The models are broken
The market is trying to get back to the pre-Covid and pre-war times, but that model is broken. A new dawn is here and the financial world needs to adapt.
Chief Investment Officer
Summary: Markets are trading in nervous, sideways fashion after the US session yesterday. But in Europe, a sudden cloud has formed in the sky for risk sentiment as the Sunday first round of the French Presidential Election suggests that right-populist Marine Le Pen could make a strong showing that would up-end the sense the EU is pulling together with deepening integration in the wake of the Russian invasion of Ukraine. The weekend poll could rattle the markets further if it points to a close race in the run-off two weeks later.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - S&P 500 futures are pushing above the 4,500 level in early trading extending the rebound trade. Initial jobless claims yesterday were on par with the recent all-time low bolstering sentiment that the Fed will continue to be aggressive on interest rates to cool down the economy. Regardless of tightening financial conditions, US equities are staying firm ahead of the weekend.
Hang Seng (HK50.I) and China’s CSI300 - Hang Seng Index was down modestly and Hang Sang TECH Index was almost 2% lower. The market consolidated amid heightened anxiety about economic growth, higher US interest rates, Shanghai’s continuous lockdown, and tension in the Sino-American relationship. Chinese internet and EV autos stocks were among the biggest losers while Chinese properties, infrastructure construction, oil and gas, coal mining, gold mining and fertilizer stocks gained. In A-shares, CSI300 was 0.5% higher driven by construction, property developers, financials and fertilizer names gained.
Stoxx 50 (EU50.I) – European equities are mustering a rebound trade in early European trading hours with Stoxx 50 futures trading around the 3,773 level with yesterday’s opening print at 3,820 being a psychologically important level up the upside. There are no macro events or earnings releases on the calendar that can move European equities, so we expect a quiet session unless we get some negative headlines out of Ukraine. Next week, the French election with Le Pen gaining in polls is going to be the key market risk to monitor as the France-Germany yield spread is widening.
EURUSD and EUR pairs – the euro is weak versus USD, GBP and even the JPY over the last couple of sessions, perhaps on growing unease that this Sunday’s French presidential election could deliver a strong result for right-populist leader Marine Le Pen (more below) and lead to a nerve-wracking wait for the run-off round on April 24 in a race where predictions have dramatically tightened in recent weeks. The downside may be due to euro hedging, which provides its own opportunities for a spring-loaded rally on the April 25 should the election result in a Macron victory, which has been given a roughly 80% probability recently. Then again, many remember the high probabilities assessed for the Brexit vote resulting in Remain and US Presidential election going for Clinton in 2016, even if Le Pen fared poorly in 2017. Watching EURUSD as 1.0800 approaches as a far better than expected showing for Le Pen could see the bottom fall-out toward 1.0638, the pandemic-breakout low of 2020, and even toward 1.0500, with lower levels still possible (parity in discussion here) if Le Pen were to become the next president of France after the run-off.
AUDUSD and USD/commodity FX – Oil prices corrected steeply yesterday, and the energy seems to have gone out of the commodity space in general lately, although natural gas prices remain elevated globally, with Australia boasting of the world’s largest export volumes of LNG. This week has been a roller coaster ride for AUDUSD, which pumped above multi-month highs in the 0.7556 in the wake of a more hawkish RBA guidance, only to have the move reversed by hawkish rhetoric from the Fed this week and, importantly, on a souring of risk sentiment linked to that rhetoric. The weekly candlestick for AUDUSD as of this Friday morning is a huge shooting star with a long upper shadow, traditionally considered a bearish pattern. This will have us watching for a test of lower support, which begins to get critical around 0.7355 (61.8% retracement of rally off mid-March lows) and possibly existential at around 0.7300 (200-day moving average) for the rally off the late January lows.
