The extent of the impact of China’s Covid-zero policies on the domestic economy was highlighted this morning as the Caixin Services PMI for April recorded its second-largest fall on record. Caixin Services PMI fell from 42 to 36.2. It is likely to be one of several headwinds facing China markets as they return from the Labour Day holiday break.
China is tightening Covid-19 restrictions in Beijing and extending them elsewhere as its Covid-zero policy continues to weigh on the domestic economy and exacerbate supply-chain issues internationally. Reuters is also reporting that the US SEC has expanded its list of US-listed Chinese entities that face delisting over audit transparency. Another 80 companies were added today including heavyweights such as JD.Com (NASDAQ:JD and Pinduoduo (NASDAQ:PDD). The massive post-FOMC relief rally staged by US stock markets yesterday could pass Chinese markets by today.
Perhaps the only silver lining for the rest of the world around the China slowdown is in the energy space. The EU announced yesterday it was moving to enact a ban on Russian oil imports by the end of the year, with exceptions for Hungary and Slovakia. That was enough to torpedo European equities yesterday, but Brent crude finished the day over 5.0% higher. Although I believe the world continues to materially under-price Ukraine/Russia risks in the energy space, the slowdown in China is acting as a brake on rising oil prices.
In the EM space, India surprised markets yesterday with an unscheduled 40bp interest rate hike. That send the SENSEX tumbling, while the Indican Rupee surged higher. Having held steady at the recent meeting, it speaks volumes about the inflation stresses that central bankers are facing now that India has shifted its policy bias. India’s RBI has tolerated stagflationary monetary conditions throughout the entire pandemic to keep the lights on in the economy. Its shift is an important one, and it will be interesting to see if other Asian central banks start blinking on inflation as the year progresses. I would expect more rate hikes from South Korea, the picture is muddier for the rest of the region. Especially given that many Asia-bloc countries have a high beta to China, and it continues to face serious downside risks to growth. The post-FOMC rally in Asia FX will be temporary I believe.
Turning to the FOMC policy decision which has been analysed to death already, it was a case of sell the rumour, buy the fact. The FOMC hiked by 0.50% as expected, with Chairman Jerome Powell signalling that another 0.50% hike is pencilled in for the next two meetings. That sparked a huge relief rally in equity and currency markets, with gold also rallying as the street breathed a collective sigh of relief that 0.75% hikes were unlikely to happen. In fact, Mr Powell didn’t specifically rule out a 0.75% hike next month, citing the need to be “nimble.”
Markets are geniuses at picking out the bits of a story that fit their preferred narrative though. And naturally, we saw the US dollar plummet versus DM and EM currencies, equities rallied aggressively, bond yields eased, although mostly at the short end, and gold and silver posted handsome gains. The FOMC also saved Bitcoin’s bacon, which rallied 5.0% higher after threatening a major downside technical breakout earlier in the day. The price action is suggestive of positioning, something I have been telegraphing the last few days, as opposed to a structural change in sentiment.
Lost in the noise, the Fed also announced a start to balance sheet reduction, or quantitative tightening if you want to use a couple of buzzwords that make you sound clever. From June the Fed will start selling $45 billion of bonds and MBS’ a month, ramping up to $95 billion a month by September. It will be interesting to see if we can avoid a “taper-tantrum” this time. In 2013, the previous exercise was quickly halted as EM started to meltdown, and that was in a low inflationary environment. I would argue that QT could have a far more important downstream impact on markets than Fed Funds rate hikes and has, until now, had its risks discounted like those from the Ukraine/Russia war. The Fed believe it can get away with aggressively tightening and reducing its balance sheet and a soft landing will prevail. Given their track record on “transitory inflation,” I am as nervous as a fat steer at a BBQ festival or using a pedestrian crossing here in Jakarta.
Australia’s trade surplus expanded to AUD 9.314 billion. But it was driven by bloated demand for everything the lucky country grows, pumps, or digs out of the ground. Instead, the headline number was flattered by a 5.0% slump in imports even as exports were almost unchanged. Building Permits also slumped by 18.50% in March. Perhaps we are seeing the first signs that a lower Australian dollar, making imported goodies more expensive, a surging cost of living, and rising financing costs, are starting to drag on the domestic economy, just as the RBA starts to hike rates. Australia will be as insulated as any country from the Ukraine/Russia resource inflation surge that is yet to be fully felt by the global economy, but it won’t be fully immune to those downstream impacts.
