March 1, 2022

Markets Today: Moderate contagion, so far

News from Ukraine remain bleak with Russia Ukraine talks yielding no resolution while fighting rages on.

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Overview Unstable

  • Russia Ukraine talks yield no resolution, fighting rages on
  • West increases financial pressure on Russia. Focus now on China
  • Rouble and Russian assets collapse, USD dollar funding a focus
  • Market volatility remains elevated, US equities turn south before the close
  • Core yields fall amid safe-haven demand. 10y Bunds and UST down 10bps
  • EU FX pairs under pressure, AUD and NZD perform along safe haven pairs
  • Coming Up: RBA, China PMIs, US ISM Manufacturing, CA Q4 GDP, State of the Union

News from Ukraine remain bleak with Russia Ukraine talks yielding no resolution while fighting rages on. The slump in the Rouble and Russian assets have not (yet) shown severe signs of contagion, but demand for USD in the cross-currency market is a warning sign. After a sharp decline at the open, EU and US equity markets showed signs of improvement, but in the last hour US equities have turned sharply lower again. Volatility remains elevated with the VIX index now at 32, reflecting the level of uncertainty and instability. Sovereign bond markets are unambiguously showing a demand for safety with core yields lower across the board, front end yields leading the move the US. EU FX pairs remain under pressure, AUD and NZD perform along safe-haven pairs. Antipodean currencies benefiting from the ‘tyranny of distance’ while buoyancy in commodity prices is helping too.

Russia Ukraine talks came and went with no concrete developments. Before the meeting, Ukraine’s President Zelensky urged Russian troops to lay down their weapons and called for immediate EU membership. Both parties have agreed to the possibility of a second round of talks, but reading the demands from President Putin, it is hard to see talks yielding a positive outcome, at least not in the near term. Putin wants the surrender of Ukraine’s military and the removal of the country’s democratic leadership, which he denounces as a “junta.”. Also, one has to say that Russia has form in doing a lot of talking while doing exactly the opposite of what it says, furthermore the low profile of the Russian delegation, at deputy ministerial level, is yet another reason not to hold high hopes.

Meanwhile fighting rages on as the West looks to increase efforts to isolate Russia. After the sanctions announced over the weekend, the US banned US individuals and companies from doing business with the Bank of Russia, the Russian National Wealth Fund and the Ministry of Finance. Switzerland put aside its traditional neutrality and joined in also enacting penalties.

Unsurprisingly the Rouble and Russian assets have collapsed with the Russian currency down 24% relative to Friday’s closing levels while Russia’s central bank doubled interest rates to 20% in attempt to stabilise the domestic economy. Russian bonds have also come under pressure as investors prepare for the possibility of the country defaulting on its debt for the first time since 1998.

Looking at the equity market fear of contagion has been relatively subdued. After opening sharply lower EU regional equity indices managed to recover, ending the day down around 1%, after being down close to 3%. The Euro Stoxx 600 index fell to an intraday low of 1.88% before ending the day down just 0.09%. The US market exhibited a similar price action, but in the last hour earlier signs of a recover have completely evaporated with main US equity indices heading south yet again. As I type the S&P 500 is down 1.25% while the NASDAQ is 0.75%.

Uncertainty remains elevated with the VIX index trading at 32 as investors struggle to assess the real economic impact from sanctions as well as Putin’s aggression . Investors are becoming growingly concern over the implications from the West decision to freeze Russian central bank’s assets and exclusion of some of the nation’s biggest lenders SWIFT, the international payment. We still don’t know exactly which Russian lenders are affected and the degree of exposure by global investors.

The demand for USD in the cross-currency markets is raising concerns over a potential funding crisis with many expecting the Fed to step in as the lender of last resort through swap lines . Sanctions are also increasing the attention on China with many wondering to what extent the PBoC will provide a lifeline to Russia. The PBoC has a multi-billion dollar currency swap with Russia’s central bank, allowing the two nations to provide liquidity to businesses so they can continue trading and Russia also has 13% of its reserves invested in yuan assets.

