Market Quick Take - September 27, 2021

What is our trading focus?

Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - S&P 500 futures continue higher this morning having firmly broken above the prior two trading sessions’ highs. If momentum can continue the next resistance level sits at 4,489. We struggle to understand the underlying dynamics of the current risk-on sentiment given the brewing energy crisis that is spreading worldwide hitting production in China and causing a crisis in the UK.

Hang Seng (HSI.I) - Chinese equities have stabilised over the past week and DBS CEO says that Asian banks have limited exposure to Evergrande so the contagion risks according to this Singaporean bank are not as bad as feared. As with equities in Europe and the US, we think the brewing energy crisis in China is a bigger risk to economic growth and equity valuations as it drives inflationary pressures. The Hang Seng is boxed into a trading range from 24,000 to 25,000.

EURUSD – the euro is trading sideways after the results of the German election, which were inconclusive and make it clear that forming a ruling coalition will likely prove difficult and policy initiatives may prove weak on conflicting agendas of the eventual components of the coalition. Focus this week could revert to US treasury yields, which could help continue to support a move higher in the US dollar and in any case, EURUSD looks heavy, ready to extend lower to possibly 1.1500 if the 1.1664 range support gives way.

USDJPY and JPY crosses – after a big jolt to long treasury yields late last week that sent the JPY tumbling, the currency could continue to get a lot of focus this week, particularly as USDJPY has been compressed into an impossibly restricted range and a more determined move higher in yields could spark more volatility across currencies, led by JPY crosses. EU yields are less likely to act as a leader if the process of building the new German government coalition in the wake of the election proves a long and difficult process. Technically, the key area in USDJPY is 111.00 to 111.66, the pivot high from July.

Gold (XAUUSD) trades higher after finding support in the $1745 area. With real yields and the dollar not providing any support currently, the bounce seems to be driven by continued Evergrande angst and the global energy crunch which is spreading from gas and coal to crude oil, and which in our opinion could reignite the reflation trade, thereby supporting gold at a time where bonds safe-haven status is challenged given the prospect for early tapering. Speculators are not positioned for a potential bounce in precious metals after making deep cuts last week, most notable in silver (XAGUSD) where the net long collapsed by 94% to just 900 lots, a 27-month low. Focus this week on CPI date as well as US stimulus package and debt ceiling.

Crude Oil (OILUSNOV21 & OILUKNOV21) continues higher as the global energy crunch that started in the gas, coal and power market has spread to crude oil as users around the world start to switch fuels. Together with a vaccine-led rise in demand, Hurricane Ida related supply disruptions, and OPEC+ not being able to deliver the promised production increases, these developments are likely to underpin prices into the northern hemisphere winter. WTI trades above $75 while Brent at a fresh three-year high is closing in on $80, with Goldman Sachs lifting its year-end forecast by $10 to $90. In addition, the monthly Brent chart shows a break above the downtrend from the 2008 record high, potentially signaling a move to the October 2018 high at $86.75. Increased focus on OPEC+ and their October 4 meeting.

US Treasury yields remain in a fast area which could lead them to test the 1.5% level (IEF, TLT). US Treasury yields remain vulnerable to high inflation readings. Yet, strong demand from the Federal Reserve and foreign investors are poised to continue to underpin them amid fears of a global slowdown stemming from China’s Evergrande. Today, the Treasury sells 5-year notes, but the market's focus will be on tomorrow’s 7-year auction. The same auction sparked a deep selloff within the bond market in February. We expect demand for US Treasuries to remain high during this week’s auctions, however, the election in Germany, as well as GDP and PCE on Thursday and Friday, could increase volatility and help US yields higher.

German Bund yields remain vulnerable to news coming from the German election (IS0L). Last week, 10-year Bund yield broke above a key resistance at -0.25%, closing the week at -0.23%. Therefore, they remain in a fast area, leaving them vulnerable to noises coming from a close German election. We expect Bund yields to turn positive by the end of the year, however there is potential for them to drop once again below -0.25%, depending on how long negotiations for a new coalition take. In the meantime, US Treasury yields will continue to influence Bund yields direction, most probably contributing to higher yields.

What is going on?

German election sees weaker result than expected for left-leaning parties, with the center-left and far left gaining insufficient support to form a majority coalition, and the CDU/CSU stumbling badly to a new record low result of 24.1%, although this was considerably better than many polls suggested heading into the election. In the wake of this election, majority coalition building will prove complicated, with the key to watch the “kingmaker” parties like the Greens and the liberal FDP, who could theoretically team up with either the social-democratic SDP to form a “stoplight” coalition, or with the CDU/CSU to form a “Jamaica” coalition instead. Either way, a coalition looks difficult as the FDP and Greens are far apart on key issues, while the CDU/CSU and SPD are clearly against forming another “grand coalition”. The process is likely to take months.

UK Prime Minister Johnson considering mobilizing army resources to relieve petrol crisis, potentially using army personnel to drive fuel tankers around the country after UK petrol stations are running dry of fuel on panic buying.

COT on commodities in the week to September 21 saw funds respond to pre-FOMC jitters and not least the potential fallout from China Evergrande’s debt problems by cutting bullish bets across 24 major futures markets by 7% to 1.87m lots, a 13-month low. This despite seeing the Bloomberg Commodity Spot index, which does not include surging EU gas, coal and power prices, near a ten-year high.  Net selling was seen across all sectors led by natural gas (-53.5k), gold (-25.8k), silver (-13.2k) and copper (-13.3k). Selling across the agriculture sector extended into a fifth week, albeit at a slower pace than in recent weeks.

COT on forex markets showed the speculative flow being substantially skewed toward dollar buying. Overall, the dollar long against ten IMM currency futures and the Dollar Index jumped by 39% to $15.8 billion, a 21-month high. All the major currency pairs except JPY were sold with the most notable flows being sales of euros and CAD.

What are we watching next?

Inflation data this week – as we are set for the September inflation readings for CPI from German and the EU on Thursday and Friday, respectively and for the US Aug. PCE inflation data point on Friday (the Fed uses the PCE series as its chief gauge of inflation). The psychology around inflation looks critical for this market, also as fossil fuel prices, from soaring natural gas to new significant highs in crude oil benchmarks, are another key focus.

US stimulus packages/debt ceiling in focus this week - the situation with the US stimulus packages in play is very complex, but the chief question is whether some progressive Democrats will follow through on threats to vote against the $550 billion infrastructure bill passed by the US Senate if it is not linked with the larger $3.5 trillion social- and climate- spending bill that contains the bulk of their agenda. House Speaker Pelosi had promised a vote on the bill today, but that has been delayed until Thursday. On top of this is the debt ceiling issue, with the US financial year ending on Thursday and no resolution passed to continue funding the government beyond that date, which will require a “stop-gap” measure of some kind and an eventual lifting of the debt-ceiling or a US default is theoretically possible some time in October. This is extremely unlikely, but Congress could uncomfortably extend the suspense until the issues is resolved as in 2011 and 2013.

Economic calendar highlights for today (times GMT)

0730 - Sweden Aug. Household Lending
1145 – ECB President Lagarde at EU Parliament hearing
1200 – US Fed’s Evans (voter) to speak
1230 – US Aug. Preliminary Durable Goods Orders
1300 – US Fed’s Williams (voter) to speak
1430 – US Dallas Fed Manufacturing
1500 – Bank of England Governor Bailey to speak
1600 – US Fed’s Williams to speak
1650 – US Fed’s Brainard (voter) to speak
0130 – Australia Aug. Retail Sales

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