Todays podcast

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Overview Fortune Faded

• US equities close lower on Friday and on the week
• EU share gain on Friday and on the week
• Friday’s contrasting fortunes a function of mixed Russia- Ukraine messages
• Another decline US consumer sentiment not helping US equities either
• EU leaders agree to phase out dependency on Russian gas, oil and coal imports “as soon as possible”. No EU funding agreed
• Rise in 2y yields flattens UST curve on Friday. Big rise in core global yields on the week
• USD ends stronger on Friday and on the week. DXY above 99, USD/JPY 5y high, Euro into low 1.09s, AUD sub 73c
• Oil up on Friday, most commodities down on the week, except for gold and iron ore
• China covid cases double, Shenzhen goes into a week lockdown
• Coming up today: NZ House prices, China MLF
• Rest of the week: China Feb activity readings, Fed, BoE and BoJ meet, AU Labour force report, NZ Q4 GDP

So divine, hell of an elevator
All the while my fortune faded – Red Hot Chili Peppers

Friday was a day of contrasting fortunes for US and EU equity markets. The latter boosted after Russian President Putin cited positive developments in talks with Ukraine while the former was deflated after Ukraine officials pushed back on the suggestion of any positive developments. Another decline in US consumer sentiment didn’t help US equity vibes either. Markets remain jittery with the VIX index closing the week above 30. The USD was broadly stronger on Friday with CAD the exception after a solid labour market report while the two-year UST yield led a flattening of the UST curve in a week which recorded a big rise in core global bond yields. Oil prices gained on Friday with most commodities down on the week.

The S&P 500 fell 1.3% on Friday with all 11 major industry sectors closing with negative returns . Looking at the week, the S&P fell 2.88% with consumer staples the big underperformer, down 5.78%, its worst week since the pandemic began as volatile commodity prices fuel inflationary concerns. The tech-heavy Nasdaq 100 Index fell 2.2%, while the blue-chip Dow Jones Industrial dropped 0.7% ending the week down 3.253% and 1.99% respectively. The VIX index closed the week at 30.74, lower than its weekly peak of 37.59, but still well above its long-term average of 19.72 (since 1990).

In contrast, the Stoxx 600 Index ended Friday 0.95% higher, after gaining as much as 2.7% intraday, boosted by comments from President Putin saying that there had been “certain positive developments” in talks with Ukraine . Travel/leisure and financial services shares led gains, while the energy and utilities underperformed. On the week, the Stoxx 600 Index gained 3.19%, its first weekly gain in four weeks. That said, the index remains in correction territory and it is hard to get too excited on its weekly performance, if anything the lesson in recent weeks is that it pays to watch what Russia does rather than what its leaders say. Ukraine continues to be pounded by Russian forces, indicating no end in sight to this nightmare until at least Kyiv falls under Russia’s control. Overnight Blomberg reported fighting has continued on the outskirts of Kyiv, where Russian forces may be attempting to encircle the capital while Russian air strikes were reported on the west of Ukraine as well on Mykolaiv on the Black Sea. The DAX was the notable outperforming regional index, gaining 1.38% on the day and 4.07% on the week.

Equities Performance

Responding to Putin’s comments and partly playing into the US equity market’s underperformance, Ukrainian Foreign Minister Dmytro Kuleba said he didn’t see the progress cited by President Putin in talks between both nations . The White House said National Security Adviser Jake Sullivan will meet in Rome on Monday with China’s top diplomat, Communist Party Politburo Member Yang Jiechi with the Ukraine expected to be discussed among regional and global security concerns emanating from Russia’s war against Ukraine. Over the weekend the FT reported tentative signs of movement in talks between the Ukrainian and Russian sides. Mykhailo Polodnyak, an adviser to Zelensky, said Russian negotiators were “no longer making ultimatums, but are listening carefully to our proposals”, this of course along side numerous reports of Russian bombings all ove the Ukraine.

