US equities were a bit stronger Tuesday, S&P 500 up 0.2%, European equities weaker. US 10-year treasury yields fell 7bps to 2.81%, 2-year yields down 2bps to 2.82%, leaving 2s10s inverted for the third time this year. EUR/USD fell to 1.0267, the lowest in twenty years, as the USD rallied.
The move lower in US rates exacerbates the rotation as tech internet and e-commerce names lead the way, with the top performers being the year-to-date worst suggesting investors went on a bargain-hunting spree.
While US investors continue to rummage through the recent stock market firesale looking for bargains, Europe remains at the epicentre of stagflation. EGBs felt the heat yesterday as global sentiment collapsed: mounting fears over gas supply and weak PMIs helped fuel that doomsday market scenario. In line with the risk-off mood, country spreads widened significantly, with BTP-Bund yawning over ten bp intraday to close 9bp wider.
Oil Hit By De-Grossing
There is no "new" piece of news behind the selloff in oil. However, oil markets are likely to view recessionary doom and gloom through the eyes of the steep fall in the euro as the single currency is the poster child for stagflation.
While the strong US dollar generally hurts commodity prices, I think the greenback's safe-haven bid reflects a more sinister story scaling to a 20-year high.
The natural gas situation is very worrying in Europe, especially if the Nordsream shutoff is unresolved in the coming weeks; the fear is this will lead to a broadening out of energy disruption with material upfront effects on economic growth and, of course, much higher inflation. Beyond the market's worries about slower global growth in recent months, what is unfolding in Europe in recent weeks is a new big negative economic shock.
The economic situation on the continent is dire on the back of soaring gas prices, which could cripple the economy and send a recessionary tsunami around the world. Hence investors are bringing both recession risk and demand destruction and de-grossing risky assets.
While lingering in the background, oil investors are asking themselves should they be concerned with OMICRON sub-variants as we move into the northern hemisphere winter, especially when viewed through the lens of China's zero covid policy.
On top of recession risk getting brought forward, macro investors will still take the opportunity to liquidate length across the complex, even with no precise supply and demand catalyst to spark any selloff. However, this is not unusual as pressure builds across risky asset portfolios; risk managers typically lower traders' exposure limits and ask them to raise hedges across many assets. Hence, we think this current oil market malaise is as much about risk aversion as anything else.
Stagflation Poster Child
The euro has depreciated sharply due to a toxic cocktail of negative drivers. An oddly hesitant ECB contrasts with a more aggressive Fed, worries about natural gas supply disruption and economic recession are deepening, and skepticism on the ECB's pre-announced anti-fragmentation program is growing.
The probability of short squeezes increases when sentiment and positioning become too one-sided. However, we have unlikely reached maximum uncertainty and total negativity, which opens the door to a test below sub-parity. So with the EUR/USD in the mid-1.02s, it might not be too late to punch your ticket for a ride on the parity party bandwagon.
Positive catalysts are far and few between, as a ceasefire in Ukraine, a more aggressively frontloading ECB or new pan-European bond issuance seem unlikely over the next couple of months.