Market Quick Take - February 4, 2022

What is our trading focus?

Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - volatility is here to stay with yesterday’s dramatic moves in social media stocks driven by the 27% decline in Meta shares pushing the VIX Index to a close at 24.35. Nasdaq 100 futures were heavily bruised down 4.1%, a dramatic reversal of the recent rebound, highlighting the fragility of the US equity market. After the US market close, the reaction to Amazon’s earnings lifted sentiment on Nasdaq 100 futures and they are trading 2% higher this morning. It all shows that this market is out of balance and can go everywhere, but given yesterday’s central bank appearances, most likely down.

Hang Seng (HK50.I) rose more than 3% after returning from the Chinese New Year holiday.  Much of the gain attributed to HSBC (0005.HK, +4.6%), Alibaba (9988.HK, +4.8%), AIA (1299.HK, +4.8%).  EV stocks advanced 6% to 12% after releasing strong sales numbers.  BYD (1211.HK), Xpeng (9868.HK) and Li Auto (2015.HK) had EV sales +362%, +115%, +128% respectively in January 2022 versus the same period last year. While we are expecting that EV sales will continue to grow strongly, we are concerned about the significant risk of margin compression due to rapidly rising input costs.  We consider EV battery-related metal producers, e.g., Ganfeng Lithium (1772.HK) a better play in the medium-term to benefit from the growth in EVs. 

EURUSD, EURGBP and EURCHF – nearly all euro pairs were launched on a rocket ride higher by the ECB’s capitulation on the need to review its stance on inflation at yesterday’s ECB meeting (more below). The EURUSD pair shot all the way to multi-month highs just ahead of 1.1500 in one go yesterday. The move has extended so far and so quickly off the lows that some consolidation may be in order before any major extension above 1.1500 is possible, but if risk assets stabilize and rally again after absorbing the latest round of more hawkish central bank talk, the path may be open to the 200-day moving average, currently 1.1678. EURGBP looks to have put in a major low after exploding higher off new lows below 0.8300 after what appeared a hawkish BoE on first look sounded less hawkish in the press conference. Similar goes for EURCHF, where the focus is now shifting toward 1.0700 after the largest single day rally in years yesterday.

Crude oil (OILUSMAR22 & OILUKAPR22) trades up more than 4% from Thursday’s low point as a strong afternoon rally took WTI above $90 for the first time 20141. The seventh consecutive weekly gain being driven by the current tight supply outlook, geopolitical tensions and freezing weather in Texas hurting some oil supplies.  OPEC+ this week agreed to raise production by another 400k barrels per day in March but at the same time failed to address the growing gap between quotes and what is being produced. Next week, monthly oil market reports from EIA, IEA and OPEC should shed some light on the current supply and demand situation.

Gold (XAUUSD) responded to turmoil in the interest rate market yesterday by first slumping below $1790 before finding a bid as the dollar weakened, especially against a surging euro (see above) after traders brought forward the timing of the first ECB rate hike. With other central banks joining the FOMC to combat uncomfortably higher inflation levels, the outlook for the dollar has turned more bearish, something that may help offset the negative impact of rising bond yields. Focus on a potential but temporary weak US job report (see below) with resistance at $1810 ahead of $1817, the 50% retracement of the Jan 25-28 FOMC related slump.

US Treasuries (IEF, TLT). Following yesterday’s BOE and ECB meetings the US yield curve bear steepened driven by a rise in real yields. Today’s markets focus is on the nonfarm payrolls report, which seems likely to surprise on the downside. Regardless, we believe strong average hourly earnings and an unemployment rate in line with expectations will be enough to pave the way for a rate hike in March. The focus is on 2-year yields which continue to rise and will find first resistance around 1.4%. In the long part of the yield curve, 10-year yields are trading rangebound between 1.75% and 1.87%.

German Bunds (IS0L). Following yesterday’s ECB meeting, markets advanced interest rate hikes expectations, now pricing 40bps hike by the end of the year. It sparked a deep selloff across European sovereigns, which saw 5-year German yields rising above 0% for the first time since May 2018. Two-year yields also spiked by 12bps, closing the day at -0.32%. The focus now shifts on the March’s meeting and the ECB’s forecasts, which if they look close to fulfilling conditions, will give the central bank leeway to end purchases under the APP program early and plan for interest rate hikes. Within this scenario, we can expect volatility in the euro sovereign space to remain sustained and yield to continue to climb. Negative Bund yields are going to be a memory, soon.

Italian government bonds (BTP10). The biggest problem with an aggressive ECB is that spreads in the periphery are going to widen quickly, tightening financing conditions in these geographical areas faster than in Germany. The poof came yesterday as a not-dovish-ECB provoked Italian yields 20bps up versus 10bps only in Germany and 12bps in France. This is a topic worth monitoring, and a point of concern which could slow down the plan of the central bank to tighten the economy early. Normally a BTP-Bund spread above 180bps is reason of concern for policymakers. Currently the BTP-Bund spread is trading at 145bps.