Gold (XAUUSD) trades unchanged on the week as it continues to find buyers despite a stronger dollar and Treasury yields reaching a fresh cycle high after the Federal Reserve signaled a more aggressive trajectory for rate hikes and quantitative tightening. Overall, the yellow metal remains stuck in a wide $1890 to $1950 range with selling attempts being offset by asset managers and long-term focused investors seeking protection against the risk of slowing growth, elevated inflation as well as continued volatility in bonds and equity markets. A fresh upside attempt, however, remains difficult without renewed support for silver and platinum, both currently missing.
Crude oil (OILUKJUN22 & OILUSMAY22) trades lower for a second week with covid related lockdowns in China reducing demand by more than 1 million barrels per day. Together with the release of additional barrels from strategic reserves announced by the US and IEA, these developments are currently offsetting most of the slowdown in sales from Russia where lack of buyers, mostly through self-sanctioning, has Urals trading at a discount to Brent of more than 30 dollars. In addition, the prospect of accelerated central bank tightening driving an economic slowdown helped send Brent below key trendline support this week, potentially signaling additional short-term weakness.
What is going on?
EU bans Russian coal imports, Asian coal shares in focus. The European Union agreed to ban coal imports from Russia. The sanctions package also includes a ban on most Russian trucks and ships from entering the EU. Meanwhile, Japan is also said to be considering measures to curb imports of Russian coal, signaling a key shift of energy policy. Coal stocks in Asia such as Whitehaven (WHC) and Shaanxi Coal surged, eyes on Coal India. Indonesia miners may be looking to add capacity
Sanctions against Russia bring opportunities for Asia amid a global search for alternative supplies. Japanese company Toho Titanium Co. is ramping up output of the metal used to make aircraft amid a shortfall caused by Boeing Co. and Airbus SE avoiding purchases from Russia, the world’s largest supplier. We have been talking about similar opportunities for Australia’s LNG producers, Australian/Indian wheat suppliers, Indonesian nickel suppliers or Asian coal miners.
Oil company dividends to deliver the goods this earnings season. Even as Brent crude falls below $100 a barrel, Bloomberg indicates the World Energy Index is set to deliver a yield of 3.7%, which is higher than the world index average dividend of 2.9%. Exxon Mobil is set to declare its dividend April 27, and has a current dividend yield of 4.2%, but looks to increase that and its buybacks, which support share price growth.
US and EU gas markets showing signs of converging. US Henry Hub (NATGASUSMAY22) has reached a 2008 high at $6.40 per mmbtu, driven by robust domestic demand due to unseasonal cold weather and strong exports via LNG terminals. Natural gas inventories shrank by 33 bcf last week, with inventories now some 17% below the five-year average, the widest gap since 2019. In Europe meanwhile, a reluctance to ban Russian gas, together with milder weather and record LNG imports have seen the price of Dutch TTF gas (TTFMK2) slump by 17% to a still elevated €104.5/MWh or $33.4/mmbtu.
What are we watching next?
French Presidential election first round this Sunday. This event bears close watching as a major event risk for the EU, even as probabilities lean for Macron to emerge victorious again – though those probabilities seem to be shifting every day as right-populist Le Pen is showing strong momentum in the polls. At least one pollster (Harris) put the second-round run-off scenarios (set for April 24) between Le Pen and Macron as close as 51.5% to 48.5% in favour of Macron. The incumbent Macron is guaranteed to get a weak mandate at best, and if the first round brings notable surprises that suggest Le Pen has a fighting chance in the run-off, it could be gray swan time for Europe, as the general sense that the EU is moving towards closer fiscal integration and rising general solidarity, particularly driven by the Russian invasion of Ukraine, could be shattered.
Earnings Watch. Today's earnings focus is on Yaskawa Electric which is a large Japanese industrial company with four segments in motion control, robotics, system engineering, and IT. Yaskawa’s business in motion control and robotics are a good indicator on industrial demand in Asia with China being 25% of their total business.
Economic calendar highlights for today (times GMT)
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