Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Summary: US Treasury yields and pricing of Fed rate tightening jumped higher during Fed Chair Powell testimony, as he indicated that 50-basis point rate hikes are potential during the coming rate hike cycle, even if he favoured a 25-basis point move at the March 16 FOMC meeting. Elsewhere, an historic day for oil markets, with the major grades rising some ten dollar at one point yesterday to new multi-year highs and up another couple of dollars overnight as the market fears extreme supply disruptions from sanctions against Russia as long as it continues its assault on Ukraine.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - US equity futures were lifted yesterday by Powell’s speech that the US economy is strong enough to absorb interest rate hikes, but Powell also stressed that inflation will be something we have not seen in decades. While the market used Powell’s speech as an excuse to buy the market the fact is that the US central bank is in such a vulnerable position and the uncertainty is so high that the market should not put too much weight on these remarks. S&P 500 futures are trading around the 4,385 level this morning with the 4,400 level being rejected in the previous two sessions, so this level is naturally a massive one to watch today on the upside if risk sentiment continues.
Hong Kong’s Hang Seng Index (HSI.I) & China’ CSI300 (000300.I) - Hang Seng traded modestly higher (+0.5%) while CSI 300 declined (-0.6%). HSBC (00005) rallied almost 4%. Techtronic Industries (00669) surged 11% following the release of strong earnings. Techtronic’s revenues and net profits rose 21% and 23% respectively in 2H21. Shenzhou (02313) fell 10% after issuing profit warning. A share coal mining stocks surged 4% to 10%, Chinese thermal coal price was up more than 4% following reports that Chinese traders had to cut down import of coal from Russia due to difficulties in getting bank financing for those trades. February Caixin China PMI Services came at 50.2 (vs consensus 50.7, Jan 51.4).
European equity markets – European equity markets rebounded yesterday, and the Euro STOXX 50 futures are slightly higher this morning relative to its opening print. Uncertainty is still elevated, and we do have a strong view on market direction at this point as the situation is too dynamic. We still prefer commodity sector, cyber security, logistics, mega caps, and defence stocks. In the Euro STOXX 50 futures the 3,800 level is the key level to watch on the downside.
EURUSD, EURJPY and EURCHF – the sudden reversal and rise in bond yields yesterday brought a new twist in the market for the traditional safe havens of JPY and CHF, which weakened against the US dollar, while the euro traded more or less sideways despite the EU (and UK) absorbing the worst of the economic damage from soaring gas and power prices (oil prices are more immediately global) and the risks to their banks from exposure to Russian assets, which have been marked down to zero in many cases. Somehow, risk sentiment in risky assets managed to hang in yesterday – if this odd confidence falters, the safe havens of USD, JPY and CHF may get another boost, with the US dollar the safest of havens in the even yields also continue to rise. Headline risk is extreme: developments that suggest Russian pullback or diplomatic overtures in Ukraine could spike the euro higher.
AUDUSD and EURNOK – We still see a strong commodity overlay in this market, as gas prices in Europe soared again yesterday (Australia also gains from strong natural gas/LNG prices, it is the world’s largest exporter). One can’t help but wonder if Norway will donate some of its profits from this conflict to Ukraine once we get to the other side of this? AUDUSD has pulled up through a key resistance zone this morning above 0.7300, also close to the 200-day moving average and is only vulnerable if risk sentiment stumbles badly, or perhaps in other crosses like EURAUD, etc., if the situation in Ukraine improves suddenly.
Crude oil (OILUSAPR22 & OILUKMAY22) keeps rising with ‘self-sanctioning’ seeing buyers avoiding Russian crude with no help from OPEC more worried about not upsetting Russia than actual responding to the unfolding energy crisis. Following a 13-minute meeting OPEC+ rubber stamped another 400k b/d increase even talking about a well-balanced market while making no mention of the Ukraine war. Crude oil is likely to continue rising until something breaks, and with that we are seeing futures spreads continuing to blow out with the prompt spread trading above $5/b while the Brent twelve month spread has reached an astonishing $28/b, a level not seen since the Gulf war several decades ago.
Iron ore (SCOH2, SCOK2) futures soared more than 6% on Thursday in Singapore to $158, taking the steel-making ingredient’s price back to August 2021 levels after surging 14% this week. Fresh highs were reached firstly because, China’s manufacturing and construction activity picked up. And secondly, because China’s top government officials issued orders to prioritize securing commodity supply and to fill any potential supply gaps from the Ukraine-Russia war regardless of price. China’s government agencies were ordered to push state-owned buyers to scour markets for materials, including oil and gas, barley, corn and of course iron ore. Shares in BHP (BHP) rose 3.6% to $50.60. Rio Tinto (RIO) rose 3.7%, taking both heavyweights shares to 7-month highs.
