Summary: Fed Chair Powell’s dismissal of a 75 basis point rate hike for now suggests room for Fed’s hawkish surprises is getting restrained, but the relief rally remains at risk of reversal as the liquidity tightens. China’s disappointing April services PMI may be hinting at a dismal Q2 GDP print. Battery mineral/Lithium companies are charging higher in Australia, and emerging markets are feeling the pinch from higher food prices and embarking on/elongating their tightening cycles.
What’s happening in markets?
US relief rally. The Fed rose rates 0.5% (50bps) as expected (the biggest hike since 2000). As the move was as expected and the Fed Chair said policy makers may consider a Fed funds rate that is neutral for the economy (of between 2-3%), sentiment got a boost, as that has been baked into market expectations already. Although we think rates could rise higher than that, markets enjoyed the certainty from Powell and the mood was risk on. The Nasdaq 100 (USNAS100.I) rose 3.2%, the S&P 500 (US500.I) gained 3%, which was the best-Fed day return since 2011. Short term risk on could continue until the tone changes. If next week’s US inflation data (released Wednesday, May 11) is hotter than expected then sentiment will likely fade and stocks could take a fresh haircut. Medium to long-term returns are expected to be weak though, as the economy is expected to shrink and earnings are below historical averages.
Asian equities follow Wall Street gains after Powell remains less hawkish than expected. Equity markets in Asia traded higher on Thursday amid a healthier risk mood after Fed’s 50 basis point hike was accompanied by a less hawkish tone than what some had feared. Markets were relieved with Fed Chair Powell ruling out a 75 basis point hike for now but the mood was soured after a sharp fall in China’s Caixin services PMI. Singapore’s STI Index (ES3) was in gains of nearly 0.5% in the morning as Yangzijiang Financial Holding (YF8) reversed yesterday’s losses and Thai Beverage (Y92) was higher on IPO plans for its brewery unit BeerCo in Singapore.
Shanghai and Shenzhen returned from a long holiday with modest gains in stocks. CSI300 (000300.I) rose 0.4%. E-commerce, agriculture and pharmaceuticals gained. CATL (300750) shares fell 7%, reacting to the disappointed Q1 results the Company reported before the long market holiday. JD.COM (09618) announced a special cash dividend of US$2 billion, implying a 2% dividend yield. Hong Kong Hang Seng Index (HSI.I) gained 0.6% and Hang Seng TECH Index (HSTECH.I) rose 1.5% on another round or rhetoric from Chinese authorities to pledge support to the economy. The addition of 88 Chinese companies by the U.S. SEC to the list for potential delisting does not made much negative impact on these companies’ shares traded in Hong Kong this morning.
The Australian share market rises 0.7%, while scratching beneath the surface lithium miners charge. The ASX200 rose for the first time in four days, after the Fed rose rate as expected and was a little less hawish than expected. Battery mineral/Lithium companies like Liontown Mining (LTR), Chalice Mining (CHN), Pilbara Minerals (PLS), AVZ (AVZ) are up over 6% after two of the world’s biggest lithium companies (Albemarle and Livent in the US) upgraded their annual earnings forecasts expecting higher lithium prices in 2022.
Powell saving ammunition. With a 75bps hike ruled out for now, it is clear that Powell is saving ammunition as inflation is unlikely to come down anytime soon and going too fast will mean going way above the neutral rate later and risking a hard landing. That being said, Powell has not ruled out going higher than the neutral rate or causing economic pain/modest recession in the process of taming inflation. In his press conference, Powell was heard praising the former Chair Paul Volcker who had raised rates to 20% in late 70s/early 80s to crush inflation and caused a recession. It is possible that we will start getting back to a hawkish rhetoric again from Fed spokespersons in the weeks ahead.
Crude Oil (OILUSJUN22) and Wheat (WHEATJUL22) higher. Crude oil jumped higher as EU announced a new package of sanctions on oil form Russia. Crude oil imports will be phased out in 6 months, while refined products by end of 2022. WTI remained just short of $109 and Brent breached $111. OPEC+ meeting scheduled for today, and only a small production increase can be expected. Wheat, meanwhile, was higher due to the rising likelihood of India’s export curbs as output is seemingly expected to be lower than what was previously expected.
Takeovers in the air. Australia’s biggest airline, Qantas (QAN) will buy the rest of Australia’s resource airline Alliance Aviation Services (AQZ) that it doesn’t own (80%) for $4.75per share. On the back of the A$763 million takeover, AQZ shares soared 23% on the news. Alliance Aviation operates charter flights for the resources industry, operating 70 jets that fly resources personnel typically in and out and Western Australia for companies like Fortescue Metals (FMG) and BHP (BHP).
