Geopolitical Risks Rise

Last week ended on a positive note for risk assets, with equities rallying to record highs. In particular tech stocks are back in lead this quarter. The biggest surprise was the ability of US Treasuries to rally at the same time, particularly in the wake of a strong slate of economic data. The rally may be attributable to strong foreign and pension buying amid short market positioning.  Indeed, CFTC data show that Treasury bearish positions had increased as of April 13th.  The pull back in US Treasury yields points to some relief for emerging market assets. Similarly, commodity positions had also been cut, with gold, copper and oil positioning liquidation taking place. The risk rally and lower US yields have put the US dollar on the back foot, extending its decline over the week.  As such, the USD “exceptionalism” story appears to be fading somewhat.

Last week finished off with another set of firm US data; Housing starts surged 19.4% m/m to 1,739k, well-above the 1,613k consensus, from 1,457k (revised from 1,421k) in February. Similarly, consumer sentiment continued to improve in April, according to the preliminary release of the University of Michigan survey, with the index rising to a new post-COVID high of 86.5.  This week’s highlights include central bank decisions in China (Tue), Indonesia (Tue), Canada (Wed), Euro area (Thu) and Russia (Fri).  Russia’s central bank CBR is expected to hike by 25bp while no changes are expected from the other central banks.  Canada’s Federal Budget today and CPI (Wed) will also be in focus.  Data wise, Australia March retail sales (Wed), New Zealand Q1 CPI and Euro area flash purchasing managers indices PMIs (Fri) will garner attention.  

On Friday, the US Treasury released its semi-annual FX report and found that once again Vietnam and Switzerland met all three criteria under the 2015 Act. over 2020.  Taiwan was also found to breach the Treasury criteria.  The outcome means that there will be ‘enhanced analysis’ of these countries.  However, the {US} US Treasury declined to name any of these countries as currency manipulators, citing insufficient evidence under the 1988 Act.  The other interesting development is that the Treasury questioned the foreign exchange activities of Chinese state banks given that it appears that China’s official FX intervention was very limited.  Separately, Ireland and Mexico were added to the US Treasury Monitoring List.

Geopolitical risks are rising once again and could act as a threat to markets in the day and weeks ahead. Last week the US levied sanctions on Russia including targeting Russian government debt. Russia responded with counter sanctions. However, the US administration did hold out an olive branch in the form of a potential joint summit. Focus is also on growing tensions between Ukraine and Russia Similarly, US and Japanese leaders voiced concerns over Chinese policies, which were subsequently rejected by China’s foreign ministry. Despite the US criticism of China the US and China appear to be moving ahead with cooperate on climate change. US-China over Taiwan remain elevated however.

Inflation Debate Rages On

Good morning, last week ended on a solid note for global equity markets, capped by strong gains in US stocks and in particular a surge towards the end of the session on Friday.  The S&P 500 is on track for its best month since November though in the next few days, month and quarter end rebalancing will continue to hold risks, which could result in increased volatility.  Another imponderable is potential follow through from huge equity sale block trades at the end of last week reportedly from Archegos Capital, which hit US media companies and Chinese tech stocks. All of this suggests risks of higher volatility in the days ahead.  

US interest rate markets came under renewed pressure, with yields backing up over the week, while the US dollar (USD) had a firmer week, with the USD index (DXY) ending above its 200-day moving average and technical indicators pointing to further gains this week.  CFTC IMM speculative positioning data (in the week to 23 March) shows that net aggregate USD short positions have been pared back further as USD sentiment continues to improve.  Positioning in most currencies vs. USD fell while Japanese yen (JPY) short positions increased further.  The oil market and container costs could be pressured higher by the continued delay in dislodging the stricken Ever from the Suez Canal, which seems to have made little progress over the weekend.

Attention this week will turn to a few key data and events.  Important among these will be President Biden’s speech in Pittsburgh (Wed) where he will likely give further details on his infrastructure plan and how it will be funded.  Key US data include the March ISM manufacturing survey (Thu) and March non-farm payrolls (Fri).  Solid outcomes for both are expected.  In Asia, focus will be on March purchasing managers indices (PMIs) across the region (Thu) including in China (Wed) where broadly positive readings are likely.  There will also be attention on the going malaise in Turkey’s markets since the sacking of the central bank (CBRT) governor while Europe continues to struggle with fresh virus waves, lockdowns, and vaccine reluctance as well as tensions over vaccine exports to the UK.

