Markets Today: Geopolitical risks front and centre – 21 February 2023

What’s happening in markets?

US markets closed, European indices mostly lower as geopolitical concerns weigh

Muted trading overnight with US markets closed for President’s Day but geopolitical tensions at a high with President Biden making a surprise visit to Ukraine to pledge support. Futures for S&P 500 and NASDAQ 100 continue to trade in the red with fears of escalating tensions between US and China, as well as the upcoming anniversary of Russia’s invasion of Ukraine. Geopolitical concerns also spilled over to European markets, with most European indices closing in the red on Monday. EuroStoxx 50 (STOXX50.I) was down 0.09% while France’s CAC 40 (FRA40.I) was down 0.16%. Only UK’s FTSE 100 (UK100.I) closed in a positive territory. China markets led the way on Monday with strong gains of over 2% on potential liquidity injection on Friday and expectations of a recovery in momentum as the earnings season focus shifts to Asia.

What to watch ahead?

When trade resumes in the US today, focus will be on geopolitics as well as the services and manufacturing read outs - PMIs – expected to show the US economy’s recovery is gathering pace – but with the PMIs still in contractionary phase (to show reads of under 50). FOMC minutes due on Wednesday - will have eagle eyes on them - looking for terminal rate expectation comments – given some members hinted of a potential 50bps rate hike again. Later in the week - Friday’s release of January PCE - the Feds preferred inflation gauge - will be a focus - expected to show core inflation rose 0.4% up from 0.3% in December – with the YoY read expected slow to 4.3% (from 4.4%) - according to Bloomberg consensus.

BHP’s numbers disappoint, shares slide 2%. Its 50 day simple moving average offers support

Softer commodity prices in the half year drove a decline in BHP profits –greater than expected - with underlying attributable profit falling to $6.6 billion in the six months to December 2022, vs the $6.96 billion expected by consensus. The world’s biggest miner declared an interim dividend of $0.90 per share – marking a drop from last year’s record $1.50 per share - meaning its pay-out ratio dropped to 69% from 78%. We think that’s because the board is taking the proposed Oz Minerals takeover into account. As for production - significant wet weather of its coal business impacted production and unit costs - as did challenges in securing enough staff.

As BHP’s outlook - it’s aiming to lift iron ore production to 330 mt/yr. Overall it reinforced its positive demand forecast in the second half of FY23 and into FY24 - with strengthening activity in China. BHP sees China and India demand offsetting the slowdown in trade with the US, Japan and Europe. Mining production costs are expected to be markedly higher than before the Covid-19 pandemic – due higher energy, labor and other input costs. Meanwhile we think BHP should benefit from higher-than-expected iron ore, met coal, and copper prices amid supply issues and the green transformation push. Also note, it started the process of divesting its two coal mines- as the business wants to focus on future facing commodities – copper, nickel and potash. Rio Tinto is expected to highlight similar issues  - slimmer profits and higher costs when it reports results tomorrow. For more, refer to Saxo’s Australian Resources equity theme basket.

Hong Kong’s Hang Seng (HIG3) and China’s CSI300 (03188:xhkg) rallied with A-shares leading

A-shares rallied strongly on Monday with the benchmark CSI300 rising 2.3%. Although the 1-year and 5-year loan prime rates remained unchanged at the monthly fixing this morning, the average mortgage interest in the largest 100 cities fell 6bps M/M to 4.04% in February, or 143bps Y/Y for first-home mortgages and 84bps for second-home mortgages.  China Securities Regulatory Commission (CSRC)’s announcement on Friday of rules to regulate and effectively revive overseas IPOs of mainland companies added fuel to the optimism. Construction materials, electronic appliances, telco, and brokerage names led the charge higher in A-shares.

In Hong Kong, the Hang Seng Index opened lower but managed to finish the Monday session 0.9% higher, led by industrials and financials. . Aluminum Corp of China (02600:xhkg) surged 7.6% and China Hongqiao (01378:xhkg) jumped 9.9% following the Yunnan provincial government told local aluminum smelters to cut production due to power shortage. EV makers gained, led by Nio (09866:xhkg) and XPeng (09868:xhkg).

The latest rise in tension between the U.S. and China over alleged Chinese support for Russia’s invasion of Ukraine, China’s increasing role in the day-to-day running of Hong Kong, and the issue of Taiwan are taking a backseat for the time being as investors are shifting their eyes to additional policy stimuli being rolled out at the upcoming two-session meetings to be held from March 4, 2023.

FX: RBA’s hawkish minutes, RBNZ meeting keeps kiwi in check

After extensive speeches last week from RBA Governor Lowe, focus turned back to AUD today with RBA minutes on tap. Th February meeting saw a 25bps rate hike but the statement had tilted more hawkish. AUDUSD took a brief look below 0.69 ahead of the minutes, but reversed higher as the minutes revealed that a pause was not an option at the February meeting. Focus more so on the RBNZ meeting tomorrow morning in Asia (9am SGT/HKT) with some calls for no rate hikes amid the recent flooding damages. NZDUSD slid below 0.6250 in early trading after being somewhat resilient overnight. USDJPY attempting another move to 134.50 with BOJ Governor Kuroda scheduled to appear in the parliament.

Crude oil (CLH3 & LCOJ3) gains momentum on China demand and geopolitics

Crude oil prices rebounded on sustained hopes of a recovery in China’s activity levels, especially after PBOC’s liquidity injection on Friday. State-owned enterprises have started ramping up purchases, such as Unipec which has purchased about 10mbbl from the UAE for loading in April. WTI futures traded above $77/barrel while Brent was above $84. The geopolitical backdrop added some worries, with fresh risks of sanctions on Russia that could continue to tighten the oil market.

