Summary: Global equity markets are taking the uncertainties driven by the war in Ukraine in stride and generally rallied again yesterday, encouraged in part by a significant drop in bond yields, although a portion of the drop was wiped away overnight. The coming days should indicate the degree to which the situation is registering with the US Federal Reserve, as Powell is set for semiannual testimony before Congress tomorrow and Thursday as the market has lowered expectations for the March FOMC meeting, now pricing high odds for a 25-basis-point hike.
What is our trading focus?
Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) - US equity futures are improving this morning with S&P 500 futures sitting just below the 4,400 level with the 200-day moving average at 4,456 which is a natural gravitational point should risk sentiment improve further. The key risks are of course events coming out of Ukraine or new sanctions being announced against Russia (or the other way around). The situation is highly dynamic, and we remain defensive (see equity note from yesterday).
Hong Kong’s Hang Seng Index (HSI.I) & China’ CSI300 (000300.I) rose overnight while China’s PMIs came out stronger than expectations. February Manufacturing PMI rose to 50.2 (vs. 49.8 consensus and 50.1 last). Non-Manufacturing PMI also rose to 51.6 (vs. 50.7 and 51.1 last). February Caixin China Manufacturing PMI rose to 50.4 (vs. 49.1 and 49.1 last). Li Auto (02015) rose over 10%, after having reported stronger than expected earnings and margin growth. Chinese assets, including the renminbi, Chinese Government Bonds, and equities are getting safe-haven capital inflows. Renminbi has been strong since the Russian invasion of Ukraine and currently trading around 6.31 against the U.S. dollar. The Hong Kong Government is considering putting the city into a 9-day lockdown to stop the spread of COVID-19.
European equity markets – more European companies are announcing that they are divesting or selling Russian assets with Shell being the latest to announce such a move. The Euro STOXX 50 futures are stabilising this morning, but volatility remains elevated. We expect pressure to remain on European companies with exposure in Russia as more and more companies are contemplating what to do. Investors should also remember that the weakest links in Europe are Italy, Austria, and France in terms of banking exposure, so risk sentiment will essentially be spreads of these three country indices vs the rest.
EURUSD, EURJPY and EURCHF – the main euro crosses continue to serve as barometers of concern for Europe linked to the war in Ukraine, with EURCHF slipping to new lows below 1.0300, while EURJPY and EURUSD remain rangebound, suggesting no panic there, which also fits with the general backdrop of stable equity markets. Switzerland joined the EU in sanctioning Russia, including personal sanctions against Russian president Putin and Foreign Minister Lavrov and closing of Swiss airspace to private aircraft flying from Russia. This is a departure from decades of neutrality.
AUDUSD – the AUDUSD remains firm at the top of the range despite a still-dovish RBA meeting overnight, in which the RBA kept the policy rate at 0.10% and expressed caution on the outlook, in part linked to the war in Ukraine. Australian short rates were stable in the wake of the meeting, suggesting the stance was no surprise. The Aussie has constantly sprung back higher on every sell-off inspired by weak risk sentiment recently, suggesting a remarkable underlying resilience, one that may be linked to Australia’s impressive commodity export portfolio of coal, iron ore, wheat and LNG. A close above 0.7300-15 could set in motion a more ambitious rally toward the 0.7500 area.
Bitcoin and Ethereum - The market cap of the total cryptocurrency space has rallied by more than 11% over the past 24h, with Bitcoin (up 13%) and Ethereum (up 11%) being the main contributors. According to a report on CoinShares, volumes in Bitcoin crypto exchanges that trade RUB/USD have seen increases of more than 120% week-on-week. Furthermore, major crypto exchanges are declining request from Ukraine to block Russian accounts.
Dutch TTF gas futures (TTFMJ1) have opened close to unchanged after closing higher on Monday but 25% below its intraday peak as the market tries to quantify the potential, if any, loss of supply from Russia, the region's biggest supplier. Daily price swings of more than 25% during the past three trading days has attracted an army of short-term traders which is likely to have further increased volatility making it a difficult market to navigate. Storage facilities across Europe are currently around 30% full, after withdrawals slowed during February due to milder weather. The injection season normally begins in late March but for this winter the worst is over. A prolonged conflict with Russia however raises the risk for next winter with the price for Oct-22 ti Mch-23 trading close to €100/MWh.
