Summary: Market sentiment tipped sharply lower late yesterday after an earlier rally attempt in the US session on the news of sabotage of the Nord Stream pipelines in the Baltic sea. Elsewhere, the US 10-year treasury benchmark rose again and is pushing on the major 4.00% level, taking the USD higher and pressuring global liquidity. Adding further to weak sentiment overnight, the Chinese yuan slipped sharply lower as USDCNH broke above its longer term range highs of 7.20 established back in 2019 and 2020.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) US equities jumped higher out of the gates in early trading yesterday, but the action faded all day and the market closed back near the key cycle support, with the S&P 500 index even posting a minor new bear market low intraday below the prior 3637 mark on the cash index, as the news of the Nord Stream pipeline sabotage (see below) weighed, and US yields and the US dollar continued their ascent. Pivotal levels here for equities as we await further developments and consider end-of-quarter flows into Friday.
Hong Kong’s Hang Seng (HSIU2) and China’s CSI300 (03188:xhkg) Stocks traded in the Hong Kong bourse notably underperformed those in Shanghai and Shenzhen. Shares of public utilities fell from 3% to 5%. U.K. headquartered HSBC (00005:xhkg) and Standard Chartered (02888:xhkg) continued their slide, falling 3% to 4% for the day and 9% to 11% since last Friday’s post-mini-budget turmoil in the Pound Sterling and U.K. Gilts. Both Hong Kong and China developers plunged across the board, mostly by 1% to 5%, with CIFI (00884:xhkg) falling over 27% and being the largest casualty in the property space. CIFI, the 13th largest property developer in mainland China was said to have missed a payment on a project-related debt. CSI300 fell 1%, dragged by ferrous metal, electric equipment and defence industries while banks, textiles, food and beverage stocks outperformed.
Strong USD continues to rage. We have witnessed an historic move in the USD this month, with month-end and quarter-end drawing into view on Friday. Besides the massive, more than 8% meltdown in GBPUSD this month (trading sub-1.0700 this morning), a pair like AUDUSD has lost over 6.5% as of this morning’s exchange rate. The question soon has to be: when does this strong USD finally “break something” and bring an official response, whether coordinated or unilaterally from the Fed or the US Treasury? So far, there seems no sense of emergency, judging from comments yesterday by US National Economic Council director Brian Deese, who pushed back against the idea that the a Plaza Accord-like deal is under consideration.
USDCNH reaches all-time highs, intensifying strong USD story. The strong US dollar finally took USDCNH above the 7.20 area that defined major tops on two prior occasions in 2019 and 2020. The exchange rate traded as high as 7.239 overnight, the highest in the history of the offshore CNH currency. USDCNY has not traded this high since early 2008. The move comes ahead of a major holiday next week in China, with markets closed for the entire week, which will leave markets in limbo next week as USDCNY won’t trade.
Gold (XAUUSD) remain under pressure from the stronger US dollar and rising US treasury yields, perhaps showing resilience at the margin given that the precious metal failed to post new lows for the cycle yesterday or today even as the USD surges to new highs elsewhere. The next focus is perhaps the round 1,600 level if the selling continues.
Crude oil (CLU2 & LCOV2) recovers, European natural gas surges. Crude oil shifted focus back on supply worries with curbs in the U.S. Gulf of Mexico ahead of Hurricane Ian and with reports that Russia is pushing for the OPEC+ alliance to cut production. The group of oil producing nations is due to meet early next month to discuss its production plans. They already announced a cut to output for October by 100kb/d and have warned of further reductions amid falling prices. There has been reports that Russia is pushing for a cut to output of at least 1mb/d. Meanwhile, a pause in USD rally also helped to put a floor to the declines in commodity prices. WTI futures rose but still remained below $80/barrel while Brent futures were above $86.
US treasuries (TLT, IEF) US treasury yields rose once again after a brief and relatively sharp stumble yesterday, taking the 10-year yield to the symbolic 4.00% yield. It is worth noting that large round numbers on the yield often provide sticking points – for example, the 3.50% defined the top in June. Is this an important cycle top in yields or can they continue to power higher. The 4.00% level was also the stop for much of late 2008 and 2009. Yesterday saw a weak 5-year treasury auction despite the high yields.
What is going on?
Nord Stream pipelines severed, presumably an act of sabotage. Enormous upwellings of gas in the Baltic along the Nord Stream 1 and Nord Stream 2 pipelines in the Baltic Sea and detection of seismic activity that resembled explosions rather than earthquakes suggest that the pipelines were sabotaged to prevent the delivery of gas to Germany from Russia. The Nord Stream 2 pipeline was never operational, and the Nord Stream 1 deliveries had recently ceased. EU commissioner joined others in pointing the finger at Russia for the action, promising “the strongest possible response” if it is confirmed that Russia is behind the action. The development saw European natural gas jumping more than 22%, with Gazprom also issuing sanction warnings for Ukraine’s Naftogaz, which would prevent it from being able to pay transit fees, and therefore put at risk whatever little gas is still flowing to Europe via Ukraine.