As President Biden gives his speech this week the debate about a potentially sharp rise in inflation rages on.  The Fed has tried to calm fears by highlighting that any rise in inflation over the coming months will likely be transitory.  However, with massive stimulus in the pipeline, economic recovery taking shape and the Fed set to keep policy very accommodative for years to come, market fears have risen as well as warnings from the likes of former Treasury Secretary Larry Summers.  Consumer inflation expectations remain largely subdued but the debate will not end quickly, and bond markets will be on tender hooks.  In the next few months inflation will turn up but this will largely be due to base effects as the collapse in activity in prices in Q1 last year falls out of the equation.  However, the jury is out on whether this will turn to more persistent inflation, something that could have a much more severe impact on markets and force central banks to belatedly tighten policy. 

Will the Fed Calm US Treasury Market Volatility?

The main market action on Friday was once again in US Treasuries, with another sharp sell off as the 10y yield spiked 8.8 basis points despite three large US debt auctions over the week that were received relatively well by the market.  The sell-off helped the US dollar (USD) to strengthen while oil prices slipped. USD sentiment is clearly becoming less negative as reflected in the latest CFTC IMM data (non-commercial speculative market positioning), which shows that USD (DXY) positions (as a % of open interest) are still short, but at their highest since the week of 8 Dec 2020. Tech stocks didn’t take well to higher yields, but the Dow and S&P 500 closed higher. The move in yields may pressure Asian currencies and bond markets after some consolidation/retracement towards the end of last week though equity markets look better placed. 

At the end of last week US University of Michigan consumer sentiment rose to 83.0 in the preliminary release for March from 76.8 in February and exceeded expectations at 78.5 (consensus). This week attention will turn to a plethora of central banks spearheaded by the Federal Reserve FOMC (Wed). Markets will be watching for any revisions to US growth forecasts amid a dovish tone, albeit with little sign of any push back on higher yields. US rates markets will also focus on the US 20y auction, which could keep the curve pressured steeper.  Nervousness over the Statutory Liquidity Ratio (SLR) exemption, which is set to expire at the end of the month, will also likely intensify.  A less dovish than hoped for Fed, will likely keep the USD on the front foot. 

Other central bank decisions this week will take place in the UK, Norway, Turkey, Russia, Indonesia, Taiwan, Brazil and Japan. None of these are likely change policy settings except Brazil, where the market is looking for a 1/2% hike. Developments to look out for include some push back from the Bank of England on higher yields, a move to bring forward the rate hike path in Norway, a potentially controversial no change decision in Turkey and the Bank of Japan’s announcement of the results of its policy tools and in particular clarification on the tolerated trading range for 10-year JGBs.

Data this week kicks off with Chinese activity data today including February industrial production and retail sales. Seasonal distortions and base effects will make this month’s data look particularly strong.  Other data this week includes US Feb retail sales (tomorrow) where a weak outcome is likely depressed by harsher-than-usual winter weather as well as a fading of the boost from stimulus payments. Australia February employment is also likely to be soft (Thursday).  

Overall, equity volatility has eased, especially in the equity market, suggesting some return of normal trading conditions there, but interest rate volatility remains high driven by the move in US Treasury yields.  The USD gave back some gains towards the end of last week, but will likely benefit from higher US yields and is set to start this week in firm form.  US interest rate gyrations will likely provide further direction for the USD over the rest of the week.   Much of course will depend on the Fed FOMC meeting, which will be the main event this week. 

Watching US Yields

Risk assets struggled to make headway last week, with technology stocks stumbling in particular.  Nonetheless, inflows into equities remain strong as more and more retail money is drawn in (perhaps signs of a near term peak).  Asian stocks started the week in positive mood despite last week’s nervousness, but equity investors will continue to keep one eye on the move in US yields.

US Treasuries continued to remain under pressure and the curve continued to bear steepen.  A combination of US fiscal stimulus hopes/expectations, vaccine progress and reduction in COVID cases, appear to be pressuring bonds. President Biden is likely to pass his $1.9 tn stimulus package in the weeks ahead, with a House vote likely this week, while the Fed continues to dampen down of any tapering talk, helping to push inflation expectations as reflected in break-evens, higher.  Indeed, this will likely be the message from a number of Fed speeches this week including Chair Powell testifying before Congress (Tue and Wed). 

