Equities and Bonds Sell-Off
Today’s Financial Markets Highlights
- • Stocks and bonds are selling off and the US dollar is broadly firmer. Among the majors, the yen and Swiss franc are resilient amid risk off sentiment.
- • The market recognizes increased risk that the Bank of Canada hikes rates for the first-time next week, and this is helping underpin the Canadian dollar.
- • The BOJ trimmed its growth forecast and increased its inflation projections. BOJ Governor Kuroda pushed against talk of an early hike.
- • The UK reported strong employment data and expectations for a hike next month have solidified.
- • The German ZEW was mixed. The expectations component improved markedly while the current assessment deteriorated.
- • The US appears set to accept that Europe opposes blocking Russia from the SWIFT system if it invades Ukraine.
- • The market has priced in about a 33% chance of a 50 bp rate hike by the Fed in March and has 107 bp of tightening priced for this year, while growth forecasts are being shaved.
Surging yields and plummeting equities are the main developments today. The US 10-year yield is pushed above 1.80% and the two-year yield is above 1% for the first time since February 2020. European yields are pulling back after jumping 2-5 bp. The MSCI Asia Pacific Index is off for the fourth consecutive session. Only Shanghai among the large bourses escaped the carnage. Europe’s Stoxx 600 is off around 1.1% to test last week’s lows after rising 0.7% yesterday. US futures are 1.0%-1.5% lower. The dollar is firmer against most currencies today. Among the majors, the Canadian dollar, yen, and Swiss franc are proving the most resilient as the precipitous drop in equities offset the rise in yields. The Scandis and Antipodeans are the hardest hit, off around 0.25%-0.50%. Nearly all the emerging market currencies, but the South Korean won are being sold. The Turkish lira, South African rand, and Russian rouble (~-0.6%-0.7%) are leading the move. Don’t look for gold to be much of a haven. The yellow metal is near a five-day low around $1810. Oil prices are extending their rally with March WTI pushing toward $85. Recall it finished last month slightly below $75.00. US natgas is firm after falling more than 12% in the last two sessions, while European natgas (Dutch benchmark) is off about 4.5% to a three-day low. Iron ore stopped a three-day slide with a 2.6% gain, while copper is extending the loss seen in the last couple of sessions.
BOJ Governor Kuroda pushed hard against creeping speculation that the central bank was poised to adjust interest rates any time soon. There has been some talk that BOJ could raise rates well before the 2% core inflation target was met. He was clear: “We’re expecting long- and short-term policy rates to remains at the current levels or fall even lower…Raising rates is unthinkable.” Kuroda seemed to all but rule out a rate hike during his term that expires in April 2023.
As expected, the BOJ adjusted its inflation (up) and growth (down) forecasts. Inflation in the new fiscal year beginning April 1 is expected to be 1.1%, up from 0.9%. It is expected to remain there in the following fiscal year too (up from 1.0%). This fiscal year growth forecast was reduced to 2.8% from 3.4%, but next year’s was lifted to 3.8% from 2.9%. However, in growth in the following fiscal year was shaved to 1.1% from 1.3%.
China’s real estate market remains distressed, and dollar bonds of many developers are under pressure. There is more talk about a new infrastructure initiative. The CSI 300 Infrastructure Index rose 3.7% today, its largest rise in four months. The PBOC cut the one-year medium-term lending facility rate and the seven-day repo rate yesterday for the first time in two years. The loan prime rate is set on Thursday, and although the one-year was trimmed by five basis points last month, cut in the five-year would ostensibly allow for lower rate mortgages. The takeaway is the PBOC has many levers to ease policy and it is expected to use them, and this in in stark contrast with most of the countries, who are tightening monetary and fiscal policies.
With the early buying that lifted the greenback to slightly above JPY115.00, the dollar retraced half of the loss that saw it tumble from the multi-year high on January 4 (~JPY116.35) to the pre-weekend low (~JPY113.50). The risk-off mood has seen the dollar eased back to the JPY114.50 area in the European morning. Initial support is seen in the JPY114.20-JPY114.40 area. The Australian dollar is trading near five-day lows below $0.7200, where a A$950 option expires today. Near-term potential extended toward $0.7155. It may take a move now above $0.7230 to stabilize the tone. The broad US dollar recovery helped Chinese officials who have made it clear that they prefer a weaker yuan. The deputy governor of the PBOC was explicit, one-way bets on the currency will not be allowed. The greenback initially fell to CNY6.3380, a new three-year low, before recovering above CNY6.35, where a $775 mln option rolls off today. The reference rate was set tightly to expectations today (CNY6.3521 vs Bloomberg survey median of CNY6.3520).
