Nobody could complain about a lack of volatility yesterday as the Russia/Ukraine sell-off staged the mother of all reversals, in equity markets anyway. Oil also reversed almost all its early session gains and gold finished lower on the day. Industrial metal and grain prices remained elevated with their more direct correlation to Ukraine, and currency markets staged only a partial reversal.
The stunning reversal by US equity markets and gold, and to a lesser extent, oil is telling. The new round of sanctions announced by the US, Europe and the UK amongst others was notable for two things. Firstly, in President Biden’s own words, the mechanisms were there for energy exports to continue. Secondly, the Europeans baulked at shutting Russia out of SWIFT, the global interbank payments network. President Biden also made great store out of an impending global strategic petroleum reserve release.
So, the limits to the economic pain that the “West” was prepared to tolerate to support Ukraine and punish Russia have been revealed within 24 hours of Russia’s offensive beginning. Timing is everything, and the Russian offensive has occurred in a time of already high inflation and commodity shortages globally, and the West has blinked immediately. The process of throwing Ukraine under the geopolitical bus has begun. Markets clearly felt the same way, that this is the worst it can get, and have responded in kind. Thereafter, the power of buy-the-dip proved irresistible.
I will, of course, have to revisit my stagflationary shock thesis, much to the relief of many readers, but not today. I will revisit it over the weekend, although I expect industrial metal and more worryingly, food prices, to remain elevated due to the conflict and Ukraine’s role as a food producer. My initial thoughts are that it will cause a stagflationary wave, but not a shock.
The West’s capitulation also allows the world’s central banks to breathe a sigh of relief and should not now stop them from continuing the monetary normalisation path unless things materially change in Eastern Europe. With that in mind, although equities will now stage a “Ukraine under the bus” rally over the next few days, I am not getting too excited that a medium-term bottom has occurred. The global denial that the cost of capital is no longer zero still pervades global markets. That acceptance of reality will cause pain in the months to come, particularly once the Fed starts getting busy with rate hikes. The NASDAQ staged a truly spectacular comeback yesterday, with the gnomes of Wall Street also convincing themselves that technology was a non-Russia-correlated haven play, you have to love group-think. That is likely to continue for a few sessions yet, but the Federal Reserve will serve up a cold dose of reality to those rich valuations in March.
Yesterday, US data came in on expectations with GDP QoQ Q4 printing at 7.0%, New Home Sales rising by 801,000, PCE Prices rising 6.30% and Initial Jobless Claims coming in at 232,000. That further boosted sentiment on Wall Street as the picture painted suggested that the US economy continues to perform strongly, omicron or not.
Today, New Zealand’s Balance of Trade missed slightly at NZD -1.082 billion, but the headline masked massive misses in both exports and imports. Q4 Retail Sales staged an Auckland reopening bounce, rising by 8.60%. With higher mortgage rates already starting to bite, and a central bank so far behind the curve, it can’t be seen, New Zealand is quickly rising to the top of my hard landing list.
Japan’s Tokyo CPI rose just 0.50% YoY for Feb, just above expectations. A dovish Bank of Japan will be relieved as the need to think about some sort of monetary policy normalisation for the first time in 20 years remains distant, with the inflationary pressures rampant internationally, relatively absent domestically. The data should be supportive for USD/JPY going forward as Japanese investors hunt for yields offshore.
The data is mostly second-tier in Europe today, but the US releases Personal Income and Spending for January, and the PCE Index, along with Durable Goods. The former are closely watched by the Fed, so high prints are likely to crank up the 0.50% hiking air raid siren again for the March FOMC meeting. In this environment, that overnight equity rally may run into a few headwinds at the end of the week. As it is I suspect investors will be reluctant to go into this weekend loaded up on risk
Next week brings the usual tier-1 first-week-of-the-month data frenzy from across the US, China, and the rest of the world. But first, let's get through this weekend and we will talk about it on Monday.
Equities stage 'peak-Ukraine' rally
US equities staged an impressive rally yesterday, wiping out the earlier day's losses and rallying to finish strongly in the green. Positive US data played its parts, but mostly it appears to be a relief rally sparked by the announcement of the scope of US sanctions on Russia. Without explicitly cutting off Russian energy from international markets, equities staged a “peak-Ukraine” rally. The S&P 500 finished 1.49% higher, the NASDAQ a breath-taking 3.34% higher, and the Dow Jones just 0.26% higher. The latter was hobbled by still high commodity and metals prices, while the tech-heavy NASDAQ was priced as having limited exposure to the Russia/Ukraine situation.
That peak-sanctions rally has spilt over into Asia today, although with less exuberance than New York, partly due to Asia’s strong reliance on imported energy and commodities. Investors are also unlikely to want to go into the weekend heavily long risk, something also being seen in oil markets today, which is capping gains.
Japan’s Nikkei 225 is 1.33% higher, with South Korea’s KOSPI climbing by 1.35%. China’s Shanghai Composite is 0.80% higher with the CSI 300 rallying by 1.10%. A weak Alibaba (NYSE:BABA) result is crimping Hong Kong, the Hang Seng easing by 0.35%.
