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Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - S&P 500 futures suffered a big setback yesterday closing below the 100-day moving average proving that there is little support above 4,600 and the market is still fragile. Inflation pressures and supply constraints are still big issues and with financial conditions still tightening week after week, we remain defensive of US equities. The key risk today is the Nonfarm Payrolls figures and later the ISM Manufacturing, but the data from ADP earlier in the week suggests the risk to the market is small.
Hong Kong’s Hang Seng (HSI.I) and China’s CSI300 (000300.I). Hang Seng Index fell almost 1% and Hang Seng TECH Index (HSTECH.I) declined 2%. Chinese internet stocks were particularly weak. Alibaba (09988), Bilibili (09626), JD.COM (09618) and Baidu (09888) were off between 3% and 6%. More Chinese private property developers and property service companies failed to report 2021 earnings before deadline and announced suspension of trading in the Hong Kong bourse. Chinse state-owned property developers, China Resources Land (01109) and China Overseas Land & Investment (00688) reported inline FY21 results, but the latter’s gross margin was worse than expectation. In mainland China, CSI300 rose more than 1% with financials, terminals and duty-free shops leading the gain. March Caixin China PMI Manufacturing came at 48.1 (vs 50.4 in February).
Stoxx 50 (EU50.I) – momentum in Stoxx 50 futures has vanished completely with the index futures trading at the same levels as two weeks ago. The culprit is Russia’s move to demand RUB for gas which could lead to Russia cutting gas supplies if Europe does not comply. Inflation figures yesterday in Europe above 7% y/y in all EU countries will add pressure on the ECB to move sooner rather than later on its central bank rate which is still negative. The 3,800 level is key to watch today in Stoxx 50 futures on the downside should risk-off accelerate into the weekend.
USDJPY and JPY crosses – USDJPY snapped back higher as US treasury yields did likewise. As we have flagged extensively in recent days, yesterday was the end-of-quarter and end of the Japanese financial year after some of the strength in bonds this week was likely down to portfolio rebalancing and end-of-financial period effects. Now that we are clear of these effects, we will continue to watch the treasury market for the reaction function to incoming data like today’s US jobs report, with USDJPY traditionally one of the most sensitive pairs to US data, moving in positive correlation with long US treasury yields (particularly given the BoJ yield-curve-control policy, which prevents 10-year JGB yields from rising above +0.25%, even when bond yields are rising elsewhere).
EURUSD and EUR pairs – the euro rally has been approximately chopped in half from the Tuesday lows of this week, as the Russian withdrawal from hostilities in some areas of Ukraine has not sustained hopes for a more comprehensive cease-fire, and natural gas/power prices are still inordinately high in Europe on concerns that Russian gas deliveries may be disrupted by Putin demands for payment in rubles. As well, key ECB speakers were out yesterday with rather dovish rhetoric (more below). The key resistance zone for EURUSD remains the 1.1125-1.1200 zone where the rally this week faltered, while a close below 1.1000 could seal the deal for a return to the lower part of the range toward 1.0800.
Crude oil (OILUKJUN22 & OILUSMAY22) dropped further after the Biden administration ordered the release of 1 million barrels a day for six months, a target that given the infrastructure around the SPR may be difficult to achieve. Meanwhile, it took OPEC+ 12 minutes minute to rubber stamp an already agreed but increasingly impossible to achieve production hike, and it highlights the growing rift between producers and consumers. With lockdowns in China already causing a potential 1 million barrel a day drop in demand, the limited downside price reaction highlights the long-term structural challenges the market faces in bringing down prices. Brent trading below its 21-day moving average for a fourth day with the next support being the $101.50 to $102 area.
Gold (XAUUSD) rallied again yesterday, after investors once again to advantage of the latest correction to enter longs. In addition to peace hopes in Ukraine fading, the reasons for buying being worries about the growth outlook, a prolonged period of inflation forcing strong Fed action and with that the risk of a policy mistake. Adding to this a general uncertain outlook for stocks and bonds reducing the otherwise normal adverse impact of rising real yields. Key support in the 1,890-1,900 area while a move above 1,950 is needed to ignite fresh speculative buying.
European sovereigns (IS0L, VGEA, BTP10). European government bonds rebounded yesterday. Money markets pared back on ECB hike expectations while inflation expectations dropped amid falling oil prices. Today Eurozone’s CPI numbers are in the spotlight together with the nonfarm payrolls report in the US.
US Treasuries (TLT, IEF). Treasury yields decline as concerns regarding oil prices ease. Ten-year US Treasury yields fell from their three-year highs by 20bps to 2.31%, In the upcoming months we still expect higher yields as the Fed prepares to hike rates by 50bps in May. However, during the second half of the year, yields will slow down their rise as growth concerns become more prevalent. Today’s nonfarm payrolls are in focus as a strong job report will leave the way open for a more aggressive Fed.
What is going on?
Asia manufacturing PMIs remained broadly in expansion in March, more gains remain likely for April as restrictions and travel eases broadly this month. Japan’s Jibun Bank manufacturing PMI was up to 54.1 in March from 53.2 previously, and Indonesia, Thailand and Vietnam also remained in expansion. Remember that a reading above 50 indicates expansion and below 50 indicates contraction. Malaysia’s manufacturing PMI dipped to 49.6, its lowest level since September 2021.
