Inflation nerves seem to be lingering around financial markets
Although China has returned from its week-long break today, there are little signs that Mainland markets want to play catch-up with the equity action seen elsewhere over the past week. Indeed, after spiking higher on the open, both the Shanghai Composite and the CSI 300, having risen 2.0% in early trading, is now nearly 1.0% lower, dragged down by the index’s Shenzhen components, which is enduring a torrid day.
Inflation nerves seem to be lingering around financial markets despite the FOMC minutes overnight, reassuring hinting at lower for longer, with no change in tack in sight. That may have arrested the rise in US longer-term yields, which traded sideways overnight, but wasn’t enough to push them materially lower. Any good work from the FOMC minutes was offset by higher US PPI numbers and US Retail Sales, which blew expectations out of the water by rising 5.30% in January.
The US Retail Sales was undoubtedly powered by the stimulus cheques hitting American’s bank accounts in December. Interestingly, Pantheon Macroeconomics estimates that only $29 billion of the $166 billion disbursed made its way into the Retail Sales number. American households remain cash-rich with Pantheon estimating that 60% of the cheques have been saved or used to pay down debt. That suggests that Americans have plenty of fuel in the tank to shop still.
There was noise overnight that the Retail Sales data would partially nullify the reasoning behind the $1.9 trillion Biden-stimulus package, making it likely that the headline number would be cut. I would argue precisely the opposite. The December cheques were meant to reduce the pandemic burden and stimulate domestic demand. Therefore, they achieved exactly what they set out to do, boosting domestic consumption and economic activity.
What cannot be denied, is that the whole exercise will be inflationary, with aggregate demand certain to ramp higher once the economy reopens further in March and April. However, there are 10 million fewer jobs than before the pandemic, so any inflation is likely to be cost-push and not wage/price spiral, thus transitory in inflation measures. Europe is an even grimmer picture, with much of the bloc still in lockdown and miles behind schedule in its vaccination race and facing a double-dip recession.
Government bond yields are grinding higher globally at the moment, but given the nature of the inflation pressures, are unlikely to derail the global recovery buy everything rally. The world is still awash in capital looking for a home, and the world’s central banks have not wavered in their intent to keep flooding the world with free money. What should happen, is the long overdue, and very welcome arrival of two-way pricing risk in global financial markets, notably the equity and crypto space. These days, markets contain more jump-suited bull market heroes than an Avenger’s movie, it’s about time they learned the challenges of using the bathroom in them.
Notably, the US Dollar continued rallying overnight. The US Dollar short squeeze may have more legs to it, which I had admittedly thought had run its course. One unintended consequence could be seen in Indonesia today. Markets, including myself, had pencilled in a rate cut by Bank Indonesia this afternoon. With USD/IDR climbing back above 14,000.00, those hopes are receding, and I expect BI to stand fast, even as the domestic economy remains under tremendous pressure.
Energy prices remain elevated, as vast swaths of US refining and extraction capacity remains shuttered due to the Texas big freeze. The global recovery trade is well and truly alive in the commodity space. Platinum is 1.60% higher today, Copper future have rallied by 1.85%, and Iron ore futures 0.80% higher. The movements in commodity and energy prices this year so far tell us the cost-push inflation is the new normal going forward.
As long as the world’s central banks keep the monetary spigots open, the buy everything trade should stay on track this year, even if it becomes more subject to the nearly forgotten concept of two-way price action. The taper-tantrum, when it comes sometime in 2022, will be a sight to behold.
Asia can’t shake off inflation nerves.
The rotation play continued to play out overnight on Wall Street quietly. The S&P 500 was unchanged, but the NASDAQ retreated by 0.58% while the more cyclical-heavy Dow Jones rose by 0.29%. Movements in the energy and commodity space explain much of the Dow Jones versus NASDAQ price action direction and why the more balanced S&P 500 was unchanged. The impressive Retail Sales numbers appear to have been shrugged off by markets as a stimulus-driven one-off.
The grind higher in energy and commodities are weighing on Asian markets, which are perpetually hungry and beholden to both. Mainland China returned to the office today, but the initial rallies by the Shanghai Composite, and notably the CSI 300, were quickly reversed. The Shanghai Composite is now 0.55% lower, with the CSI 300 suffering a 3.0% round trip in fortunes, currently 0.85% lower for the session. Hong Kong tells much the same story, and tentative rally, followed by a fall from grace, now 1.50% lower for the day.
