Market Quick Take - September 24, 2021

What is our trading focus?

Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - big move in S&P 500 futures yesterday as investors were clearly relieved over Evergrande despite no news on the coupon payment and US interest rates making a big move higher. The hangover has started today with S&P 500 futures trading lower sitting at the 4,432 level in early European trading with the first support level down at 4,416 and then 4,393. If the US 10-year yield continues higher today, we could see Nasdaq 100 futures leading the selloff into the weekend.

Hang Seng (HSI.I) - Evergrande shares are selling off again down 12% as the company is silent on the coupon payment. To stabilize the overall market the PBOC continues to inject liquidity. Hang Seng futures are slightly down from yesterday’s close but intraday volatility is down and we do not expect a risk-off move into the close unless we get negative news related to Evergrande.

EURGBP and GBPUSD – sterling got a significant shock yesterday from a far more hawkish than expected Bank of England meeting (see more below) which managed to support sterling even as prior rises in short UK rates in recent months has generally failed to do so. The price action took GBP away from key support in GBPUSD down just below 1.300, with that pair rallying well north of 1.3700, while EURGBP shied away from. This double underline these key levels as major support for as we watch whether the BoE news and follow up market action can take GBP through its next important resistance levels, namely the 0.8500 support in EURGBP and the 1.3850-1.3900 area in GBPUSD.

USDJPY and JPY crosses – the JPY dropped like a stone yesterday on the sudden acceleration higher in US treasury yields, with the 10-year yield a full 12 basis points higher than it started the day yesterday and above the highs level since early July. This took USDJPY well back north of 110.00, even as the USD was relatively weak elsewhere. If US yields continue to rise, USDJPY could be set to challenge the layers of resistance between 110.50 the major 111.66 high, with further energy potential based on who emerges as the new LDP leader and the kinds of promises he or she makes going into Japanese snap elections within the next two months.

Gold (XAUUSD) trades higher after falling to a six-week low at $1738 yesterday in response to a hawkish Bank of England (see below) and a 10bp jump in US ten-year real yields, to near a three-month high at –0.88%, after traders brought forward expectations for the first US rate hike. While often being closely correlated to movements in the dollar and yields, demand for gold is also inverse correlated to confidence in financial assets, which currently, along with financial market valuations, remains near all-time highs. One positive development to take away from the renewed weakness was silver and platinum’s ability to hold their own, with the XAUXAG ratio falling to near a one-week low.

Crude Oil (OILUSNOV21 & OILUKNOV21) is heading for its fifth weekly gain with Brent trading near its highest settlement since 2018. This on the day where China holds its first major sale of oil from its strategic petroleum reserves. According to WoodMac, China may release 33m to 82.5m barrels in this round of sales, but the limited price impact highlights not only a tightening market but also a belief that China, given daily import of 10m b/d, eventually will return and buy those sold barrels back. The monthly Brent chart is now showing a break above the downtrend from the 2008 record high, potentially a sign of more gains to follow.

Early BOE rate hike provokes bear flattening of the yield curve (IGLT, GLTS, GBPG). The bond market was caught by surprise when the BOE said it sees it appropriate to hike interest rates before its bond-buying program finishes around year-end. It implies the central bank could tighten monetary conditions as soon as November or December. The hawkish tilt was driven by inflation forecasts seeing it rising to 4% and staying elevated throughout 2022. The yield curve bear flattened with short-term yields up to five years rising more than 10bps while long term years rose roughly 8bps. Ten-year yields closed at 0.90% testing resistance. If yields break above this level, they will enter a fast area where they could rise fast to 1.07% or drop fast back below 0.90%.

Bond investors reconsider Wednesday’s Federal Reserve meeting forcing the yield curve to bear steepen (IEF, TLT). Following a hawkish BOE, bond investors began to fret about the Fed being behind the curve to tighten monetary conditions. It caused investors to dump Treasuries. The move was substantial as the flattening of the yield curve we saw on Wednesday reversed utterly, with the 5s30s spreads widening above 100bps once again. Ten-year yields broke above their 1.40% resistance. Yields are now trading in a fast area where they could rise fast to test 1.50% or drop again below 1.40%.

What is going on?