Dovish ECB talk from Chief Economist Lane and Guindos. Yesterday, ECB Chief Economist Philip Lane said that the ECB needs to remain open for two-way policy risks, particularly if “fragmentation” (varying conditions for transmission of monetary policy across Europe – indirectly likely meaning peripheral sovereign yield spread widening) sets in and if the rise in input prices impacts the growth outlook. The ECB’s Guindos also weighed in yesterday, suggesting that inflation will likely peak in the next two-three months and that “we” haven’t seen much in the way of wage increases, while predicing a weak economy in the second half of this year.
BASF CEO warns of massive repercussions if gas Russian supply is cut. The German gas industry is out with dire warnings if Russia cuts gas supply to Europe as it would cause serious disruptions to many value chains in the economy and sharply increase the risk of an economic recession. This is probably the biggest underlying risk to Europe.
Euro area inflation is not temporary. This is partially structural. March HICP was painful in most countries: Spain (9.8 % year-over-year), Germany (7.6 %) and France (5.1 %). The only downside surprise was Italy at 7.0 % year-over-year. This is still uncomfortably high. It is all about energy and food. Energy increased by 28.9 % year-over-year and fresh food by 7.2 % in France, for instance. Expect inflation to keep increasing in the short term at least and squeeze households’ purchasing power. Yesterday, ECB’s Philip R. Lane indicated that inflation may stabilize around the central bank’s target two per cent, among other things. This is a bold call, in our view. Looking at the latest business surveys in euro area core countries (notably Germany), the risk of stagflation has incredibly increased over the past few months. In other news, the euro area unemployment rate dropped to a record low in February at 6.8 % versus prior 6.9 %. The unemployment among youth aged below 25, which is usually higher, also dropped to 14 % from 14.3 % in January. This is positive. But the recovery of the job market is set to slow from here on, especially due to the consequences of the Ukraine war.
US annual core PCE rose less than expected in February. It was out at 5.4 % versus expected 5.5 % and 5.2 % in January. Usually, investors and the U.S. Federal Reserve pay a lot of attention to this statistic. But it is viewed as out of date given the Ukraine war and the surge in prices which followed in March. The headline Feb. PCE deflator was in-line with expectations at 6.4% (vs. 6.0% in Jan.), a 40-year high.
The US grains market saw a mixed reaction to the long-awaited Prospective planting report, the first survey-based glimpse into potential harvest outcomes for the upcoming US growing season. While the US cost of fertilizer has risen far less than other regions - given the availability of cheap gas required for production - it still ended up being a major catalyst with farmers switching acreage to soybeans (+3.8 million acres to 91 million) from corn (-3,9 million acres to 89.5 million). In addition, high wheat prices supported a 0.7 million acres increase to 47.4 million. New crop soybean futures (ZSX2) dropped to a one-month low while December corn (ZCZ2) reached a contract high.
India’s oil trade with Russia is positive for Indian refiners. India is back in focus for its oil purchases from Russia using a Rupee-Ruble trade as an alternative to the SWIFT payment system. Russia is offering discounts of as much as $35 a barrel on prices before the war to lure India to lift more shipments. This could lift Indian state oil refiners like IOCL, BPCL or HPCL. But we need to watch how far this rally can last, given India's appetite for Russian oil is rather limited as the refineries are not built for that grade of oil particularly
What are we watching next?
The EU gas market was thrown into fresh turmoil yesterday after Putin signed a decree saying foreign hostile buyers must pay in rubles for Russian gas from April, and contracts would be halted if these payments were not made. Russia supplies about a third of Europe's gas, so energy is the most powerful lever at Putin's disposal as he tries to hit back against sweeping Western sanctions over his invasion of Ukraine. Dutch TTF benchmark gas (TTFMK2) trades back above €130 while the 2022/23 winter contract remains elevated at around €115/MWh, thereby highlighting a market increasingly worried about Europe's ability to rebuild stocks before next winter.
US jobs report and March ISM Manufacturing today. Any Fed response incoming? The Feb. PCE Inflation data release was in-line with expectations (see more above), at least not escalating the pressure on the Fed to catch up to the curve with more policy tightening. Today sees the release of the March Non-farm payrolls data change, the Unemployment Rate and Average Hourly Earnings. There is still some room for strong payrolls growth via a rising participation rate, which has not yet fully normalized to pre-pandemic levels (about a full percent point to go), but job openings data at record levels suggests a labor supply shortage, which leads to a strong focus on whether average hourly earnings are set to rise at a faster clip. The Average Hourly Earnings data is expected to show earnings rising at a +5.5% year-on-year clip. The wait until the May 4 FOMC meeting feels like a very long one if earnings data rises strongly and we get a strong payrolls number with a rise in the participation rate and lower unemployment rate. Will the Fed have to surprise the market with an extremely rare inter-meeting move to buy back some credibility next week? The only high-ranking Fed member currently scheduled to speak next week is Fed Vice Chair Brainard, who will speak on Tuesday on the “unequal impacts of inflation” at a virtual discussion hosted by the Minneapolis Fed.
Earnings Watch. No earnings today
Economic calendar highlights for today (times GMT)
- 0715-0800 – Euro zone Final Mar. Manufacturing PMI
- 0800 – Poland Mar. CPI
- 0830 – ECB's Centeno to speak
- 0900 – Euro zone Mar. CPI Estimate
- 0945 – ECB's De Cos to speak
- 1100 – ECB's Makhlouf to speak
- 1230 – US Mar. Nonfarm payrolls change
- 1230 – US Mar. Unemployment Rate
- 1230 – US Mar. Average Hourly Earnings
- 1305 – US Fed’s Evans (non-voter) to speak
- 1400 – US Mar. ISM Manufacturing
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