Japan, South Korea, and Indonesia are on holiday today, but we have Inflation releases from Thailand, Philippines RPI, India Services PMI and Singapore Retail Sales. The RBI hike yesterday will drown out any noise around the India PMI, but Singapore Retail Sales has definite downside risks as rising costs squeeze discretionary spending on the Red Dot. The MoM for March number is expected to fall by 0.50%, but a much larger fall will weigh on stocks, particularly banks, and may unwind some of the impressive gains the Singapore Dollar made overnight.
Today we have German Factory Orders although I expect developments around the Europe/Russia oil ban to drown that out. UK Services PMI has downside risks and could weigh on Sterling. We will have the results from the Northern Ireland election and a policy decision from the Bank of England. Markets have priced in a 0.25% hike to 1.0% from the BOE. The BOE have been using the Ukraine situation as a reason to reel in hawkish expectation and rightly so. They, like Europe, face least-worst choices in this respect. They should also announce their own plans for balance sheet reduction. A hike of less than 0.25%, a soft approach to QT, and/or a dovish outlook, should stop Sterling’s overnight rally in its tracks and resume the downside pressure. The Northern Ireland election could also be Sterling negative if Sinn Fein sweeps the vote.
Finally, don’t forget that we also have the US Nonfarm Payrolls data due out tomorrow. Markets are pricing in around 400,000 jobs, steady from last month. We had a very soft ADP Employment print yesterday. Although the two are not strongly correlated, and the JOLTS data suggests the labour market remains impressively robust, there is a downside risk to this month's print now. Perversely, a soft print could be fuel for the fire for the market’s peak rates narrative, sparking another big rally in equities, US bonds, EM, and gold, while punishing the US Dollar. To paraphrase the musical Chess, this week really is the show with everything but Yul Brunner.
Asia equities rise As China returns
Yesterday Wall Street saw a powerful relief rally as the Federal Reserve hiked by 0.50% as expected while downplaying the risks of 0.75% hikes ahead. That saw pent-up bottom fishing demand propel the S&P 500 2.99% higher, the NASDAQ rallying 3.19%, while the Dow Jones gained 2.80%.
In Asia, Japan and South Korea are on holiday, impacting on volumes and volatility. Mainland China markets have returned from the Labour Day holiday break and have posted modest gains this morning. That is a story being reflected across Asia today, gains but with far less exuberance than shown by the FOMO gnomes of Wall Street overnight.
There are a few reasons for this I believe. The 5.0% rise in oil prices yesterday is a headwind for energy-dependent Asia. The unscheduled rate hike by India yesterday throws down the gauntlet to other central banks across Asia. Delisting fears surrounding US-listed China companies will be felt in Hong Kong. Finally, the Beijing virus restrictions and those elsewhere in China, and its covid-zero policy overall, is a powerful headwind to the region, much of which has a strong correlation to China's economic performance.
Nevertheless, Asian markets are in the green today with Mainland China’s Shanghai Composite rallying 1.10% higher, and the CSI 300 gaining 0.55%. Hong Kong is 0.65% higher while Singapore is flat ahead of Retail Sales data. Taipei has risen by 0.65%, while Kuala Lumpur continues to underperform, easing 0.30% lower today. Jakarta is on holiday, but Bangkok has added 0.65% with Manila gaining 0.90%. Australian markets have also risen, with gains possibly limited by slumping import data today. The ASX 200 has risen by 0.60%, with the All Ordinaries gaining 0.70%.
European stock markets slumped yesterday as the EU started the process of banning Russian oil imports by the end of the year. Any relief rally by European markets today after the Wall Street performance overnight is likely to be limited. The threat of energy shortages and the resulting potential slowdown in Europe will cap any incipient rallies in European equities.
