Summary: The overshoot in US inflation is supporting our argument of higher-for-longer inflation and Fed rate tightening expectations have picked up. This has meant another round of coordinated sell-off in bonds and equities, with only commodities continuing to provide a room to hide for traders and investors with a shortage in supply for physical assets. The Japanese yen is closing in on a 24-year low and the duo of Fed and BOJ meetings this week risks a further run lower.
Risk aversion has picked up in the Asian session after a record high US inflation on Friday has meant Fed will need to be more aggressive. Meanwhile, a slip in US consumer confidence levels is also sending shock waves of concerns around an economic slowdown, which has increase the scope of a policy error by the Fed. In addition, Shanghai is returning to a lockdown for mass testing just days after returning from a 2-month shutdown, which affirms our view that China’s will stick to zero-COVID and that means lockdowns will keep returning throughout this year. Japan’s Nikkei 225 plunged over 2% in the morning, while Singapore STI index was down close to 0.8%. Australia market were closed for Queen’s birthday.
Last week, CSI300 (00300.I) and Hang Seng Index (HSI.I) were up more than 3%, led by Chinese Internet Stocks. Hang Seng TECH Index rose 9.7% last week. Northbound net buying US$5.5 billion last week and was the highest weekly northbound net buying in 2022. The better sentiments was help by positive regulatory headline news on Chinese internet stocks. Starting this week, two black clouds gathered over the Hong Kong and Chinese equity markets. First, investors are becoming concerned again about the likelihood of reintroduction of lockdown to more cities anytime. Shanghai reported 37 new local Covid-19 cases and 5 of them were outside quarantine on Sunday. Beijing reported 51 new local cases and said that it was hard to control the spread of a recent bar cluster, from which there had already been 166 cases found. Last week, President Xi, during a trip to Sichuan, remarked that China adheres unwaveringly to the Zero COVID policy. Second, a repricing of a more aggressive Fed tightening are putting pressure on the Hong Kong and China equity market. As of writing, Hang Seng Index and Hang Seng TECH Index were down around 2.4% and CSI300 was 0.7% lower.
USDJPY hit the key 135 level in the Asian morning session, getting in close sights of the fresh 24-year highs of 135.10. With the Fed tightening expectations picking up further after the US CPI overshoot on Friday, there is little reason to believe that the trend will reverse. The verbal and written warnings from Japanese authorities on the decline in the yen will possibly be futile, and the widening yield differential with the US means more pressure on the yen is still in the cards unless the Bank of Japan considers real policy action.
Gold prices bounced back on Friday to five-week highs as the focus shifted to growth slowdown risks after higher than estimated US inflation has increased the possibility for aggressive interest rate hikes from the Fed. Gold (XAUUSD) however reversed from 1880 in the Asian session as gains in the dollar weighed on the precious metal.
US May inflation print of 8.6% y/y came in above expectations and at a fresh 40-year high, crushing the peak inflation rhetoric in favor of our view of higher-for-longer inflation. Besides the usual food and energy, core CPI at 6% y/y saw largest contributions from shelter, airline fares, used cars and new vehicles. Services inflation was also at its highest since 1991. Rate-hike expectations are soaring to their highest during this cycle with the market expecting Fed rates at 3.00% by year-end. The odds of a third 50bps rate hike at the September meeting are now 100% but more importantly, we are starting to see calls for a 75bps rate hike this week.
Even as CPI climbs to a new peak, the University of Michigan consumer sentiment index has hit a historic low - a reminder of the extreme difficulty for the Fed as they attempt to squash inflation without hammering growth. The index plunged to 50.2 in June from 58.4 in the previous month, printing a record low. This has led to increasing calls for Fed rate cuts next year as fears of a recession have ramped up due to declining confidence and aggressive rate hikes this year.
With the expectations of Fed rate hikes picking up, but the Bank of Japan (BOJ) still married to its yield curve control policy, there is likely more room for USDJPY to head above the 24-year high of 135.15 which will open the doors to 150. A 3-party meeting between Japan’s Ministry of Finance, BoJ and Financial Services Agency on Friday expressed “extreme concern” about the rapid decline in yen against the USD, which suggests a response is well due. Despite the verbal and written warnings, yen has continued to slide, which suggests any intervention may also be futile. There is some scope for tweaks to the BOJ’s yield curve control policy at the meeting on Friday, but these may still fall short to stall the decline in the yen.
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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.