Another factor not helping US equity vibes was the larger than expected decline in the Michigan consumer sentiment index sentiment, falling to 59.7 from 62.8 vs 61 expected by consensus, a level not seen since 2011 . Most of the dip in the headline was due to a 5-point drop in the expectations component, its lowest level since October 2011. Expectations are sensitive to both the equity market’s performance and gas prices, thus it is not surprising to see a dent in sentiment in March. That said, US consumer sentiment is now well below is long term average of 81 and while the current narrative is that US consumer still has a lot of cash to spend (watch what they do, not what they say), the truth is that sentiment has been on a steady decline since June last year and history tells us that a persistently downbeat consumer is not a good omen for the US economy’s outlook . The jump in gas prices pushed up near-term inflation expectations too, by 0.4% to 5.4%, the highest since November 1981, but well below the current headline CPI inflation rate, 7.9%. Expectations for inflation in five-to-10 years were unchanged at 3.0%, which will be a relief to the Fed.

The EU head of states summit concluded on Friday with leaders agreeing to phase out dependency on Russian gas, oil and coal imports “as soon as possible” and also agreed to draw up a plan to support the continent’s economies amid skyrocketing energy prices, exacerbated by the war in Ukraine. The strategy will involve accelerating the reduction of an overall reliance on fossil fuels, diversifying supplies and routes for gas and oil, and speeding up the development of renewable energy. The European Commission has now been task to draw up a proposal by the end of May, that is in two and half months’ time, again another reason why gains in European equities last week may be deemed a little bit too optimistic.

As for the important aspect of how all this spending will be funded, nothing concrete was agreed. French President Macron, who is pushing for “joint European investments” along the lines of the €750 bn EU recovery fund approved last year noted that Europeans “have an interest in financing” investments together to help protect the bloc from the consequences of war. But other leaders including Dutch Prime Minister Rutte suggested it was premature to discuss EU common funding with energy price caps also a consideration.

Of note too, EU Commission head Ursula von der Leyen re-affirmed that it is considered “feasible” for the EU to dispense with two-thirds of Russian natural gas imports by the end of the year. “It is something doable. It is not a ban on Russian gas, but a reduction”.
Moving onto the rates markets, like EU US equities contrasting fortunes, European yields declined on Friday with 10y Bunds down 2.5bps to 0.243% while 10y Gilts fell 3.5bps to 1.487%. 10y UST were little changed, ending the week at 1.9917%, but the 2y Note, rose another 5bps to 1.75%, its highest level since 2019, flattening the curve on the day. That said, ahead of the FOMC meeting this week (more below) the theme for last week was a broad rise in core global bond yields with 10y rates from Australia, Europe, and the US up between 25 to 32bps.

My BNZ colleague, Nick Smyth also notes that the real yield story is worth a line, US 10-year ‘breakeven inflation’, a market-based measure of inflation expectations, is nearing 3% for the first time on record.   The 10-year breakeven jumped 9bps on Friday, closing the week at 2.97%.  The elevated level of inflation expectations mainly reflects expectations that inflation will be extremely high over the next year or two.  But longer-term measures are also drifting higher, with the 5-year/5-year forward inflation swap closing at 2.72%, its highest level since mid-2014.  Central banks tend to watch the 5-year/5-year measure closely, as a guide to whether longer-term inflation expectations remain consistent with their inflation targets.  On the week, the 10-year US real yield was broadly unchanged, at around -1%, while the 10-year nominal rate increased by 26bps.

US Treasuries over the past week

In other economic news, Canada’s unemployment rate fell to 5.5% in February vs 6.2% expected, after a 6.5% print in January . A full percentage point in one month.  This on the back of an out-sized 336.6K employment gain, easily more than payback after January’s -200K, also sweetened with a rising participation rate, up 0.4% pts to 65.4%, again at pre-pandemic levels.  A super strong report, even if skewed to an extent by survey noise. Yet another reminder of the stance of macro policy as extremely accommodative.  Canada, like Australia New Zealand on the receiving end of the commodity price step up and terms of trade boost in train now.

