JPY crosses reversed back lower in yesterday’s trade, with USDJPY reversing after testing the new cycle highs and other JPY crosses looking at support suddenly rather than local resistance. GBPJPY, for example, is perched near the cycle lows and is near a support line established since February near 149.00, while EURJPY is suddenly not that far from its own major low near 128.00. Ideal conditions for further JPY strength would be deepening risk-off with yields stable or even falling rather.
HG Copper trades lower for a fourth day as widespread power shortages in China and the debt crisis within the property sector have reduced industrial activity, thereby potentially lowering the demand outlook for copper and other metals such as nickel, tin and zinc. The mentioned developments helped drive the first contraction in Chinese Manufacturing PMI in 19 months last month, thereby adding further pressure to the metal sector with the Bloomberg Industrial Metal index heading for a five-week low.
US yields consolidate amid month-end buying, however the PCE index and the University of Michigan survey today might spark bearish sentiment (IEF, TLT). Sentiment in the US Treasury market improved yesterday, and yields fell below key levels with 10-year yields dropping below 1.5%. However, today’s PCE deflator and the University of Michigan survey are in the spotlight as they might show signs that inflation is less transitory than expected ultimately forcing the Federal Reserve’s hand into tighter monetary policies.
What is going on?
US House delays vote on infrastructure bill - a clear sign that the votes weren’t there to pass the bill as progressives within the Democratic party are using their leverage to defeat the bill unless the party continues to look to pass the larger $3.5 trillion social- and climate spending bill, which moderate Democrats want to significantly reduce in size. A vote may be held today on the bill, but most likely only if House Speaker Pelosi has the votes.
Prices for silicon metal are up 300% in under two months, with the rise due to a production cut in China, the world’s largest producer, as a function of the power crunch there. Silicon is used in everything from semiconductors to solar panels and car parts and a plethora of other industrial uses.
Czech central bank hikes 75 basis points, more than the 50 bps expected – as it made a clear signal on fighting inflation. This sent EURCZK toward the low of the range into the 25.25 area. The bank’s policy rate is now 1.50%.
Polish Central Bank minutes show a decision to hike 190 basis points rejected – but the mere consideration of such a move, to take the policy rate to 2.00% was considered hawkish and boosted the zloty sharply. The central bank is trying to bide its time as long as possible for making a decision on whether inflation is an immediate concern, and it is clear that the November policy meeting will prove pivotal, with its inflation and other projections.
Energy prices from crude oil to natural gas and coal all traded higher yesterday after China’s Vice Premier Han Zeng ordered the country’s top state-owned energy companies to secure supplies for this winter at all costs. China is just like the rest of the world running low on fuels to get them through the winter. The central bank and government sponsored overstimulation of the global economy during the past 18 months led to a surge in demand for consumer goods, many of which are produced in China. The result has been surging shipping costs, supply chain disruptions and a 16% jump in Chinese electricity demand as production surged to meet all the additional orders from consumers around the world. The result has been a severe energy crisis in which several regions are curtailing power to the industrial sector. Over in Europe we are faced with some of the same problems resulting in record high prices for gas, power and emissions used to offset the higher usage of coal.
Inflation nightmare is here in the eurozone. In September, German inflation came in at 4.1% year-on-year, from 3.9% in August. This is partially explained by the full base effects from a VAT reversal but by higher energy prices and supply chain disruptions too. Given the increasing risk of energy crunch in Europe together with persistent inflationary supply chain snags, Germany headline inflation is likely to get close to 5% by year-end. Expect ECB hawks to get out of the woods and call for a swift exit from emergency monetary policy measures. In France, headline CPI reached 2.1% year-on-year. This is the highest level in ten years.
Mixed U.S. data. U.S. Q2 real GDP grew 6.7% between April and June, up slightly from the previous estimate of 6.6%. The U.S. economy is now above pre-Covid level. Consumer spending and business investment are above path too. But investors are more interested in Q3 growth. Expect Q3 GDP to disappoint due to the fourth following factors : 1) Covid resurgence ; 2) spike in inflation ; 3) chip shortage hitting auto and other supply chain disruptions and ; 4) hurricane Ida. The end of emergency employment benefits together with the resurgence of the pandemic seem to have done some harm to the labor market. New claims for U.S. employment benefits increased for the third straight week, to 362,000 in the week ended 25 September. This is once again above expectations.
The UK furlough scheme ended yesterday. About 9 million people were on the scheme at peak. This large government economic intervention cost around £70bn. It represented around 20% of all UK government Covid response spending. The Bank of England expects the official unemployment rate to slightly increase following the end of the furlough scheme.
What are we watching next?
Chinese markets are closed from today and through Thursday for Golden week which comes at an interesting time with the huge policy shifts there and ongoing energy crunch, while the Chinese currency has been kept in a very narrow range against a very strong US dollar. China returning from the holiday late next week could market a key moment.
US stimulus prospects are a signal on whether US fiscal cliff will prove bad or really bad - We’ll watch closely for whether the US Congress is able to get any of the stimulus bills through to President Biden’s desk and if not, consider whether there is any chance of the US avoiding a massive “fiscal cliff” as the emergency spending from the pandemic time-frame fades and may not be offset by consumers spending out of its significant savings next year. Complicating the picture is the weak prospect of “real growth” as prices are far higher for consumers in this economy than they were a year and more ago.
Economic calendar highlights for today (times GMT)
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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.
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