US Dollar slumps after as-expected FOMC
A holiday in Japan will limit FX volumes in the region today. The US Dollar slumped after the FOMC hiked the Fed Funds by 0.50% as expected and signalled that 0.50% hikes are coming in the next two meetings. With the threat of 0.75% hikes off the table, for now, markets had an excuse to reduce extended US Dollar long positioning.
The US Dollar slumped against DM and Asian currencies, with the dollar index plummeting 0.90% to the breakout level at 102.50. From a technical perspective, the dollar index should hold around these regions and resume its uptrend. The moves seen yesterday in currency and equity markets appear to be more about positioning rather than a structural shift in sentiment. Nevertheless, given how far the US Dollar has risen, I am not ruling out a deeper correction to the 101.00 area.
EUR/USD staged a corrective 0.90% rally to 1.0620 post-FOMC, before easing to 1.0610 in Asia. The Euro rally was a US Dollar story and not a Euro one, and as such, I believe the move higher is corrective. Rates are going nowhere in Europe and the proposed European oil embargo on Russia has brought Eastern European risks rightfully back to front and centre. Retaliation via natural gas from the Russian side can’t be ruled out. The EUR/USD technical picture remains extremely bearish, even without the external risks to the single currency. It remains well below its multi-decade breakout at 1.0800, and only a weekly close above there would suggest the downtrend is over for now. Rallies above 1.0700 will remain hard to sustain with risks skewed to a resumption lower.
As mentioned yesterday, sterling was due a relief rally as well and yesterday, it climbed 1.10% higher to 1.2635 post-FOMC. The rally has quickly faded, and GBP/USD has slumped by 0.56% to 1.2565 in Asia, ahead of the BOE rate decision this evening and the Northern Island election today heightening Brexit risk. Although the BOE should hike by 0.25%, there are, I believe, risks that the BOE may be more dovish in their policy outlook than the market believes. That will snuff the Sterling rally out. Rallies will likely be limited to the 1.2700/1.2800 region, while support lies at 1.2450 and 1.2400.
Oil prices leap on EU oil ban
Oil prices leapt higher yesterday as markets digested the impact of the proposed EU ban on Russian oil imports. Additionally, the OPEC+ JTC is indicating that there will be no change in the monthly schedule of production increases, with some members in fact, noting that China's demand has slumped.
Brent crude rose by 4.05% to $111.10 yesterday, with WTI climbing by 3.90% to 107.55 a barrel. In Asia, Brent and WTI have had a muted session, adding just 0.50% each to $110.60 and $108.10 respectively. In the bigger picture Brent crude is still in a broader $100.00 to $120.00 range, and WTI in a $95.00 to $115.00 range. Only a weekly close above or below those levels signals a new directional move.
Overall, we remain in a situation where the Ukraine/Russia conflict and the inability of OPEC+ to even meet their pre-agreed quotas is keeping spot prices tight, while China’s covid-zero-induced slowdown is acting to cap price increases. With the sanction situation on Russia escalating, and with Russian retaliation not out of the question, I believe the risks of the Ukraine conflict becoming more fully priced into energy markets, are increasing.
Gold rallies on a weaker US Dollar
Gold rose sharply yesterday as the US Dollar plummeted post-FOMC after the Fed hiked by 0.50% as expected, and eased concerns around future 0.75% hikes. Gold rose 0.70% to $1881.50 an ounce, before continuing its rally in Asia, gaining an impressive 1.10% to $1901.65 today.
The move in Asia is unusual, even more so because other asset classes in Asia are not showing a strong continuation of the US Dollar sell-off seen yesterday, although Asian currencies have rallied modestly in trading today. I suspect the buying is coming out of China as that market had returned from holidays today.
From a technical perspective, gold reclaimed the 100-day moving average at 1881.00 yesterday, which becomes intraday support, followed by $1850.00 and $1835.00 an ounce. Gold faces resistance at $1920.00 and $1960.00 an ounce. It is too early to say that gold prices have turned a corner. If the US Dollar correction lower continues, then gold can certainly continue rallying. But if the US Dollar sell-off runs out of steam, then gold will struggle to maintain gains above $1900.00 an ounce.