Canada’s solid labour market report helped the CAD outperform on Friday, up 0.2% to 1.2729 on a day where the USD was broadly stronger. JPY was the big underperformer on Friday ( -0.99%) and also on the week ( -2.15%). The yen (and CHF for that matter) has been unable to display its typical safe-haven attributes, partly because of the big rise in UST 10y yields and the BoJ yield curve control policy that prevents JGBs following the move up in core global yields. Japan is also a big energy imported adding to concerns over a terms of trade shock from higher energy prices. That said, USD/JPY’s break above the ¥116.35 area (Jan ’22, Nov ‘21 highs) during our session on Friday played into the acceleration of JPY weakness which saw the pair end the week at ¥117.32.

European currencies also struggled on Friday with the euro down 0.67% and now starting the new week at 109.33.  On the week GBP was a bigger underperformer, down 1.46%, opening the new week at 1.3053. After breaking below its previous low of 1.3163, cable’s technical picture looks rather bleak with not a lot of support before we get to levels with a 1.28 handle.

The broad USD rise on Friday also weighed on antipodean currencies with the AUD down 0.88% on the day while NZD fell 0.82%. The AUD opens the new week at 0.7298 while the Kiwi is at 0.6813, in addition to USD strength, softness in commodity prices played into the AUD and NZD underperformance during the week.

FX Performance

Oil prices gained on Friday, up just over 3% with Brent closed the week at $112.12 and WTI at $109.09.  Aluminium also gained on Friday (+1.62%) while most other commodities struggled with iron ore down 3% to $157. Looking at the week however, volatility was one common theme, iron ore was up 0.5% with gold the other gainer, up 0.94% to $1988.46. All other commodities were down on the week, oil -5%, copper -6.0% while Aluminium was -9.5% and thermal coal was -12%.

Commodities Performance

In other news, China reported more than 3,300 Covid-19 infections on Saturday as the country faces its worst outbreak since the early days of the pandemic. The north-eastern province of Jilin accounted for more than 2,100 cases and over the weekend the southern city of Shenzhen with 17.5 m of residents went into a lockdown that’s due to last until March 20. After having a zero-tolerance covid strategy for most of the past two years, China has shifted in recent months into a “dynamic zero” strategy. The new strategy, has allowed a more flexible approach to fight the virus, provided city leaders are able to stop big outbreaks. The spike in numbers is now a big test and it remains to be seen if officials will tolerate large outbreaks or whether drastic and long-lasting lockdown measures are reintroduced with the latter potentially having a hindering impact on China’s domestic economy with supply constraint issues globally.

Coming Up

• We have a quiet start to a busy week that includes China February activity readings, Fed, BoE and BoJ meetings as well as Australia’s labour force update and US retail sales figures. New Zealand releases house prices early this morning and China’s PBoC announces its decision on its Medium-Term Lending facility, no change expected (2.85%).
• Wednesday’s FOMC is the key event of the week. Fed Chair Powell confirmed at last week’s testimony that he will be recommending a 25bps rate rise to 0.25%-0.5%. The FOMC meeting also comes with an updated Fed funds dot plot as well as the usual forecasts for growth and inflation. At the December meeting, the median dot plot saw only four rate rises with most Fed officials having publicly flagged 4-7 rate rises in 2022 (NAB has forecast 5 rate rises this year). Markets are well priced with 6.4 hikes priced, with the main interest likely to be on Powell’s assessment on how quickly the Fed needs to get to its 2.50% neutral rate.
• Another strong Australian Labour force report is expected with NAB forecasting the unemployment rate to fall 2 tenths to 4.0% on the back of a 50k gain in employment (consensus 4.1%/40k). NAB sees the unemployment rate moving below 4% in coming months, and again outperforming the RBA’s forecasts which at February only saw this occurring by Q3 2022.
• Our BNZ colleagues reckon Thursday’s NZ Q4 GDP will register a rebound of 3.2% (3.3% y/y), from a “Delta-dented” Q3, versus RBNZ expectations of a 2.3% gain.
• China sees monthly activity reads on Tuesday. Whether recent stimulus measures are feeding through might be visible in the Fixed Asset Investment number, seen at 5.0% YTD y/y from 4.9% y/y previously.

Market Prices

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