Summary: A new hawkish blast from an important Fed figure, Vice Chair Lael Brainard, yesterday turned risk sentiment sharply lower. Brainard indicated that the Fed is set to reduce its balance sheet “at a rapid pace” and that it would likely kick off this tightening at the May meeting. US treasury yields jumped to new cycle highs in response, this time a bit more aggressively at the longer end of the yield curve, and sent the US dollar higher.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - Brainard’s comments yesterday fueled a rally in US interest rates as the Fed signals more aggressive steps to fight inflation as lower-income households are hit harder by inflation as they cannot substitute their existing consumption. S&P 500 futures were down 1.3% closing below the 100-day moving average and they are flat in early European trading hours. In our view, the equity rally from mid-March to late March was “bear market rally” on hopes over Ukraine, but reality around inflation and financial conditions will begin to weigh on equities. The 4,500 level is the key level to watch today on the downside in S&P 500 futures.
Hang Seng (HK50.I) and China’s CSI300 - Hang Seng Index fell more than 1% with technology stocks leading the decline. Shanghai announces that the city will do a second round of city-wide nucleic acid-tests today. Caixin China PMI Services came at 42.0, much weaker than expectation and signaling the Chinese service sector is contracting. Upstream focused integrated oil, CNOOC rose more than 6%. MMG, a base metal mining company, was up 3%. State owned developers China Resources Land and COLI were up 4% to 6%.
Stoxx 50 (EU50.I) – European interest rates are also responding to the rally in US interest rates impacting European equities to the downside. Stoxx 50 futures are in a tight trading range with the 3,800 level being important to watch on the downside. The EU announced yesterday a ban on Russian imports of thermal coal which could prolong the upward pressures on electricity prices and thus being negative for economic growth.
USDJPY and JPY crosses – USDJPY jumped back higher toward the spike high of 125.00 +from last Monday in response to Fed Vice Chair Brainard’s hawkish comments yesterday, but the Bank of Japan’s recent mentioning of “rapid” moves in the JPY exchange rate has perhaps slowed the JPY’s descent. Still, as long as the Bank of Japan maintains its policy of capping 10-year Japanese government bond yields, higher US treasury yields are JPY-negative. In addition to bond yields, it is also important for JPY traders to monitor key commodity prices like LNG and crude oil, as Japan is totally reliant on foreign imports for its energy complex. And on that note, oil prices are a few dollars lower than early last week.
AUDUSD and AUD pairs – an interesting test for the Australian dollar rally yesterday came just after AUDUSD had jumped into new territory above the prior 0.7556 high from late last year and run all the way to above 0.7650 on a slightly hawkish upgrade to the RBA’s monetary policy statement on Tuesday. That test was, of course, Fed Vice Chair Brainard guiding for a powerful balance sheet reduction likely starting in less than a month. The break higher in AUDUSD is still hanging in there as of this morning, but the 0.7500-50 area bears watching for whether the move was a false breakout, as a significant further correction in risk sentiment could suddenly ice the Aussie’s ambitions.
Gold (XAUUSD) remains stuck midrange between $1890 and $1950, after another upside attempt was rejected following Fed Governor Lael Brainard hawkish comments (see below). The comments strengthened the dollar while sending US Treasury yields sharply higher with the 10-year real yield trading at a two-year high at –0.25%. Gold remains up on the year, despite sharply higher yields and the market pricing in ten 25 bps rate hikes during the next ten month, supported by investment flows into ETFs from asset managers looking for protection against inflation, slowing growth and policy mistakes, as well as elevated stock and bond market volatility. Focus on today’s FOMC minutes (see below).
Crude oil (OILUKJUN22 & OILUSMAY22) ended lower yesterday driven by relief selling after the EU avoided adding Russian crude oil to the list of fresh sanctions. In addition, China lockdowns as well as growth concerns and a stronger dollar following Brainard’s comment on rates and balance sheet reduction helped further deflate the market. The Saudis have increased their official selling prices for all oil grades to all regions for May cargoes. Arab Light into Asia was increased by $4.40/b to a record $9.35/b over the benchmark, a sign of robust demand for its crude as self-sanctioning keeps Russian Urals trading at +30 dollar per barrel discount to Brent. Focus on EIA’s weekly stock report with the API reporting a 1.1-million-barrel increase in crude stocks.