Crude oil (OILUSAPR22 & OILUKAPR22) continues to trade close to 100 dollar per barrel as the market tries to quantify the potential drop in supply from Russia amid banks pulling financing and shipping costs rise. Also, in focus are talks about releasing 30 million barrels of oil from strategic reserves, Wednesday’s OPEC+ meeting where the group is expected to rubber stamp another but illusive 400k b/d production increase, and ongoing nuclear talks with Iran which has reached the final and most difficult stage. With global supply still struggling to meet robust demand, the result may end up being a continued rally until global growth slows, which it will, or soaring prices kill demand.
Gold (XAUUSD) holds above $1900 with sanctions against Russia potentially increasing an already elevated risk to global growth while inflation is likely to remain higher for longer, thereby raising the risk of a gold supportive period of stagflation. In the short term the market will continue to look for direction from developments in Ukraine as well as any further news on sanctions and so far, futile talks between Russia and Ukraine. The prospect of a 50 basis US rate hike is off the table with the market reducing the number of rates hikes this year to less than six. While support has been established at $1877, the 50% retracement of the recent rally, a signal for further upside gains may emerge on a break above $1937.
US Treasuries (TLT, IEF). The focus is on Fed’s officials and what the market can expect from the FOMC meeting this month as inflationary pressures soar, but the economic outlook remains uncertain. The FRA/OIS spread is rising indicating that the central bank might need to increase the money supply to ensure stability in financial markets. The 2-year Treasury/2-year forward dipped below 2% in a sign that aggressive monetary policies will be shorted lived. Therefore, the US yield curve shifts lower as investors buy the safe-haven and pare back rate hikes expectations. Jerome Powell will testify before the House Committee on Financial Services on Wednesday and before the Senate Banking Committee on Thursday. On Friday, the market will be waiting for the non-farm payrolls and average hourly earnings. Volatility will likely maintain high, and yields will adjust lower as the market continues to weigh whether inflation or growth is going to be at the forefront of monetary policies.
European Sovereigns (VGEA, BTP10). The bid for safe-havens continues to compress yields in the euro-area as the ECB looks to prepare for a dovish March monetary meeting. Yesterday, Lagarde said that the central bank will do whatever it takes to maintain stability, while Panetta talked about the dangers of removing accommodation early. At the same time, the European Commission has confirmed that a first payment under the NGEU fund will be delivered to Italy, improving sentiment in the periphery further provoking Italian yields to drop by 12bps. The focus will be on ECB’s official speakers before the blackout period on Thursday and the eurozone CPI figures released tomorrow.
US Corporate space (HYG, USIG). Corporate bond spreads continue to widen, while the primary market remains frozen for high yield borrowers and challenging for high-grade bonds. The average yield on junk bonds rose to 5.85%, the highest since September 2020. The more the primary bond market remains paralyzed because of war, the more likely a tantrum is to ensue.
What is going on?
Ukraine-Russia negotiations yesterday yield no progress. The talks took place at the border between Ukraine and Belarus and were led from the Ukrainian side by defense minister Reznikov and on the Russian side by only deputy minister level representatives. The talks led nowhere, as Russia’s request for Ukrainian neutrality have been rejected and Ukraine separately even appealed for EU membership yesterday. With a long convoy of military vehicles stretching north of Kyiv, Ukrainian president Zelenskiy has declared that today is an important day for the country.
Inflation is still running hot in the eurozone. Spain’s CPI rose 7.4 % year-on-year in February versus 6.1 % in January. This is the fastest pace since July 1989. The sharp increase is partially explained by high energy prices and the fact we compare to a flat month in 2021. France’s CPI is getting uncomfortably high too. It rose 4.1 % year-on-year this month versus 3.7 % estimated. Both CPI reports cover the period before the recent rise in energy prices related to the Russian invasion of Ukraine. The inflation headache will be a major issue for the European Central Bank in the coming weeks and months, in our view.
