Recession Meltdown

Recession fears buffeted markets yesterday, with the price action across various asset classes looking like a self-sustaining negative feedback loop, triggering more stop losses as prices slumped and dragging in trend-following momentum-hunting fast money.

Europe endured a torrid day yesterday as the Norwegian oil worker strike proved the last straw for an energy-starved Europe. European equities plummeted and rightly so, as Europe's energy-from-Russia Achilles heel was cruelly exposed. The euro also capitulated, EUR/USD taking out 1.0350 on its way to a 1.50% loss to 1.0260. Sterling and UK equities were also hammered by the extra headwind of political instability as three senior ministers resigned yesterday with immediate effect. There may be some respite for Europe today though as the Norwegian government imposed a settlement on both sides effectively ending the strike. It is likely to be temporary.

In the US, equity markets opened much lower, but US bond yields outdid them, slumping on recession nerves yesterday and sending the US 10-year down to 2.805%, leaving the 2-year 10-year yield curve teetering on inversion. Perversely, the slump in US bond yields, which might also be due to haven inflows and not just recession fears, saved the bacon of US equity markets. US stocks reversed most of their losses, and ironically, the NASDAQ actually rallied to a 1.75% gain. The still-richly-valued growth stocks of the NASDAQ are the most interest-rate sensitive on US markets, and small moves in the risk-free discount rate have outsized price impacts in these environments. Still, the NASDAQ gains looked like a mechanical rear-guard action and not a brave new dawn. A US and Europe recession won’t do their ambitious valuations any favours either.

The big winner yesterday was the US Dollar, which rallied imperiously versus both developed and emerging currencies. A sign of the nerves around US Dollar strength came from China, which set a much weaker Yuan fixing rate of 6.7346 versus the US Dollar, as it glanced around at the slump in other Asia currencies yesterday. The only winner was the Japanese yen. USD/JPY held steady yesterday at 135.90, to my great surprise, as the US/Japan rate differential plummeted lower. However, it has immediately fallen by 0.50% to 135.15 in Asian trading. As I have said previously, the long USD/JPY has become a dangerous one as the primary reason for it occurring in the first place, the US/Japan rate differential narrows sharply.

Oil prices also slumped yesterday on recession hype. Ironically, one of the outperformers was Bitcoin, which reversed intraday losses to close unchanged at $20,200.00. I can only surmise that the NASDAQ’s rally lifted Bitcoin as well so that’s the short-term correlation to watch now, although it has already fallen 1.80% to $19,800.00 today. My line in the sane for Bitcoin remains $17,500.00, everything above that will be noise, failure should trigger another wave of margin stop outs among the geniuses conjuring 20% returns out of thin air.

Commodities also slumped on recession fears, notably copper. But as a grouping, hard and agricultural commodities look to have peaked a few weeks ago except for European natural gas for obvious reasons. Gold finally fell below $1780.00 an ounce yesterday, an ominous technical development. But spare a thought for palladium. It is trading at $1909.00 an ounce today, it's hard to believe it traded at $3400.00 an ounce in early March.

Asian markets are starting the day on the back foot for different reasons. The PBOC USD/CNY fix today will have regional central bankers looking over their shoulders, although looking at the price action of pairs such as USD/INR and USD/IDR yesterday, it looks like regional central banks are increasing their US Dollar selling. Mostly, though, it is China and covid zero that are weighing on the sentiment in Asia, which was going to be fragile anyway. As I have said till I am blue in the face, covid zero means covid zero in China, not one and down and we all live happily ever after. The City of Xi-an has enacted a series of restrictions yesterday, and 9 districts of Shanghai are undergoing mass testing. Chinese authorities will try, initially, a district-by-district approach to restrictions, But nobody should be under any illusion that they won’t go harder and faster if needed. As I’ve said before, China needs to get lucky 100% of the time, omicron has to get lucky once. This remains a key risk factor too often ignored by anybody pondering China markets in 2022.

The Asian data calendar is empty today except for Malaysia’s Bank Negara policy decision. The market is locked and loaded for another 0.25% rate hike to 2.25% and I won’t disagree. With USD/MYR testing 4.4200 today, they won’t have a choice. No rate hikes likely see USD/MYR starting with 4.50 in double time. South Korea, the Philippines and Indonesia all face the same unsavoury choice in the weeks ahead at their policy meetings, especially with another Federal Reserve hike looming at the end of the month.

On the subject of the Fed, the noise will increase that Fed will now have to mollify the pace and size of its rate hikes. Unfortunately, inflation in the US, like elsewhere, is showing no signs of abating and the data recently has really been that bad, much like Australia. This is more likely to be a story for Q4. If the US JOLTs Job Openings remain at 11 million or above, and the US Nonfarm Payrolls is comfortably above 250,000, there will be no sensible reason for the Fed to blink. Most of all, it is a credibility issue. Having got transitory inflation so utterly wrong and stubbornly clung to a dogma past its sell-by date, if the FOMC blinks now, they may as well do an Elvis and leave the building. Puppies and kittens don’t need to be trained to chase their tails, we certainly don’t need it from our central banks, who aren’t even cute to boot.

Today we get German Factory Orders and Pan-Europe Retail Sales. The releases won’t make good reading and could heap more pressure on the Euro and European equities, although I don’t discount the Norwegian oil strike settlement giving both a temporary reprieve. US JOLTs Job Openings will cause recession head-scratching above 11 million, but June’s ISM Manufacturing PMI for June and its activity, prices, new orders, and employment sub-indexes will probably decide the direction of travel in the short-term. The FOMC Minutes afterwards will probably be discounted somewhat given market developments over the past two weeks.

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