Summary and Price Action Rundown
Global risk assets are steadying this morning after two days of losses as Treasury market volatility eases in the wake of increasingly hawkish guidance from the Federal Reserve. S&P 500 futures indicate a 0.2% higher open after the index lost 1.0% yesterday, deepening year-to-date downside to 6.0%, while the Nasdaq underperformed to extend 2022 losses to -11.2% thus far. EU equities are retracing a portion of this week’s losses, while Asian stocks were broadly lower overnight. Longer-dated Treasury yields are stabilizing after two days of incrementally hawkish Fed signals, with 10-year Treasury yield wavering below yesterday’s cycle highs at 2.66%, which was the loftiest level since spring of 2019. The broad dollar index is holding slightly below its recent 2022 peak, which was its strongest level since July 2020. Oil prices are rebounding after yesterday’s losses that followed the announcement of further strategic supply releases, with Brent crude rising back above $103 per barrel as EU leader contemplate more action against Russian energy (more below).
Mixed Signals from Chinese Markets Amid Redoubled Pledges of Stimulus from Beijing
Despite the State Council reiterating its intent to counteract downside economic risks, which have been exacerbated by renewed COVID lockdowns, Chinese and Hong Kong stocks are struggling to find support though the renminbi remains solid versus the dollar. The communique from the State Council indicated that an array of monetary policy measures would be enacted at the “appropriate time,” citing the “complexity and uncertainty” of the economic landscape on the mainland and abroad. Similar statements have preceded Reserve Requirement Ratio (RRR) cuts by the People’s Bank of China (PBoC) in July and December. Analysts are also anticipating further reductions in benchmark lending rates in the coming months.
For context, statements from key officials with the State Council, PBoC, Financial Stability and Development Committee in the middle of last month promising to “actively introduce policies that benefit [Chinese] markets” spurred a steep rally in mainland and Hong Kong stock markets. These communications suggested that the campaign against Chinese IT companies would be concluded, support for beleaguered property developers would be forthcoming, and additional monetary stimulus would be enacted. Since that bounce, however, greater Chinese share prices have struggled to make further headway, as the rhetoric does not appear to have been matched by policy action. – MPP view: We have retained our longstanding negative posture on Chinese assets as we suspect that Beijing’s expressions of market/economic support are more rhetorical than substantive and China’s backing of Russia opens it to higher risk of being caught up in the sanctions. There was also no indication that PCAOB or the Biden administration in general would be favorably disposed to compromise with China on this audit disclosure / delisting issue, or do Beijing a favor on any other count either. After such steep losses, there is always a temptation to buy the dip but we continue to think that Chinese stocks are, from an index perspective, dead money at best over the medium term, despite the likelihood of tactical bounces this year ahead of the Party Congress in the fall at which President Xi will assume an unprecedented third term.
Sanctions in Focus as Russia’s Invasion Strategy Shifts
With Russian troops reportedly massing in eastern Ukraine for a renewed offensive, western leaders are evaluating the impact of sanctions and ability of Russia to skirt them. Reports this morning indicate that Russia has sold the full complement of its Sokol crude in the east of the country for next month and that Chinese buyers are using renminbi for coal transactions. Meanwhile, ongoing gas and oil exports to the EU and elsewhere are helping support the ruble, which is trading back to pre-invasion levels, though US officials, including Treasury Secretary Yellen, have warned that capital controls and other measures taken by the Kremlin have artificially supported the currency, suggesting an outlook for renewed depreciation. This comes as the US expanded sanctions yesterday on Russian financial institutions and individuals and EU leaders are meeting today to discuss the potential to ban Russian coal, with consensus remaining elusive to take similarly strict measures on Russian gas imports. The benchmark price of EU natural gas remains historically elevated but roughly half the level of the super-spike peak early last month. – MPP view: Our base case is that the US administration policy is to force Russia into sovereign default, if possible. Meanwhile, the EU has come further and faster than many had expected on Russia sanctions, but a full embargo on Russian energy is still a bridge too far. But this is a case of mutual dependence – therefore, we do not think Russia will cut off EU gas if the EU doesn’t pay in rubles, as keeping this flow is probably almost as import to the Kremlin as it is to the EU. But with the conflict grinding on and potentially turning even more grim (chemical weapons, further atrocities), the embargo will be revisited repeatedly and there is a significant chance that the Kremlin’s brutality in Ukraine will leave the EU with little option, with this upside risk skew keeping a floor under energy prices.
Additional Themes
German Industrial Production Holds Up in February but Signs of Weakness Mount – Though yesterday’s more forward-looking factory orders data for February reflected significant deterioration and a darkening economic outlook, this morning’s release of February industrial production data for German was only slightly weaker than anticipated. The 0.2% month-on-month (m/m) pace matched estimates but the downwardly revised January reading, to 1.4% m/m from the previous 2.7%, dragged the annualized rate to 3.2% for February and 1.1% in January versus a forecast and preliminary reading of 3.7% and 1.8%, respectively. The Bundesbank has been issuing increasingly dire warnings of downside growth risks over the coming months in the face of a commodity supply shock and stagflationary dynamics.