In regional markets, Singapore is 1.0% higher, Kuala Lumpur has jumped 1.40%, with Jakarta rising 0.85%, and Taipei is flat. Australian markets are also cautious, the ASX 200 is unchanged, while the All Ordinaries is up just 0.20%.
European markets suffered heavy losses yesterday, with those with a high exposure to Russia and Ukraine having especially bad days. The “peak-Ukraine” rally in the US and Asia is unlikely to have the same scope thanks to geography, but some small gains are expected. European markets will continue to have the highest propensity to bad news coming from Eastern Europe.
Given the price action yesterday, US markets are likely to have another positive session into the end of the week, given that Wall Street is already pricing in that the West has blinked and quickly reached its threshold for economic pain to support Ukraine, and that we have seen the worst of the sanction announcements. However, weekend caution should limit gains.
US Dollar remains elevated
The US Dollar soared on haven flows as Russia commenced its invasion of Ukraine. However, DM currencies rallied later in the session after the announcement of the next tranche of Western sanctions. Although the relief rally mirrored equities to some extent, the US Dollar still held onto much of its early session gains, with the dollar index closing 0.90% higher at 97.05. Further long covering has pushed it slightly lower to 96.95 in Asia. The index spiked to 97.70 intraday and that remains initial resistance, with a failure of 96.50 likely to spark a deeper correction. US bond yields (prices fell) recovered their early falls, and this will provide some support to the greenback.
EUR/USD plummeted to just shy of 1.1100 before removing to 1.1200, taking back half of its intraday losses. 1.1100 is now support for the single currency, although it will need to reclaim 1.1300 to set up a meaningful recovery. Likewise, GBP/USD sank to near 1.3250 before recovering to 1.3410 as of this morning. 1.3250 and 1.3500 are support/resistance for Sterling now. Both currencies, with their high correlation to the Eastern Europe situation, are vulnerable to sudden moves down on negative headlines around Russia and Ukraine. But both may have traced out medium-term lows overnight if we are indeed, at peak-sanctions.
USD/JPY moved higher towards 115.50 yesterday before falling to 115.20 in Asia. Only a fall through 114.50 signals a deeper correction as Japanese investor flows head offshore in a search for yields as the BOJ remains firmly on hold. The CNY and CNH have strengthened yesterday thanks to the capitulation of non-Dollar components of the basket and, I suspect, haven flows from regional investors. I expect those haven flows to keep the Yuan firm in the coming week.
Elsewhere, regional currencies had a torrid session and remain on the back foot this morning. A rush to haven assets partly explains yesterday's risk rally passing them by. But with most of the region a massive importer of energy, raw materials, and food, and all of those prices remaining at recent highs, Asian currencies will remain challenged as supply disruption and pricing fears persist.
Brent crude rises once again as Asian buyers buy the dip
To describe the price action on oil markets as wild yesterday would be a gross understatement. Brent rose nearly $10 to just shy of $106.00, before retreating to $99.00 at the close, a 2.0% gain for the day. Likewise, WTI touched $100 a barrel before retreating to $93.00, a 0.80% gain. With US and European sanctions notably excluding Russian energy exports and their payment paths, energy markets quickly priced in the limit of Western sanctions and its low tolerance for economic pain to support Ukraine. Additionally, President Biden said that a coordinated global release of oil from SPRs was on the way, adding another headwind.
In Asia, though, prices are rising sharply once again, as Asian buyers piled into the dip in prices ahead of the weekend. Brent crude has risen 2.80% to $101.80 a barrel, while WTI has rallied by 2.70% to $95.50 a barrel. I suspect the Asian price action highlights the nervousness of regional importers, with Asia a huge net energy importer. It also suggests that despite the sharp reversal yesterday, geopolitical nerves are going to keep prices elevated. It is also clear that nobody wants to go into the weekend short oil. Short of an Iran nuclear deal being announced today, I cannot see any strong reason to sell oil at these levels still, and the risks are still skewed to the upside.
Gold retreats on peak-sanctions
Gold had a frenetic session yesterday, trading in a nearly $100 range, rising from $1910.00 to $1975.00 an ounce, whilst touching support at $1880.00 intraday. It was clear that a lot of fast money, and not haven money, got involved in the intraday price action yesterday, as gold staged a spectacular fall from its highs after the Western sanctions were perceived as limited in scope. Gold finished the day 0.30% lower at $1904.00 an ounce.
With the weekend upon us, Asian buyers are loading up on gold today as a weekend risk hedge. That has pushed gold 0.50% higher to $1913.50 an ounce. Gold has immediate resistance at $1920.00, and then nothing until the overnight highs at $1975.00 an ounce. Support lies at $1875.00 and $1850.00 an ounce.
I expect dips to remain supported in gold now that the fast money has disappeared, and some normality has returned to trading. Gold's next move will be determined by whether markets receive indirect confirmation that the West has reached peak-sanctions with Russia, or whether they intend to escalate them further. My money is on the former, meaning that gold may have seen it's medium-term high yesterday.