US Reverse Repo facility rises to new record after Fed increases counterparty limits to $160 billion, with the facility now at $1.35 trillion, effectively representing more than 10 months of $120 billion/month of QE at the current pace of asset purchases (this facility effectively represents the Fed lending out securities that it has already bought and has on its balance sheet).

Troubled Chinese real estate developer Evergrande missed bond coupon payments due yesterday. Some $83.5 million in coupon payments on offshore USD bonds was due yesterday but were not paid. In other Evergrande news, the company’s Electric Vehicle subsidiary has failed to pay suppliers for months and has not paid employees this month.

Nike shares down 4% on revenue miss. Nike reported Q1 earnings (ended 31 August) last night with revenue hitting $12.2bn vs est. $12.5bn with gross margin 0.2%-point better than expected at 46.5%. EPS came in at $1.16 vs est. $1.12. On the conference call the company said all footwear factories in Vietnam are still closed due to Covid-19 while factories are all open in Indonesia. The company also said that the Asia to North America shipping time has doubled to 80 days and margin will be hurt by spike in ocean freight surcharges.

Hawkish surprise from the Bank of England. The Bank of England managed to more than meet rising rate expectations in recent weeks with a meeting that added a full 10 basis points to the 2-year UK yield as anticipation of the lift-off date for BoE rate hikes was moved all the way forward to as early as late Q1 of next year. The bank said it expected inflation to rise to over 4% and stay there into Q2 of next year, and said that future decisions on the timing of interest rate hikes will depend on the trajectory of unemployment and labour shortages as the furlough scheme launched during the pandemic are set to run off this month. A reference was made to bring forward the anticipated date of rate hike lift-off as the bank statement said that recent price rises brought a “strengthened case” for a “modest tightening of monetary policy” in coming years. Previous guidance linking policy tightening with the economy recovering from the pandemic was dropped.

Norway’s central bank becomes first G10 central bank to hike rates – lifting its deposit rate 25 basis points as expected yesterday and forecasting another rate rise in December. With a backdrop of strengthening risk sentiment and new highs for the cycle in oil prices, the Norwegian krone got a powerful boost, with EURNOK moving to new multi-month lows below 10.10. Do note that USDNOK sits right at its 200-day moving average and that the decision did not further boost yields at the short end of the Norwegian yield curve, so NOK could quickly revert to reacting to these other factors.

What are we watching next?

German election on Monday – and the resulting coalition that forms in the wake of the election, a process that could take months as the results could fail to give any clearly aligned coalition a majority. While it seems clear that the SPD, or Social Democrats under Olaf Scholz, are set to gain the most votes and the CDU/CSU, long-time Chancellor Angela Merkel’s party, is set for a historically weak result, the composition of any center-left coalition with the SPD and the Greens is complicated by the lack of obvious additional parties. A far stronger than expected result for these two parties would lead to the strongest market reaction, likely boosting long yields in the EU further on a clearer path to more fiscal stimulus and as these two parties are the most EU-friendly.

Biden’s stimulus agenda and debt ceiling on the line next week - the situation is simply too complex to reduce to a few lines here, but the basic outline is that some Democrats are engaging in their own brinksmanship over the smaller, bipartisan $1 trillion infrastructure bill passed by the Senate but not yet by the House. Progressive Democratic House members have declared they will not vote in favour unless the progressive $3.5 trillion (over 10 years) mostly climate- and social spending bill is tied to the infrastructure deal. In other words, the risk is of a failure of both bills and a complete failure of the domestic Biden agenda. Meanwhile, the debt ceiling issue has not been addressed, with the US treasury needing to enact emergency measures after September 30 (end of the budget year next Thursday) if no stop-gap funding bill is passed and a theoretical default possible “some time in October” according to US Treasury Secretary Yellen if nothing is done.

Economic calendar highlights for today (times GMT)

• 0800 – Germany Sep. IFO Business Climate Survey
• 1245 – US Fed’s Mester to speak on economic outlook
• 1315 – ECB’s Lane to Speak
• 1400 – US Aug. New Home Sales
• 1400 – US Fed’s Powell, Clarida to speak
• 1405 – US Fed’s George to speak

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