Elsewhere, the Nikkei 225 has fallen 0.25%, while the Kospi is 1.0% lower. Singapore is down 0.50% with Kuala Lumpur down 0.25% while Jakarta has bucked the trend on rate cut hopes today, rising 0.45%. Australian markets are caught between an unimpressive Wall Street session and higher commodity prices. That has left the All Ordinaries and ASX 200 almost unchanged for the day.
US index futures are in negative territory, notably the NASDAQ futures, which are down 0.50%. Europe, another considerable energy and commodity importer, is likely to follow Asia’s lead and track lower this afternoon. At this stage, though, the price action looks corrective still, with equity markets going through a cost-push inflation repricing exercise.
The US Dollar rallies again.
It is probably no coincidence that the moves higher in base metals and energy, almost all of which is priced in US Dollars internationally, has also been reflected in US Dollar strength. The greenback also continues to gain a tailwind from the firming of long-end bond yields. Overnight, the dollar index rose another 0.50% to 90.95, leaving it squarely in the middle of its broader 90.00 to 92.00 five-week range.
The G-7 currencies and AUD, NZD and CAD all retreated modestly overnight, except the Japanese Yen. Once again, USD/JPY showed its sensitivity to the US/Japan interest rate differential. A sideways day in US bonds is seeing USD/JPY retreating to 105.90 this morning. Any firming of US yields should see the USD/JPY test 107.00, having staged a multi-month upside breakout on Tuesday.
This morning, China’s return saw the USD/CNY fixed at 6.4536, almost identical to the last fix a week ago. This morning China offered CNY 200 bio vis the 1-year MLF, offsetting maturing amounts, but continued draining liquidity via the 7-day repo. That has kept the Yuan firm at 6.4545 and has spared the rest of Asia any blushes from the Dollar strength apparent in the developed market space. As long as China keeps the Yuan firm and drains domestic liquidity, the rest of Asia orbiting on China’s event horizon should maintain some immunity from dollar strength.
The rally by the US Dollar versus the developed market space has been impressive over the past few days. In general, though, the technical picture suggests this is a correction to underlying Dollar weakness still. That could change, but I would prefer to wait for the dollar index to break either 90.00 or 92.00 before drawing any longer-term conclusions.
The big freeze pumps oil.
With large swaths of US refining and production capacity offline due to the Texas power crisis and big freeze, oil prices marched higher again overnight. Brent crude rose 2.30% to $64.90 a barrel, and WTI rose 2.60% to $61.70 a barrel. Both contracts have crept higher in Asia, notably Brent crude, which has broken through the $65.00 a barrel mark, rallying 0.50% to $65.20 a barrel.
As long as the Texas power crisis and big chill persist, oil prices will remain elevated, occurring with the futures market’s curves in a bullish backwardation already. US API Crude Inventories unexpectedly fell by 5.8 million barrels overnight, hinting that official Crude Inventories will also slump as the Texas supply crunch bites. Although there seems to be some reluctance by Asian buyers to chase the market at these levels, any dips should be shallow and short-lived.
A move higher through $66.00 a barrel by Brent crude targets further gains above $70.00 a barrel. Similarly, WTI’s picture suggests an initial target of $66.00 a barrel. Support is distant at $62.60 and $59.50, respectively. Neither is likely to be tested unless the US situation changes materially and rapidly. At that stage, the overbought technical picture could temporarily reassert itself.
A fall in official US Crude Inventories this evening by more than 3 million barrels, is likely to provoke another sharp spike higher in prices.
Gold remains in deep trouble.
A strengthening US Dollar overnight heaped more woe on gold, which fell another 1.0% to $1776.00 an ounce. Asia has granted it some respite with the return on Mainland China markets, rising 0.45% to $1784.00 an ounce. The bounce, though, is asthmatic compared to the recent falls, and gold remains clinging by a thread above long-term support. Any more Dollar strength, or a rise in US yields today, is likely to see the sell-off resume.
The 50-DMA has crossed below the 200-DMA at $1857.00 an ounce, a bearish technical signal. The 100-DMA at $1865.90, could well cross lower the 200-DMA next week, adding more gloom to the bigger gold picture. All three moving averages form a formidable resistance zone to any gold price recovery.
Gold broke support at $1785.00 an ounce overnight, which becomes short-term resistance. The overnight low at $1769.50 an ounce is initial support, followed by the 50% Fibonacci of the March to August rally around $1760.00 an ounce. As I have stated previously, $1760.00 is the must-hold level for the longer-term gold rally, and marked, I believed, a structural low. Failure may well provoke a capitulation trade by longer-term gold longs to near $1600.00 an ounce.
This commentary is kindly contributed by Jeffrey Halley, Senior Market Analyst, Asia Pacific, OANDA