US Treasuries (TLT, IEF). Yesterday, Jerome Powell made it clear that the Federal Reserve will begin to tighten the economy in March and although a 50bps rate hike is not in the cards this month, it might be in a later meeting if inflation remains sustained. Consequently, money markets advanced rate hikes for this year and now consider five hikes by December. Jerome Powell will testify before the Senate Banking Committee today. On Friday, the market will be waiting for the non-farm payrolls and average hourly earnings. Volatility will remain high as the market continues to weigh whether inflation or growth is going to be at the forefront of monetary policies.
European Sovereigns (VGEA, BTP10). Eurozone’s yearly CPI rose to a record high level. However ECB speakers maintained a cautious stance in light of the war in Ukraine. Following Powell’s speech, the European sovereign yields curve flattened sensibly, and the market went from pricing zero hikes in 2022 the day before to more than two. However, ECB’s official speakers sound much more cautious than Fed’s peers keeping yields compressed.
US Corporate space (HYG, USIG). The Move index rose to the highest level since the pandemic, breaking above the levels during the 2013 taper tantrum. Yet, the corporate bond space remains indifferent as credit spreads are somewhat stable since the beginning of the week. The primary junk bond market resumed activity with BellRing brands pricing a 10y bond at 7%, the same level as guidance before the war in Ukraine started. Macy’s is now looking to sell bonds next to refinance existing debt. We remain concerned that aggressive monetary policies and an uncertain economic outlook will weigh negatively on credits provoking a tantrum.
What is going on?
Fed Chair Powell mentions possibility of 50-basis-point hikes, if likely not at March FOMC. Fed Chair Powell expressed concern on the outlook yesterday for the US economy stemming from the war in Ukraine, but maintained a strong line on wanting to begin the rate tightening cycle. And while he suggested he leans in favour of a 25-basis point move at the March FOMC meeting, he also said that it might be appropriate for the Fed to hike 50 basis points at some point – which would be the first time the Fed has done so since 2000. Powell was a bit cagey at times, expressing the desire to stay “nimble” no doubt as the Fed has no clue where inflation might head in coming months due to spiraling energy prices. The US 2-year treasury yield surged 17 basis points as the entire US yield curve lifted aggressively
MSCI and Russell remove Russian equities from benchmark indices. The decision is coming off consultation with market participants viewing Russian equities as un-investable and the country’s securities will be removed already by 9 March and set to zero value on 7 March. The most likely scenario for many fund managers is that Russian equities will have to be marked to market at zero for the time being and as long as the Russian main market is closed. When the Russian equity market is opening again one day it is not even sure that fund managers will be able to get trades settled, so zero value is the most prudent action on Russian equities.
The concern that Russia will use cryptocurrencies to bypass economic sanctions is growing on a global scale. FED chair Jerome Powell called for congressional action on crypto and the French Minister of Economy asked the EU to take measures on cryptocurrencies to ensure that Russia cannot circumvent economic sanctions. However, crypto experts say that politicians should not be worried, as the capabilities with cryptocurrencies for Russia will be too small, too costly and too transparent to do it on the required scale.
Chinese equities are rallying as government is considering easing Covid policy. This is a very positive news for global supply chains and China’s economy itself, and Chinese equities have reacted positively to this news.
European coal and gas prices trade up more than 85% since Russia attacked Ukraine and it highlights the risk of supply disruptions for both. In addition, coal production has faced challenges elsewhere with labor shortages in China and Mongolia, flooding across Australian mining regions and a decision by top shipper Indonesia to ban exports in January.
What are we watching next?
US February Nonfarm payrolls – and Average Hourly Earnings – up tomorrow. Yesterday we saw the US February ADP private payrolls at +475k vs. +375k expected, while the January data was revised higher from –310k to +509k (suggesting there is something very wrong with data collection?). This brought it in line with the strength in the Nonfarm payrolls in January, with consensus expectations for tomorrow’s February NFP change number at +418k. The US Average Hourly Earnings number will also be closely watched and is expected at +0.5% month-on-month and a new local high of +5.8% YoY. The unemployment rate has almost dropped to pre-pandemic levels (low was 3.5% - currently 4.0%, but the participation rate has bounced back strongly in recent months.)
Earnings Watch. Today’s key focus is on Canadian Natural Resources, CRH, Costco, Trip.com and Elastic. Earnings have been more mixed this week and outlooks are getting more uncertain due to the war in Ukraine.
Economic calendar highlights for today (times GMT)
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