The UK employment data were stronger than expected, and the unemployment rate eased to 4.1% from 4.2%. Payrolls increased by 184k in December, well above the median forecast (Bloomberg) of 130k. The November payroll gains of 257k was revised to a still strong 162k. The unemployment claimant could fell by 43.3k, after the November series was revised to show a 95k decline rather than 50k fall. Average earnings growth slowed in the three-months through November, which are reported with an additional one-month lag. The report saw the market edge up the odds of a hike at the February 3 MPC meeting to a little more than 90%.
Separately, the UK political drama continues to play out. Cummings, who some suspect was the source of the leaks about the parties at 10 Downing Street, is strongly claiming that Johnson knew about the party that the Prime Minister denied. Chancellor Sunak is seen as a likely successor, and some media reports are playing up his lukewarm support for Johnson. One such report compared Sunak’s recent actions with Major during Thatcher’s last days.
Germany’s ZEW survey showed a larger than expected improvement in expectations but a more pessimistic assessment of the current situation. Recall that at the end of last week, the federal statistics office estimated that the economy contracted by 0.5%-1.0% in Q4. The ZEW measures of expectations rose to 51.7 from 29.9. It is the highest since last July. The current situation was marked down to -10.2 from -7.4. This is the worst since last May.
Reports suggest that Europe has resisted US efforts to threaten to cut Russia off the SWIFT system if it invades Ukraine. Apparently, to show a solid front, the US may be agreeing. Meanwhile, the UK has confirmed that it will expand military aid to Ukraine to provide light anti-armor and defensive weapon systems. There may still be a reluctance to send Ukraine offensive weapons.
The euro posted a key downside reversal before the weekend, but follow-through selling has been modest. It reached a four-day low in Asia near $1.1385 and this has held so far in the European morning. The euro has not closed below $1.14 since last Tuesday. There is an option for almost 420 mln euro at $1.1370 that expires today, while the (50%) retracement of this year’s gains is slightly below $1.1380, and the next retracement (61.8%) is closer to $1.1355. Sterling is off for the third consecutive session, the longest losing streak in over a month. It has rallied more than a nickel since mid-December and faltered near the 200-day moving average (~$1.3735) last week. Initial support is seen around $1.3600. A break would confirm a high is in place and the first target may be the $1.3530 area. The euro is forging a possible rounded bottom against sterling. Today’s low is about GBP0.8350, where an option for roughly 340 mln euro expires today.
The market has turned more aggressive about the outlook for Fed policy. At the end of last year, the market had less than a 2-in-3 chance of a March hike. Now it has a hike fully discounted and about a 1-in-3 chance of a 50 bp move. At the end of last year, the market had almost three hikes fully discounted for this year. Now the market has about 107 bp completed priced in.
Meanwhile, as the Beige Book warned and the preliminary University of Michigan consumer survey showed, economic confidence has waned. This may be reflected in the Empire State manufacturing survey today. On the other hand, the Philadelphia survey due Thursday is expected (Bloomberg survey) to have improved. However, the takeaway is that after the dismal retail sales and the unexpected decline in industrial production reported last week, estimates for Q4 GDP are being reduced. The Atlanta Fed had seen the economy tracing 7.3% annualized growth in Q4 is now at 5.0%. The US also reports November TIC data today. In October, the net inflows surged by $143 bln. The monthly average this year through October is almost $88 bln. In 2020, the average monthly portfolio capital inflow was a little less than $50 bln, and in 2019 was almost $5.5 bln.
Canada reports December housing starts, and another strong gain is expected. However, the more important development is that the market has become more convinced that the first Bank of Canada rate hike could come as early as next week. At the end of last year, the market has a slight leaning in favor of a January 26 rate hike, but the odds have increased to 70%. Tomorrow’s December CPI report, which is expected to see the core measures tick up, may see the probability of a hike increase further. November retail sales out at the end of the week are expected be strong, with the second consecutive monthly increase of more than 1%.
The US dollar appears to have entered a consolidative phase against the Canadian dollar after falling almost 4% from the December 20 high (~CAD1.2965) to the January 13 low (~CAD1.2455). In this phase the CAD1.2600 area, the neckline of the head and shoulders pattern we are tracking, offers initial resistance. The greenback has tested the CAD1.2485 in early Asia and bounced to CAD1.2535 to mark the range so far today. The risk-off mood has seen the dollar rise to a three-day high against the Mexican peso (almost MXN20.41). It is the first time since January 10 that the greenback has risen above the previous session’s high. However, before that, it was sold marginally through yesterday’s lows. This sets up for a possible key upside reversal for the dollar. The close is key to this one-day pattern. It needs to close above yesterday’s high (~MXN20.3530) to confirm it. If confirmed the first target may be the MXN20.50-MXN20.55 area.
Bannockburn Global Forex