Summary: Equities are in a funk after the FOMC minutes released late yesterday showed Fed members had discussed not only an end to balance sheet expansion, but how to approach actually shrinking the balance sheet, although there was lack of agreement. Regardless, the entire US yield curve lifted, and longer US treasury yields are poking at the highs since last spring, spooking highly valued. The crimp on liquidity was also evident in cryptocurrencies, with market leader Bitcoin plunging through important technical support yesterday.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - brutal session yesterday in US technology stocks as Nasdaq 100 futures plunged 3.1% extending the declines this morning to around the 15,680 level which is exactly at the 100-day moving average. This moving average was accidentally the rebound level on 20 December before rallying into the New Year. In any case, just above 15,500 the market has shown strength a couple of times recently. The declines across growth pockets came as the FOMC Minutes showed the Fed is a bit more nervous about inflation compared to the official press release in December and that monetary conditions could be tightened faster than expected. The US 10-year yield is up 22 basis points this year to 1.73%, almost the highest level in a year, and Nasdaq 100 futures are down 4% suggesting an implied equity duration of around 20.
USDJPY and JPY crosses - it is interesting to note that despite the strong new local highs in longer US interest rates (and the 10-year Treasury benchmark yesterday even leaped above the highs of last October and is already threatening the post-pandemic outbreak highs from last spring), that the relative JPY weakness has faded sharply, likely as the JPY is also sensitive to credit spreads, as higher US yields could begin to impact lower quality credit and EM credit and thus JPY carry trades, leading to weak performance in JPY crosses perhaps more so than in USDJPY. On that note, it is worth noting a pair like AUDJPY, which turned tail badly yesterday and may continue back lower if risk sentiment craters further.
AUDUSD and USD/EM – a far more hawkish than anticipated FOMC minutes could continue to support the US dollar strongly versus traditionally pro-cyclical currencies and especially EM currencies, with most EM currencies under considerable pressure yesterday, particularly the ruble, as geopolitical concerns weigh there ahead of NATO-Russia talks starting this weekend. AUDUSD is a decent benchmark for the USD versus the smaller G10 currencies, as AUDUSD turned sharply lower yesterday from new local highs in the wake of the – the pivot high serving now as important resistance and the focus on an extended sell-off on the huge 0.7000 area.
Cryptocurrencies – are hurting badly and the major currencies have cratered through support on the implications of a more hawkish Fed, revealing once again that liquidity prospects are a key driver of this market. As well, the space showed some prescience in its recent heavy price action despite signs of strong risk sentiment elsewhere. Bitcoin dropped through the important 45,500 area and trades near 43,000 this morning and near the “neckline” of a head and shoulders formation, with 40k also an important area a bit lower. Ethereum is trading at the lowest level since last October and right on its 200-day moving average in the low 3,400’s.
Ark Innovation ETF (ARKK:arcx) - Cathie Wood’s flagship fund tumbled 7.1% in yesterday’s session mimicking our Bubble Stocks basket down 6.6%, reaching the lowest level since September 2020. The Ark Innovation ETF is probably the most liquid instrument for this part of the market and a good beacon for risk sentiment in speculative growth stocks, so we recommend investors to have this fund on the radar.
Crude oil (OILUKMAR22 & OILUSFEB22) trades lower for the first time in four days after succumbing to the sell-off in global risk assets. In addition, China’s aggressive handling of its worst Covid-19 outbreak since Wuhan could drive some short-term demand weakness. The price support following Tuesday’s OPEC+ decision was driven by the prospect of some members struggling to meet their production targets. Despite rallying this past month, the open interest in WTI and Brent futures has only seen a slight increase, potentially a sign that many investors remain skeptical about oil’s upside potential as the global balance switches to a surplus in Q1. Brent support at $78.50 and $77
Gold (XAUUSD) has once again returned to the $1800 area of support with yesterday’s selling being driven by surging bond yields in response to stronger economic data and not least following the release of the FOMC minutes (see below). US ten-year real yields has spiked higher by 25 basis points this week to a three-month high at –0.85% but so far, the negative price impact has been minimal with a more hawkish stance from the Federal Reserve being partly offset by a softer dollar as well as virus and geopolitical risks. From a technical perspective, however, the short-term outlook has deteriorated with a triple top around $1830 raising the risk of a deeper downside reaction below the 200-day moving average at $1800.
