Equities: New extremes and a challenging opportunity set
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Head of FX Strategy
Summary: Markets are in a positive mood as the energy price spike has partially reversed, the US debt ceiling issue looks to have been punted down the road a couple of months, and as long term yields are orderly. Hard to believe that the market can have its cake and eat it too here, but the US dollar is on its back foot here on the combination of risk sentiment reviving while US longer dated US treasury yields remain below recent highs.
FX Trading focus: Market hoping for a goldilocks vibe.
The powerful reversal in energy prices after Russian president Vladimir Putin claimed yesterday that Russia is ready to supply the market with gas has dramatically improved sentiment in Europe and in generally risk-correlated FX, although you can’t see much of that improvement in the euro, where the dovish ECB holds back upside potential. Also supportive of risk sentiment is the US Senate apparently readying to punt the debt ceiling issue out to December, while treasury yields have remained orderly at the long end of the yield curve despite the general relief and the very strong Sep. US ADP private payrolls change yesterday, at +568k. That strong report may nudge expectations higher for the official Nonfarm payrolls change number tomorrow, which, together with the Average Hourly Earnings data is the next test for whether a kind of brief “Goldilocks” interlude can be achieved here in which yields remain tame at the long end of the curve and the energy crunch story fades for now, helping to relieve concerns of stagflationary outcomes.
I’m not a fan of the idea – but we just may have a window if the US jobs report is sufficiently boring. Surely a reasonably strong US jobs report surely sees a fresh pull higher in US yields? Let’s see, Powell spelled out at the press conference of the September FOMC meeting that the Fed doesn’t need a particularly strong report tomorrow to move forward with a QE taper, but if we get a very strong report, together with much higher than expected average hourly earnings, this could affect the pace of tapering and jolt this market.
The ECB is said to be studying how to continue doing QE beyond the telegraphed expiry date of March of next year to their PEPP program. Maybe it should consider funding some resilience in the EU’s energy supply system, although given Lagarde’s focus on the climate, linking the next round(s) of QE to the climate agenda wouldn’t be a huge surprise.
Sterling is on the brink of key resistance in GBPUSD as the 1.3600+ area the was so important on the way down has been in play in recent sessions. Prime Minister Boris Johnson’s speech yesterday seemed to make a solid impression on BoE rate expectations as he talked up the Conservative “Build Back Better” and “Leveling up” platform. Just over the last few weeks, UK 2-year rates have outpaced EU rates by more than 20 basis points as rate hike anticipation from the BoE rises. The UK-EU spread is around 118 basis points today and at its widest level in more than two years (the high in this spread since way back in 2007 is a mere 138 basis points – we’re almost there). Against the US, the UK 2-year spread is also widening – with the UK-US rate spread rising a further 15 basis points in under a month to reach the current level near 35 basis points. I doubt sterling is responding as much to these developments as it is to the relief on the energy crunch/risk sentiment side of the equation, which seems to dominate the correlation with GBPUSD more so than yield spreads, even if the latter certainly don’t hurt and get more focus if risk sentiment continues to improve. Regardless – the 1.3600-50 area in GBPUSD and the 0.8450-0.8500 zone look pivotal for whether sterling can achieve a new lift-off in coming days and week or whether it is brushed back lower on the fears that have seen it underperforming the rate rise developments this year – including Brexit uncertainties, lower real rates, and capacity constraints in energy and transport and supply chain infrastructure. The huge correction in energy prices is especially a relief for the import-reliant UK.
Interesting to note RUB rising as gas prices are crushed – the market rates the overture from Putin to supply gas (clearly contingent on NordStream 2 pipeline becoming operational) far higher than the fact that oil and especially gas prices have cratered in the wake of his move yesterday. USDRUB trades below the September lows this morning and only has the June low-water market remaining as a range support down just above 71.5.
Poland surprises with a rate hike – 50 more bps in November? The inflationary pressure was apparently too much to bear for National Bank of Poland, which surprised the market yesterday with a rate hike of 40 basis points to take the policy rate to 0.50%. This came after the bank had signaled that it would wait for the November meeting and new forecasts on inflation before moving. It also came after the minutes of the prior meeting showed a motion to hike by 190 basis points to take the rate to 2.00% in one go was voted down and shortly after Governor Glapinski said earlier this week that policy normalization could be on hold until as long as 2023. Huh? Last Friday, the September CPI headline reading was a heady 5.8% year-on-year versus 5.3% in August and the NBP apparently decided it was simply time to act, perhaps to cover political risks as some have pointed out that just hours before the announcement, Poland’s prime minister said the inflation is “worrisome”. Guidance from the meeting was generally lacking on further hikes, though a reference to continuing the bank’s bond-buying program was removed.
Table: FX Board of G10 and CNH trend evolution and strength
Not much life in the Euro even with relief on the energy price front since yesterday. Sterling is doing what it can to remain interesting – needs another half percent or a bit more versus the USD and EUR to turn the tables. Elsewhere, CAD and NOK strength holding on reasonably well, but could be in for rough sailing if the energy reversal deepens.
Table: FX Board Trend Scoreboard for individual pairs
Note AUDUSD vying to reverse to an upside move as it trades near local 0.7300 area resistance.
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