Signs of a commodity recovery gather pace: production ramps up in anticipation of demand picking up

Fitch Ratings put out a report on China’s reopening driving a modest recovery in oil - this positive sentiment flowed to other commodities. Secondly – as Ole mentioned on Saxo Market Call Podcast, copper inventory has started to roll over in London, Shanghai, and New York - indicating demand for copper and other commodities would theoretically need to pick up. Copper prices (HGA) gained 1.3% on Monday to $4.18 – taking copper back over its 100-day moving average – to its highest levels since January and June last year. Iron ore (SCOA) prices moved up 1.9% to $130.85 – which is its highest level since June last year on supply concerns - with Brazil heading to peak rainy season at month end. Aluminium prices meanwhile are underpinned by a province in China - the Yunnan province – cutting smelter capacity as ordered by the local power grid amid an energy supply shortfall. Lastly - consider keeping an eye on Wheat prices - as the conflict in Ukraine will raise questions about farmers ability to plant wheat int the coming season, meanwhile France - also a key wheat producer – is suffering drought.

What to consider?

President Biden makes a surprise visit to Ukraine – playbook for geopolitical risks

Biden made a surprise visit to Ukraine and met with Volodymyr Zelenskiy, declaring "unwavering support" as Russia's invasion nears the one-year mark. These visits come after Blinken’s rhetoric that the US has information that China is supplying arms to Russia, and VP Kamala Harris’ claim to charge Russia with war crimes against humanity. China is however trying to convince that it remains neutral, and State Councilor Wang Yi is set to visit Moscow in the coming days after floating fresh peace proposal to end the conflict.

In Saxo’s view, the playbook for the week should be risk-off given the possibility of any ugly turns in geopolitics. That would mean long JPY, long commodities, long Defense stocks and short risky assets. Once we are past this week with hopefully no further escalations, focus will shift back to inflation concerns and driving Fed rate cut expectations further into 2024.

Consider watching the US dollar strength, and Saxo’s Défense basket amid geopolitical tensions rising

Amid the geopolitical risks rising - consider watching likely US dollar strength play out in key currency pairs. In equities – consider watching Saxo’s Defence basket. Over the last two days we’ve seen geopolitical tensions escalate. Biden made a surprise visit to Ukraine declaring ‘unwavering support’ and pledging $500 million in new aid. Meanwhile, EU diplomats are looking at pooling 4 billion Euros of ammunition purchases for Ukraine as early as next month, with EU states pushing to ramp up their ability to hit back against those helping Russia circumvent sanctions. Also – today Putin is also expected to give a state of the nation address - potentially focusing on escalations - he also may note that 500k Russian troops have been mobilised. Meanwhile China threw cold water on allegations that it is going to help arm Russia. And finally, the White House is reportedly mulling over increasing sanctions on Russia. We continue to watch this closely - and encourage investors and traders to exercise caution.

Food security issues pick up; with fertilizers being used as a weapon

A Russian cargo ship held back in the Dutch port of Rotterdam for months- has been escorted out by the United Nations’ World Food Program chartered ship. The Russian cargo, bound for Malawi – contains 20,000 metric tons of Russian fertilizer. And the fact that Russia was allegedly holding back fertilizers - meant the nations food security was at risk, with fertilizers essential in growing crops. About 20% of Malawi’s population is already expected to face acute food insecurity during the “lean season” to March. Moreover it’s not just the lack of supply that’s the issue- costs are too. Malawi is one of 48 nations in Africa, Asia and Latin America identified by the IMF as being most at risk of higher food and fertilizer costs after Russia invaded Ukraine. China and Russia have a foothold of the industry - being the world’s largest producers of fertilizers - including nitrogen, phosphates and potash. These issues in Rotterdam highlight that food security can be used as weapon - and we are concerned should geopolitical tensions escalate - which would pressure food prices higher. Large fertilizer companies to watch include CF industries, Mosaic, Nutrien. Refer to Saxo’s Commodity basket for more.

Downshift in RBNZ’s rate hike trajectory could signal NZD weakness

The Reserve Bank of New Zealand meets on Wednesday, 22 February and consensus expects a return to 50bps rate hikes after a 75bps in November when even the possibility of a 100bps was debated. Economic data has been soft since the last meeting, with 2-year inflation expectations easing and unemployment rate seeing a slight uptick. However, Cyclone Gabrielle has brought fresh risks of inflation pressures in the short-term. Calls for no rate hikes have also picked up although finmin Robertson was out calling for RBNZ having a responsibility to address inflation yesterday. Still, risks of further kiwi weakness loom large after NZD has weakened 1.7% against the USD so far this year. If RBNZ signals that the peak for the current rate hike cycle is near, the 38.2% retracement of NZDUSD uptrend from the October low at 0.6146 could be challenged.

The cost of sea freight is back to pre-Covid levels

This is positive news on the inflation front. The cost of sea freight is now back to pre-Covid levels. The drop in prices is both explained by cyclical (1) and structural (2) factors. The U.S. consumer is very resilient, as shown by the recent release of the U.S. retail sales. But this is not the case in other countries. The rise in the cost of living is causing a drop in global consumption (1). In addition, the sea freight market is facing a surplus of containers. And this will get worse in the months to come. The number of container ships under construction represents nearly 30 % of the fleet that is currently operational. That’s three times more than normal. Companies in the sector have misjudged the evolution of global demand in the post-Covid period. Wrongly, they anticipated it will remain unchanged or it will even increase. The fall in prices is likely to continue all this year and perhaps partially in 2024. The market consensus expects a drop in transported volumes of around 4 % this year.