US 10-year Treasuries and German Bunds - yields remain a critical factor here as was made clear by the reaction to the FOMC Minutes late yesterday and the possibility that the Fed is interesting in seeing longer yields lifting as well as shorter yields (see more below on FOMC minutes comments). The US 10-year Treasury yield has risen further to above 1.70%, the highs from October and that leaves only the 1.75% area post-pandemic outbreak high as a support for this key benchmark. The longest 30-year US T-bond yield is at 2.10% this morning, still over 40 basis points below the 2021 high above 2.50%. This yield is critical for the white-hot US housing market. In Europe, the focus is on the German Bund yield, where the highs since 2019 are in play around –6.5 basis points, with further rises inevitably focusing on the magic 0% level.
What is going on?
The FOMC minutes surprise market with discussion of outright reduction of balance sheet. The market expectations for Fed rate hikes shifted sharply higher in the wake of the FOMC minutes release late yesterday, which contained a discussion of whether it would be worth considering outright reduction of the Fed balance sheet would be an effective tool relative to hiking the policy rate. The consensus was that policy hikes should be the primary tool going forward for the Fed and that balance sheet reduction back in the previous cycle may have driven an over-tightening of liquidity that heavily impacted financial conditions. But “some” argued that balance sheet reduction could be a better tool for keeping longer yields higher and avoiding a flattening yield curve, which would mean less need to raise the short-term policy rate. This argument was also made in a study release by the Kansas City Fed in October, and “several” Fed officials believe that balance sheet reduction need not be as traumatic as the 2017-19 experience because the Fed has a repo facility that can provide liquidity.
Pressure continues in China’s real estate sector. Guangzhou R&F Properties said today that it has difficulties meeting debt obligations this month with one of its USD bonds falling to 55 cents on the dollar suggesting elevated credit risk and stress. This coupled with higher USD interest rates are pressuring the entire USD credit market in emerging markets.
Tencent is on a selling spree. Tencent has recently offloaded investments in several companies as China’s new stance on technology regulation is that companies become more single-minded in their business instead of spreading their power across many industries (anti-competitive behaviour). Alibaba has also recently divested investments. Tencent spooked investors yesterday selling $3bn of shares in Singapore-based Sea Ltd, a fast-growing e-commerce company in Southeast Asia, with Sea shares falling 6.6% yesterday; its shares are down 50% since the highs in October.
US Dec. ADP employment change at far better than expected +807k, showing the strongest pace of hiring in six months in what evidence suggests is a very tight jobs market. This will lead to expectations for a strong official Nonfarm Payrolls change for December on Friday after a tepid +210k NFP change in November (and that data has been suspect from month to month due to difficulties collecting the survey data, which revisions have shown have consistently under-estimated the pace of payrolls growth).
What are we watching next?
Will the clear Fed intentions to raise the yield curve crash risky assets? This is at least the third time that the Fed has surprised on the hawkish side since Powell and Brainard were nominated as the leadership team for the next four years back in November. On the one hand, the FOMC minutes discussion of the yield curve (see more above) and hint that it is possibly as interested in raising longer rates as the shorter policy rate represents a huge risk to the riskiest, most highly valued assets, where current and future earnings multiples have led to very aggressive valuations. On the other hand, this message could be quite supportive for more neglected areas of the equity market like value stocks. So rather than necessarily engineering an indiscriminate deleveraging or “crash”, higher long yields could inspire a dramatic rotation into equities that are yielding more earnings here and now rather than far down the road.
The annual rebalancing of the world’s two biggest commodity indexes, the energy heavy S&P GSCI and the broader Bloomberg Commodities Index (BCOM) will start on Friday, and over a five-day period the indexes, followed by billions in assets, will reset their positions based on how the individual commodities performed in 2021, production levels and overall trading volumes. The biggest market impact should come from last year's biggest winners and losers as their positions will be adjusted back to their weightings. However, while creating a great deal of attention, the general market impact should be limited with the changes being well flagged in advance.
Earnings Watch – Today’s focus is Walgreens expected to report FY22 Q1 earnings (ending 30 November) before the market opens with analysts expecting revenue of $33bn down 9% y/y and EBITDA of $1.73bn down from $2.34bn a year ago.
Thursday: Walgreens Boots Alliance, Conagra Brands, Constellation Brands
Economic calendar highlights for today (times GMT)
1000 – FAO World Food Price Index
1300 – Germany Dec. Flash CPI
1330 – US Nov. Trade Balance
1330 – Canada Nov. International Merchandise Trade
1330 – US Weekly Initial Jobless Claims
1500 – US Dec. ISM Services
1500 – US Nov. Factory Orders
1530 – EIA Weekly Natural Gas Storage Change
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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.
