Market Strategist
Summary: Markets are in a risk-off with the rip higher in crude oil prices highlighting stagflation concerns. EUR remains exposed not just to higher energy prices but also the widening BTP-Bund spreads that would be another headache for the ECB. Focus turns to inflation prints out from Eurozone economies over the next two days. Meanwhile, intervention risks in Japan could bring in opportunities while AUD remains under pressure due to the souring risk sentiment.
The oil price rally took a leg further yesterday on concerns originating from the inventory data that showed a key hub starting to run dry. WTI prices are now above their November highs as it approaches $95/barrel while Brent is getting closer to the $98-mark. This fresh surge in oil prices continues to make the economic outlook even more complicated as it could increase inflationary pressures while weighing on disposable incomes and economic growth. Our Commodity Strategist Ole Hansen expects demand concerns to weigh on oil prices next year, but current tightness in the market points to risks of higher crude oil prices in the short-term. Energy importers like Europe and Japan will likely be the worst affected, and stagflation concerns in Europe could become even starker.
EURUSD is testing the 1.05 support now and January lows of 1.0484 is in focus. Credit data out yesterday showed further evidence of interest rates biting, with borrowing by companies up only 0.6% y/y in August and lending to households down to 1% y/y, both around the slowest pace in eight years and worse than the euro crisis times. German consumer confidence also plunged further to -26.5 for October from -25.6 previously. Risks for an economic contraction in H2 continue to rise.
Meanwhile, the BTP/Bund spread, or the yield spread between Italy and Germany’s bonds, is sending a warning signal. This is a key risk gauge for the Eurozone because Italy is considered to be among the Eurozone’s riskier countries, with higher debt loads and less political stability. Meanwhile, Germany is considered to be its most stable country from a political and economic perspective. This spread approaching the key 200bps mark is a fresh headwind for EUR as widening fiscal deficits remain a key focus. Italy is struggling to meet the EU fiscal rules and has set a fiscal deficit target of 5.3% of GDP in 2023 (vs. 4.5% earlier) and 4.3% in 2024 (vs. 3.7% earlier). Investors are likely to be concerned about Italy’s ability to finance the growing debt load, and that appears to be a fresh source of headache for the ECB.
Next, focus will turn to Germany and Spain’s preliminary inflation prints for September out today while the Eurozone number will be released tomorrow. Softer prints will continue to avoid any hawkish re-pricing for the ECB, posing further headwinds for EUR.
USDJPY rose to highs of 149.71, the highest levels seen since the intervention days of October 2022, amid a double whammy of higher Treasury yields and higher crude oil prices. Clearly, risks of an intervention are protecting a move in USDJPY above 150. Fed’s Kashkari has been sounding hawkish, saying that the risks for further tightening are tilted to the upside. Meanwhile, minutes of the Bank of Japan’s July meetings continued to highlight the need to maintain stimulus. Fed Chair Powell’s comments, likely to remain on script with the last FOMC, could bring further upside in USDJPY before focus shifts to US PCE data out on Friday.
Japanese officials have been vocal in verbal defence of the yen, but that has hardly proved effective. Risks of a real intervention remain, as BOJ appears to be far from real policy action and upward climb in US Treasury yields continues. Some risk of intervention remaining coordinated also exist, after comments from Treasury Secretary Yellen recently. If the intervention is unilateral, traders could have two options – either ride the direction of intervention or fade the move as fundamentals remain mis-aligned. Both of these were discussed earlier in this article. Volatility may pick up if intervention happens, so using options and stops on your positions could serve well. Key entry levels to watch will be 145 in USDJPY, or 142 if the pair goes down further.
AUDUSD has been hurt badly by the strength of the US dollar, and is one of the worst performing currencies in the G10 space this quarter. August CPI reported yesterday came in higher at 5.2% from 4.9% in July, but base effects and higher gasoline prices were at play. Other measures of inflation also showed some stickiness but the RBA may want to wait for the quarterly print due on October 25 if it was to hike rates again. For the meeting next week, expectations remain tilted towards a no change in policy rate, but language could stay hawkish.
However, inflation upside failed to provide much of an impetus to AUD, and similar impact may be likely even if the RBA was to stay hawkish next week. Dampened risk sentiment, with the surge higher in crude oil prices adding fuel to the stagflation concerns, continue to pose downside risks to AUD. Meanwhile, China stimulus announcements have also lacked in the run upto the Golden Week holiday. Iron ore prices have also eased from $120+ levels seen earlier this month, and the commodity metal has a significant contribution to Australia’s trade balance. China’s ongoing property market slump remains a drag on iron ore’s demand outlook, while the supply side is looking robust. If China’s PMIs over the weekend remain short of an upside surprise, AUDUSD could run for a test of 0.62.
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