MSCI is considering removing Russian equities from benchmark indices. The ICE has already said it will remove Russian debt from its fixed-income indices starting on 31 March when indices are being rebalanced. MSCI is under enormous pressure and in the case they remove Russian equities from their indices it will trigger large selling of Russian equities when the Russian equity market potentially opens next week.
Mixed U.S. indicators. The U.S. Chicago Fed purchasing managers index falls in February at 56.3 versus 63 expected and 65.2 prior. But growth in Texas manufacturing activity continues. The production index, a key measure of state manufacturing conditions, was out at 14.5 – above-average output growth. Other indicators also show continued growth: new orders, rate of orders, shipment and capacity utilization, for instance. Inflation is an issue in the U.S. too. Prices and wages continued to increase strongly in February. The raw material prices index was up 11 points to 73.4 and the finished goods prices index rose eight points to 44.6.
The Reserve Bank of Australia (RBA) waxes caution warning the war in Ukraine as a new source of major uncertainty, and it would likely cause energy price inflation and ‘instability’. The takeaway from here is that the RBA won’t have ammunition to hike the Cash Target rate sooner than originally expected, with the market currently pricing in a rate hike in August. Yields were little changed in the wake of the decision and risk sentiment was strong as traders heavily bought into Australian tech stocks, taking Australia’s tech sector to a 9-day high.
Wheat (ZWK2 in Chicago & EBMH2 in Paris) ended February on a strong note, thereby yielding the biggest monthly jump in six years. Russia and Ukraine supply more than 25% of the world’s wheat exports, and for now Ukraine export terminals remain shut. Somewhat helping ease global shortages caused by drought and the war in Ukraine was news that Australia, another major shipper of wheat, upgraded its already record harvest by 5.5%. The prospect of a continued rise in global food price inflation remains real with the negative consequences it may have on stability and growth.
What are we watching next?
Ukraine is to issue its first war bond today. Today Ukraine will sell war bonds to fund armed forces. There is not much information regarding the issuance, however, Ukraine’s central bank imposed capital controls which will make it difficult for foreign investors to participate. It’s worth noting that the USD Ukraine bonds with maturity 2032 plunged to 30 cents on the dollar. Despite the war, Ukraine has already sent a coupon payment of $290mm scheduled for today.
Pressure on US companies to decide on Russian activities and assets. With more and more European companies divesting Russian assets or announcing temporarily export bans to Russia, the pressure will increase this week on US companies such as Apple, Netflix, Google, Meta, and Microsoft to make decisions. This is a key risk to monitor for equity investors.
US President Biden state of the Union address. Taking place in Asian hours tonight as it is late in the North American day, Biden’s rather tardy State of the Union address before Congress comes at a difficult time for the US president, who is suffering the worst favorability ratings of his presidency and is pressured on all sides by inflation, particularly soaring gas and food prices, and the situation in Ukraine. Any new tone on urgency on Ukraine or inflation could have market implications (a more hawkish Fed, geopolitical implications, etc.).
Fed Chair Powell testimony on Wednesday and Thursday after Biden State-of-the-Union address. With signs during Powell’s renomination process that the White House was leaning heavily on the Fed to hurry up and do something about inflation, we’ll need to see if this urgency remains in Fed Chair Powell’s testimony before Congressional committees tomorrow and Thursday, or if the war in Ukraine has introduced enough concern for the Fed to merely confirm expectations for a string of 25-basis point rate rises in coming Fed meetings rather than moving with a more dramatic lift-off of fifty basis points.
Earnings Watch. Today’s key focus is on Zalando which needs to show increasing operating margin and revenue growth above fashion retailers such as Inditex and H&M. In the US session the key earnings to watch are Salesforce, Sea, Baidu, NIO and Plug Power.
Economic calendar highlights for today (times GMT)
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