What is going on?
Fed Vice Chair Brainard guides for strong quantitative tightening, like to start at May 4 FOMC meeting. Yesterday, Brainard spoke at a virtual conference hosted by the Minneapolis Fed with a speech titled Variation in the Inflation Experiences of Households. In the speech, she specifically invoked Paul Volcker’s stance that runaway inflation “would be the greatest threat to the continuing growth of the economy... and ultimately, to employment.” She emphasized that high inflation is an especially heavy burden for lower-income households and said that the various inflation metrics don’t capture how different households experience inflation., with the consumption basket of lower-income households likely having risen more rapidly than for higher income households for many years. Then she went on to discuss the implications of current high inflation on Fed policy, which she concluded would mean “a series of interest rate increases and...(reducing) the balance sheet at a rapid pace as soon as our May meeting”. To that, she added that balance sheet reduction would proceed “considerably more rapidly” than the $40 billion/month of the 2017-19 tightening.
US March ISM Services index comes in at 58.3 vs. 58.5 expected and 56.5 in Feb. This still indicates a strong pace of expansion in the services sector of the US economy.
Chr Hansen earnings surprise. The producer of enzymes and culture delivered FY22 Q2 (ending 28 February) revenue of €304mn vs est. €284mn and EBIT of €84mn vs est. €74.5mn suggesting the company has been able to pass on its rising input costs, which is a big positive surprise. But the FY outlook for profitability was lowered, suggesting the company does not expect to be able to continue to raise prices.
India is considering seeking around 500 billion rupees ($6.6 billion) next month from the initial public offering of state-owned Life Insurance Corp. (LIC). The government is discussing selling as much as a 7% stake in LIC through the listing, and this will be important for the Modi government to raise funds to finance the widening budget deficit. If successful, the insurance firm would surpass digital payments startup Paytm as India’s biggest IPO of all time.
Additional sanctions on Russia: EU members will today begin negotiations over a proposed ban on Russian coal imports as part of a new package of sanctions from Brussels that includes banning imports of wood, cement, liquors and seafood, as well as a block on transactions with four banks and the cutting of transport links. The coal import ban is one of the boldest because Russia is a big supplier of thermal coal to the EU, accounting for 70 per cent, or 36mn tons, of the bloc’s imports last year, according to Eurostat. The US, meanwhile, is close to announcing a ban on new investment in Russia while increasing sanctions on the country’s financial institutions, state-owned enterprises and government officials.
What are we watching next?
FOMC minutes are up tonight. And will generally be poured over for further support for the fresh hawkishness on display in Brainard’s speech yesterday, though Fed comments seem to age rapidly as the Fed constantly needs to upgrade its guidance to impact markets, as seen in the significant rally in risk sentiment and easing in market volatility that kicked off in the immediate wake of the March 16 FOMC meeting. Any update to specific scenarios for how the Fed plans to kick off QT could, however, add a new twist, especially if the minutes make it clear that the Fed wants to rid itself of its MBS (mortgage-backed securities) as quickly as possible.
Hungarian forint (HUF) - in the wake of the Hungarian election at the weekend, which saw a landslide victory by the incumbent Fidesz party and its populist leader Viktor Orban. The victory has now triggered the EU proceeding with sanctions against the Hungarian government for its practices in limiting freedom of the press in particular, and thus limiting the distribution of EU budget funds. The HUF is under pressure since this announcement.
Earnings Watch. Today our earnings watch is on Chr Hansen which produces cultures, enzymes, and probiotics, and is experiencing unprecedented input cost pressures. Analysts expect revenue growth of 9.2% y/y and EPS growth of 9.8% y/y reflecting rising profitability, which we think may prove too optimistic.
Economic calendar highlights for today (times GMT)
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