UK Gilts (IGLT). The whole Gilt yield curve shifted higher yesterday as the BOE showed that a great part of officials is willing to tighten the economy fast by hiking rates aggressively. Bailey said previously that the central bank would consider starting QT as the benchmark rate hits 1%. If a rate hike were to happen in March and another in May, QT could already begin in June, putting even more upward pressure on rates. The Gilt yield curve bear flattened yesterday with the 2s10s closing just above 20bps. However, the yield curve might re-steepen as QT approaches.

What is going on?

Bank of England: hawkish headlines, less hawkish press conference. The Bank of England narrowly missed voting for a 50 basis point rate hike yesterday, instead going for the expected 25 basis point move to take the policy rate to 0.50% on a vote of 5-4. On the balance sheet signaling, the Bank indicated that it will not replace maturing Gilts (government bonds) and will outright begin to sell Gilts once the policy rate has reached 1% at a stable and predictable pace. The Bank also said it would seek to rid itself of its corporate bond holdings over time. Far less hawkish than the narrow decision to not move 50 bps at this meeting was the Bank’s new set of economic forecasts, which suggest mounting stagflationary pressures, as inflation for the coming year was revised up sharply, while growth was revised down to 1.8% from 2.1% for the 12 months ahead. And in the press conference, Governor Bailey sounded far less hawkish than the initial headlines suggested, as he fretted the uncertainty of energy prices and their effect on the outlook.

ECB opens the door to policy review and opens the floodgates to short euro covering. The ECB’s initial policy statement appeared to show that the central bank was standing firm on its intent to maintain the current policy rate through this year as it announced a schedule of slowly tapering asset purchases this year, with rate lift-off not to arrive until balance sheet expansion was halted. But at the press conference, President Lagarde indicated that the ECB will use the March and June meetings to reassess its outlook on inflation, a move that the market saw as likely to leading to a capitulation on its formerly resolutely dovish stance and the need to bring forward rate hikes. European short rates soared further and took the euro sharply higher as the market moved to price in a series of ECB rate hikes, beginning as early as the June or July ECB meetings.

World food prices rebounded in January following a small dip in December according to the UN FAO’s food price index, which tracks a basket of 95 globally traded food commodities divided into five categories. The index hit an 11-year high thereby moving closer to the record from February 2011 when surging prices of cereals helped trigger the Arab Spring. Higher food prices during the past year have been driven by a combination of a post-pandemic economic recovery raising demand, a troubled weather year being interrupted by La Ninã developments, covid outbreaks challenging supply chains, labour shortages and more recently, rising production costs via surging fertilizer prices and rising cost of fuels, such as diesel.

Amazon Q4 earnings satisfy market expectations. But the ugly truth if you look at the numbers is that revenue growth dipped below 10% for the first time in many years and the EBITDA margin plunged 4.5%-point with free cash flow hitting only $3.1bn in its most profitable seasonal quarter down from $15.6bn a year ago. At the same time the company is raising its Prime membership fee to $139/month, a whopping 17% increase, suggesting the retailer is under enormous pressure on wage and logistics costs.

What are we watching next?

Weak January US jobs report set for today, but watch earnings growth: expectations for this today’s jobs report shifted lower in a hurry this week after the ADP private payrolls result for January came in at –300k jobs for the month. But the market may be willing to look through this as the assumption is that, once the omicron-covid variant disruptions lift, normal activity levels will resume and disruptions will clear. One interesting thing to watch is whether average hourly earnings see a particularly large jump for January (already expected at +0.5% month-on-month and +5.2% year-on-year) if the bulk of the job losses tallied were for lower-paid positions and whether US treasury yields are jolted higher by high earnings after yesterday’s surge in treasury yields.

Earnings Watch. Mostly European companies reporting today but the key earnings watch in the US today is Regeneron Pharmaceuticals. Analysts are expecting Regeneron to post Q4 revenue growth of 88% y/y and EPS of $14.58 up 91% y/y.

• Today: Carlsberg, Sanofi, Vinci, Intesa Sanpaolo, Assa Abloy, Bristol-Myers, Regeneron Pharmaceuticals

Economic calendar highlights for today (times GMT)

• 1000 – Eurozone Dec. Retail Sales
• 1330 – US Jan. Nonfarm Payrolls Change
• 1330 – US Jan. Unemployment Rate
• 1330 – US Jan. Average Hourly Earnings
• 1330 – Canada Jan. Unemployment Rate
• 1330 – Canada Jan. Net Change in Employment
• 1500 – Canada Jan. Ivey PMI 

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