The core bond markets have benefited from a broad safe-haven demand, suggesting a heightened level of concern relative to the up and down action in the equity market. 10y Bunds and UST yields are down 10bps to 0.13% and 1.84% respectively. Moves in the front end of the UST curve have been more pronounced with the 2y Note 14bps to 1.43%. Pricing expectation for Fed rate hikes this year have also been paired back with less than 1% of Fed tightening by July, down from a peak of 1.16% earlier this month. The market is still pricing a rate hike in March (28bps), but there has been a signifcat decline to the almost 50bps priced a couple of weeks ago.

Speaking overnight and while acknowledging the Russia Ukraine crisis as a risk, Fed Bostic said that he favours raising interest rates by 25 bps in March, but warned that he would consider a larger half-point move if monthly inflation readings fail to decline from elevated levels.

Moving to FX, EU currencies have remained under pressure reflecting investor concern over the proximity the Russia Ukraine conflict as well as economic/energy dependency with Russia. SEK is down around 1%, after being down over 2% yesterday morning while the euro is down 0.5%, now trading at 1.1215, after printing an overnight low of 1.1122. Notwithstanding the increase in risk aversion that has seen safe haven pairs such as CHF and JPY perform against the USD (up .88% and 0.55% respectively), antipodean currencies have also managed to perform against the USD benefiting from the ‘tyranny of distance’ while buoyancy in commodity prices has also helped . AUD now trades at 0.7260, up 0.47% over the past 24 hours while NZD trades at 0.6759, up 0.21%. For now, the increase in market volatility is not dragging the AUD and NZD lower with contagion from Russia fairly limited with EM FX ( ex RUB) also showing some resilience. A theme that bears watching, however, if we see a broadening in EM stress/ equity decline, the AUD and NZD will struggle to perform.

Brent crude traded at USD105 per barrel in early Asian trading, but has trended lower since, and is back down to around USD101, up 3% from last week’s close. Commodity prices still have an upside bias, with wheat up 8% and corn up 5%, two products heavily exposed to Russia-Ukraine developments.

For the record, in economic data, the US goods trade deficit blew out to a record high in January of $107.6b, as exports fell 1.8% y/y and imports rose 1.7%. The worse-than-expected data will see analysts shave down their Q1 GDP estimates, although an offsetting factor was higher inventory building. The Chicago PMI was also much weaker than expected, down 9 points to 56.3, increasing the chance that tonight’s ISM PMI is on the soft side as well.

Coming Up

  • New Zeeland and Australia get house prices for Feb (Core Logic) and ahead of the RBA meeting this afternoon (Sydney time), Australia also gets a few more Q4 GDP partials. Final February PMIs are released around the globe and China publishes both its official and Caixin PMIs, also for February. Canada’s Q4 GDP is out just after midnight (6.5% exp. annualised) ahead of Fed Bostic and BoE Mann speeches early tomorrow morning.
  • The RBA’s March meeting is unlikely to break from the RBA’s February talking points. Data since the February meeting will do nothing to challenge the RBA from its framing, and the RBA is likely to stick to its messaging that it is “prepared to be patient as it monitors how the various factors affecting inflation in Australia evolve.”.
  • AU Q4 Balance of Payment data is expected to show the Q4 current account surplus falling back sharply to around $14.4bn from the record high of $24.9bn in Q3, largely due to a sharp decline in net exports through the fourth quarter. Net exports are expected to subtract around 1.2ppt from GDP.
  • AU Q4 Government Finance Statistics will give some insight into public demand, which we expect to provide some support for growth in the quarter.
  • China PMIs expectations are not high given COVID containment efforts during the Lunar New Year period, along with the blue skies policy during the Winter Olympics. Consensus sees manufacturing at 49.9 and non-manufacturing at 50.8. Meanwhile the Caxin Manufacturing PMI is seen unchanged at 49.1.
  • US regional surveys suggest that the ISM Manufacturing survey dipped marginally to about 57 from 57.6 in January. The market is looking for a small uptick to 58.
  • President Biden addresses the US Congress in his annual State of the Union speech with the Russia -Ukraine, inflation and domestic policy likely to feature prominently.

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