Fed officials continue with a united hawkish voice. While inflation and higher-for-longer interest rates remain a key theme in all Fed commentary these days, there is also another common theme emerging. All three officials on the wires yesterday – Kashkari, Bullard and Evans – suggested that the US may avoid a recession. Kashkari (2023 voter), in an interview with WSJ, said he’s unsure if the policy is tight enough suggesting more rate hikes will be needed to bring down inflation. Bullard (2022 voter) said the US has a serious inflation problem and the credibility of the inflation targeting regime is at risk. Evans (non-voter) is optimistic the terminal rate the Fed has set out (4.6% median in Dot Plot) will be restrictive enough.
France releases ‘rosy’ economic forecasts for 2023. Yesterday, the French government published its economic forecast for 2022-23 as part of the parliamentary debate on the 2023 debate. The forecasts are overly optimistic. The Ministry of Finance expects that household investment (which mainly consists of the purchase and renovation of dwellings) will increase by 0.6 point over 2022-23 despite a jump of 250 basis points in the 10-year government bond yield and falling (or at best stagnant) purchasing power. We are a bit skeptical. We think that a sharp decrease in real estate prices is one of the less mentioned risks in France for 2023. This will be something to monitor very closely. It could seriously deepen the expected recession.
USDJPY testing 145, but yen crosses lower. Bank of Japan released the meeting minutes from the July meeting, understandably stale, but continuing to signal that easing intentions remain prevalent. Despite a further run higher in US Treasury yields with the 10-year touching the 4% mark, USDJPY has still remained capped below 145. More importantly, the yen is stronger against the EUR, GBP and AUD since the intervention on 22 September, and the contrast with the struggling CNH is particularly notable.
The World Bank downgraded its growth forecasts for China while upgrading the growth of Vietnam. The World Bank published its latest economic forecasts on Tuesday, cutting the 2022 growth rate of China to 2.8% from its previous forecast of 5%, and the 2023 growth rate to 4.5% from 4.8%. On the other hand, the supra-national bank raised Vietnam’s growth rate in 2022 to 7.2% from the 5.3% forecast released in April. It also raised the 2022 growth forecasts for the Philippines to 6.5% from 5.7% and Malaysia to 6.4% from 5.5%. Excluding China, the East Asia, Pacific region is forecasted to grow 5.3% in 2022 and 6.0% in 2023, which will be, for the first time over the past three decades, higher than the growth rates in China.
BHP takes advantage of sterling slump and redeems notes more than half a century early. Despite the iron ore (SCOA) price falling 1.4%, to its equal lowest level this year (US$95.90), BHP shares in Australia rallied to a three-day high after the mining giant paid off debts earlier than expected. BHP took advantage of the slump in the sterling against the USD, and used its record profits to redeem pound-denominated notes (due in 2077). This resulted in BHP effectively paying down $643 million of notes early. Last month BHP reported net debt of just $333 million. BHP also announced mining expansion plans. From exploring options to mine copper at Cerro Colorado beyond 2023, with Chilean regulation easing, to also seeing huge commodity upside in Peru, and spending $12m on exploration there over 10 months. Meanwhile, BHP also affirmed it’s working toward bringing forward production for its new potash (fertilizer) business to 2026.
BOE Chief Economist Pill also pushed back on inter-meeting rate hike. Huw Pill said the UK’s government’s fiscal announcement and the market reaction that followed it requires a significant monetary policy response, but the best time to assess and react to their impact is at the institution’s next meeting in November. He acknowledged the challenge to the bank’s inflation goal arising from the loose fiscal policy, while also saying that the bank’s program of government bond sales should go ahead as planned next week if the market repricing stays orderly, as has been the case in recent days. However, it is worth noting that BOE’s November 3 meeting is still before the medium-term fiscal strategy is announced, and if that contains significant spending cuts, the budget may prove contractionary, especially given the rise in yields.
US consumer confidence beats expectations. Lower petrol prices and a tight labor market possibly aided a rebound in sentiment, but high inflation and interest rates will continue to constrain consumer spending in the fourth quarter. Meanwhile, 1yr consumer inflation expectations declined to 6.8% (prev. 7.0%), but still remaining significantly higher than the Fed’s 2% goal. In other data, US durable goods order fell 0.2% in August, still coming in better than expected while new home sales rose to the strongest pace of sales since March to 685k in August, above the expected 500K and prior 532k (revised up from 511k).
What are we watching next?
End of quarter rebalancing? We have seen aggressive moves across markets this quarter, to say the least, which brings the question of whether significant rebalancing flows are set for the quarter end this Friday. The relative bond performance has been perhaps worse than that for equities, while in FX the focus may be on possible rebalancing after a tremendous USD upsurge in Q3.
Earnings calendar this week The chief action this week is up tomorrow as H&M, Nike, and Micron Technology deliver earnings reports, with the earnings from Micron the most interesting to watch as we already know H&M and Nike are seeing weak demand. Micron has exposure to the consumer electronics industry and manufactures memory chips in Asia which means that the company sits in at the intersection of many interesting trends.
Economic calendar highlights for today (times GMT)
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2024: The wasted year
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.
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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.
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