May 11, 2022

Markets Today: A momentary lapse of reason

Decline in inflation expectations drive core global bond yields lower with further fall in oil prices helping the move.

Todays podcast

Overview Bounce

  • APAC equity rebound extends into Europe, but shows signs of faltering in the US
  • Underwhelming news from China suggest rebound is standing on shaky ground
  • US Breakevens drive decline in core yields. 10y UST sub 3%, Bunds sub 1%
  • Oil prices decline extends. EIA trims near term forecast for Brent oil prices, higher later
  • USD remains in the driving seat. NOK and NZD lead G10 declines. AUD opens at 0.6941
  • Hawkish talk from both ECB and Fed speakers
  • Coming up: AU Consumer Confidence, China CPI/PPI, ECB Speakers, US CPI

Bounce, Bounce, Bounce, Bounce – Calvin Harris


The rebound in equities that began during our APAC session yesterday extended into the European session, but then showed signs of faltering in the US. Lack of any positive news and still elevated market volatility suggest rebound stand on shaky ground. Decline in inflation expectations drive core global bond yields lower with further fall in oil prices helping the move. After consolidating for a couple of days, the USD is back in the driving seat with NOK and NZD leading the declines within G10. AUD starts the new day at 0.6941.

The equity rebound that began during APAC yesterday extended into the European session overnight with the Stoxx Europe 600 Index closing 0.7% higher while all main regional indices also closed in positive territory. That said, looking at the intraday charts, the rebound doesn’t look as encouraging, the Stoxx Europe 600 Index pared intraday gains of as much as 1.9% with a jump in gas prices on a report that Russian flows will be disrupted not helping the cause.

US equities began the NY session with a spring in their step, but as the day progressed the positive vibes faded with the Dow falling for a fourth straight day (-0.26%) while the S&P 500 closed at 0.25% and the NASDAQ was 0.98%. Lack of positive news and still elevated market volatility (VIX closed at 33) suggest the anaemic equity rebound recorded over the past 24 hours is unlikely to set the start to a positive turnaround. Concern over the global growth outlook remain acute, news from China continue to underwhelm (more below), Russia’s aggression on the Ukraine shows now signs of abating and Europe’s energy crisis still has no solution.

There are no signs of a let up with the lockdowns in China. Yesterday Bloomberg reported that China is tightening pandemic restrictions in Shanghai and expanding a mass testing sweep in Beijing. Meanwhile, Tesla said it was having production difficulties at its Shanghai plant due to supply shortages and logistics issues, highlighting that, while many manufacturers continue to operate with staff living on site, the lockdown is hampering activity. Separately, the head of the WTO called China’s zero-Covid strategy “unsustainable” in the face of Omicron, which most, albeit not the Chinese leadership it seems, would agree with.

Moving onto the rates markets, the UST yield curve has flattened in the past day with an extension in the decline in oil prices seemingly playing into a decline in inflation expectations . 10y Breakevens fell 9bps in the past 24 hours closing the NY session at 2.65%. Oil prices extended yesterday’s decline with Brent and WTI both down just over 3%. The US Energy Information Administration on Tuesday trimmed its forecast for Brent oil prices in the second quarter while slightly boosting its price expectations for the second half of the year, as it now expects the market is balanced between supply and demand. 10y UST yields now trade at 2.99%, down 4.3bps relative to levels this time yesterday.

US front end yields were boosted by more hawkish Fed rhetoric with the 2y rate up 1.5bps to 2.606%.
Echoing similar comments from Atlanta Fed President Bostic yesterday, Cleveland Fed President Mester refused to rule out the possibility of a 75bps hike later this year, if inflation fails to moderate like the Fed expects. 

Sounding a bit more balanced, New York Fed President Williams, considered part of the Fed inner circle, said 50bps rate hikes at the next two meetings “makes sense”, a view also endorsed overnight by Cleveland Fed President Mester. Williams sounded hopeful around the prospects of a so-called ‘soft landing’, arguing that the housing and durable goods sectors, both of which are showing signs of overheating, were sensitive to interest rates and would be responsive to Fed tightening.  On inflation, Williams noted that it is being driven by factors related to pandemic disruptions and excessive demand for workers. But he does expect inflation to cool as the year moves forward, and he said he’s expecting the core personal consumption expenditures price index to ebb to 4% this year and then to around 2.5% next year, before falling to 2% after that.

In Europe, Bundesbank President and ECB Governing Council member Nagel added his voice to the growing chorus of officials who favour ending QE bond purchases at the end of June and starting rate hikes at the July meeting .  Nagel added that delaying monetary policy tightening was a “risky strategy” that could ultimately require more tightening down the line.  Despite the hawkish comments, admittedly from one of the more hawkish members of the committee, European rates have fallen sharply overnight, following the lead of US Treasuries.  The 10-year German yield is back below 1%, 9bps lower on the day, while the Italian 10-year rate is back below 3%, down 15bps on the day.  The market is still pricing around an 80% chance of a 25bps ECB hike at the July meeting and around 3.5 hikes in total by the end of the year.

Moving onto FX, notwithstanding the mild improvement in equity risk sentiment, the USD is back in the driving seat after consolidating for a couple of days. The DXY index has gained 0.25% over the past 24 hours with the broader BBDXY index up 0.15%. Looking at G10 pairs, NOK ( -0.71%) and NZD ( -0.51%) have led the declines with the former negatively affected by the decline in oil prices while the latter ‘s decline looks to have been driven by technicals rather than fundamentals. The NZD has broken below 0.63, hitting a fresh year-to-date low overnight.

Meanwhile the AUD has fared a little bit better, “only” down 0.17% over the past 24 hours and now trading at 0.6941. Commodity linked currencies like the AUD and NZD remain vulnerable to the deteriorating growth outlook for China, a dynamic that now is showing a greater deal of sensitivity in commodity prices with Iron ore and metal prices showing sharp declines in recent days. Iron ore has continued its decline – taking its loss since Thursday’s close to more than 15% – as ominous signs emerging from China’s property sector and virus curbs continued to weigh on demand. Iron ore now trades at 126.44 and last week it was looking comfortable around $145.

As for date releases, the US NFIB index was unchanged at 93.2, trivially above the consensus, 92.9. Movements in the headline index usually track the US equity market, so maybe decline is due next month, unless equities manage a decent rebound over coming weeks.

In Europe, the ZEW survey showed expectations of German economic growth picked up in May, albeit to levels which would historically be associated with recession.   The prospect of the ECB tightening against a backdrop of an energy crisis is undoubtedly weighing on analysts’ expectations.  Unencouragingly, the US said it believed Putin was “preparing for prolonged conflict” in Ukraine and his military goals were not restricted to annexing the Donbas region.

Coming Up

  • This morning Australia gets its monthly Consumer Confidence reading and before midday, Sydney time, China releases its CPI and PPI readings for April. The market is looking for the PPI yoy reading to ease from 8.3% to 7.8% while CPI is expected to climb to 1.8%yoy from 1.5% previously, China’s subdued CPI dynamics are not an impediment for PBoC easing. A 10bps cut to the MLF next week still looks the most likely outcome.
  • Moving onto Europe, later today it is going to be all about ECB speakers with ECB’s Lagarde, Vasle, Centeno, Buch, Muller, Schnabel, Knot and Nagel all on speaking duties.
  • US CPI is the data release to watch tonight with consensus expecting little change in inflationary pressure. The Core CPI reading is seen at 0.4% m/m, up from the 0.3% print in March taking the yoy reading to 6.0%, down from 6.5% previously. Fed Bostic is on high demand with two events discussing monetary policy and the economy.

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