Despite higher US nominal and real yields and visibly more nervous equities, the US dollar (USD) continues to struggle, failing to find a trigger to much covering of the massive short USD position still present.  We note that non-commercial FX futures positioning data (CFTC IMM) revealed only a limited reduction in aggregate USD short positions (as a % of open interest) in the latest week. Antipodean currencies led the way at the end of last week, but pound sterling (GBP) speculative positions have seen the biggest bounce over the last couple of weeks. 

Despite the USDs reluctance to rally lately, the short-term bias could shift to a firmer USD sooner rather than later, including against Asian emerging market currencies.  Indeed, several Asian currencies lost ground last week, with the Philippines peso (PHP) and Indonesian rupiah (IDR) leading the way lower.  The Asia USD index (ADXY) appears to have peaked and looks vulnerable to more short-term downside.

US economic data at the end of last week revealed that the flash estimates for the February purchasing managers indices (PMIs) stayed at fairly strong levels for both the manufacturing and services sectors.  Separately, US existing home sales posted stronger-than-expected numbers for January.

Attention this week will be on progress of passage on US fiscal stimulus as well as a number of central bank decisions beginning with China (today), New Zealand (Wed,) Hungary (Wed), and South Korea (Fri).  No policy changes from these central banks are likely.  Also of interest will be the UK’s announcement on exit plans from the current lockdown (today) and Germany’s Feb IFO survey, which is forecast to edge higher. 

Reflation Trade Is Back

A much softer than expected US January jobs report didn’t prevent US equities from closing higher at the end of last week as the reflation trade kicked back in.  One of the biggest driving forces for markets was the growing prospects that much of President Biden’s $1.9 trillion fiscal stimulus plan will be passed, albeit via a process of reconciliation, which allows Democrats to circumvent the need to gain the support of at least 10 republicans. This contrasts with prior expectations that the final stimulus was going to be less than $1 trillion. 

Pushing stimulus through this way highlights Biden’s urgency to inject more spending into the economy but could come at the cost of hurting bipartisan policy efforts. The impact of expectations of increased fiscal stimulus is particularly apparent in the US rates market, with US Treasuries selling off and bear steepening of the curve.  Although higher US Treasury yields failed to give support to the US dollar (USD) there is still scope for a short covering rally, which could still help give the USD relief.     

At the beginning of the year the US jobs market took a hit from renewed lockdowns and surge in COVID cases; US January non-farm payrolls increased 49k, and December was revised to -227k from -140k while more positively the unemployment rate fell to 6.3% from 6.7% though this was flattered by a drop in the participation rate as less people were looking for work.  According to the payrolls report there are still 9.9 million more unemployed compared to pre-COVID levels.  As such, the weak jobs data added more support to Biden’s fiscal stimulus proposals.   

This week focus will likely turn more to President Trump’s impeachment trial in the Senate than economic data.  Key data/events this week include China’s credit and monetary aggregates (9-15 Feb), central bank decisions in Sweden (Wed), Philippines, Mexico (Thu) and Russia (Fri).  Among these the consensus is for only Mexico to cut its policy rate. Also in focus are inflation readings in China (Wed), US (Wed) and India (Fri).  UK GDP (Fri) and US Michigan sentiment (Fri) will also garner attention. 

The return of the reflation trade, rally in risk assets and decline in cross-asset volatility bodes well for emerging markets (EM) assets.  However, there are definitely various cross currents impacting asset markets at present especially with US Treasury yields rising, which could potentially support the USD and pressure EM local bond rates markets.  EM assets were clearly favoured towards the end of last year, and while the positive story has not dissipated, EM assets may take a pause for breath before pushing higher again.  

In Asia, the Chinese-new-year holidays this week may dampen activity while China’s PBoC also appears to be limiting liquidity injections around the holidays, which could limit some of the gains in Chinese and impact China linked assets.  Chinese authorities have re-focussed attention on preventing an excessive build-up of leverage and credit metrics have peaked as a result.  As such, they may be less keen to inject a lot of liquidity into markets at present. 

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