What to consider?
U.S. SEC adds 88 Chinese companies to the list of ADRs that are provisionally subject to delisting from U.S. exchanges. Companies that are added to the list include: JD.com (09618), Pinduoduo (PDD), Bilibil (09626), NetEase (0999), XPeng (09868), NIO (09866), Huaneng Power (00902), Aluminum Corporation of China (02600), Full Truck Alliance (YMM), Tencent Music(TME), Autohome (02518), Huazhu (01179), ZTO Express (02057), Trip.com (09961), China Eastern Airlines (00670), China Southern Airlines (01055), China Mobile (00941), Youdao (DAO), Baozun (09991), Sinovac Biotech (SVA), Sinopec Shanghai Petrochemical (00338), Sinopec (00386), China Life (02628), PetroChina (00857).
While the lithium and commodity super cycle shifts into gear after USD falls from 20-year high perch, labour shortage issues remain for the commodity sector. Today in Australia, iron ore major Fortescue (FMG) highlighted iron ore demand is not slowing down despite China being in lockdown, meanwhile other major companies in Australia, including Wesfarmers (WES), Transurban (TCL) and Mirvac (MGR) highlighted that there is a skilled labour shortage which is a major concern. The companies are calling on the government to boost worker migrations. Recall that BHP and Rio previously flagged labour shortages at their mines which might delay output.
China’s central bank and financial regulators indicate additional support to the economy. The PBoC says in a statement that the central bank is going to ensure that monetary policies in the form of multiple tools will support the real economy. The China Banking and Insurance Regulatory Commission pledges to encourage banks to extend credits. The China Securities Regulatory Commission says that the commission will support real estate companies to issue bonds. The state-owned China Securities Journal suggests that the economy will improve in May with additional government stimulus measures to encourage infrastructure construction, to protect employment and enhance household consumption, and to improve logistics and supply chain. The effectiveness of these policy initiatives, in our view, hinge on the COVID-19 situation. Without significant improvement on COVID outbreaks, additional stimulus policies may be pushing on a string.
Caixin China PMI Services fell to 36.2 in April versus expectation 40.0 and 42 in the previous month. The reading of the index was at its lowest point since March 2020. Input prices were rising amid surges in material costs as well as logistic expenses during restrictive COVID prevention measures while output prices having declined.
RBI’s emergency hike highlights the food inflation problem. The Reserve Bank of India held an unscheduled meeting and voted to increase the repo rate by 40bps, bringing it to 4.40%. Cash reserve ratio was also increased by 50bps, aimed to withdraw INR 870bn of liquidity. Food inflation has become a key concern, and the central bank is shifting focus to the withdrawal of accommodation. Indian 10-year yields rose 28bps to 7.40%, the highest since 2019, while Indian equities plunged. USD/INR dropped to 76.200 in a knee-jerk but the move was largely reversed.
Bank of England faces a balancing act today. The BOE may be heading for its fourth rate hike today but the risk of recession is looming large. Market pricing suggests a 25bps hike is a done deal with a roughly 15% chance of a 50bps move. GBPUSD has surged above 1.2600 at the hands of a weaker dollar overnight, but the sustainability of these gains is the big question. EURGBP has continued to find sloppy resistance around the 200-day moving average for many months now – currently just below 0.8450. While yes, the BoE has beaten the ECB to the punch by a mile in beginning its tightening regime and will do far more than the ECB over the next six months, the UK structural headwinds are greater in terms of external deficits, a fiscal belt tightening lies ahead, contrasting with a powerful EU fiscal expansion, and the UK supply-side limitations are even greater.
Trading ideas to consider
Dollar bulls taking a breather. Given the overbought condition in the US dollar, it is no surprise that the less hawkish than expected outcome from the FOMC meeting resulted in dollar easing as the risk appetite improved. Aussie yields fell over 10bps in step with the US yields, and AUDUSD surged to 0.7250. NZDUSD was also higher at 0.6550 while USDJPY moved below 130 and EURUSD has surged above 1.06. These moves remain at risk of reversal as the policy divergence theme remains in play.
Emerging markets getting the inflation pinch. The surprise move by RBI to raise repo rate by 50bps on Wednesday and Brazil giving up plans to end the tightening cycle highlights the inflation problem that emerging markets are facing. The food inflation risks are biting emerging markets harder than ever, and this means more of them will have to part with their dovish stances and risk a selloff in bonds, something of the tune we saw from India yesterday.
Oil giants Shell (SHEL) and ConocoPhillips (COP) report earnings. Both are expected to report solid numbers but also important to watch the write down of Russian assets.
Key economic releases this week:
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