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Yesterday’s solid gains in US equity markets, which at the time saw the S&P 500 advance more than 1.0% led by gains in energy and financial stocks (respectively boosted at the time by surging energy prices and bond yields), has now been completely erased in pre-market trade. E-mini S&P 500 futures 1.2% to back below the 4300 level and are eyeing a test of recent lows around 4260, with US equity index futures conforming to a risk-off tone being observed in global markets. For reference, it was another ugly Asia Pacific session with the Nikkei 225 down another 1.0%, with losses exacerbated by losses in automakers amid concerns about global supply chain disruptions-related production problems and polls showing new PM Kishida’s approval rating at just 55%, the lowest of any Japanese leader in 13 years, which is not a good sign heading into the month-end election. Meanwhile, the Kospi 50 was down 1.2% amid the sour risk tone, but also due to hotter than expected September CPI figures which strengthen the case for a further BoK rate hike before the end of the year, and the Hang Seng index was down 0.6%.
Turning to European markets this morning, it’s a sea of red for the major European equity bourses. The Stoxx 600 is down 1.8%, having dropped from above 450 to current levels around 445, its lowest in mid-July. Meanwhile, the DAX is the worst-performing regional bourse down 2.2%, following a significantly larger than expected decline in the MoM growth rate of German Industrial Orders in August (it came in at -7.0% MoM versus forecasts for -2.0% MoM), with this data likely a reflection of supply chain issues that are holding back economic activity in the Eurozone’s largest economy. In terms of the main reason for the overall deterioration in global risk appetite on Tuesday that has seen equity indices erasing Tuesday’s attempted rebound, commentators continue to cite concerns about surging energy prices (and the impact this might have on growth and inflation). Combine this with the fact that markets still expect major G10 central banks to continue to press ahead with the removal of monetary policy stimulus over the coming months and you get what some analysts are coining as “anti-goldilocks” conditions for equity markets (thus a bad thing for overall risk appetite).
To clarify; goldilocks conditions for equities are roughly described as a state in the economy where GDP growth is decent enough to maintain healthy earnings growth expectations, but inflation is not too high, or conditions not too good, so that central banks start thinking they need to tighten monetary policy significantly (which would be bad for equity valuations). What we have now is fears that inflation will surge driven by the supply side problems such as energy shortages and supply chain disruptions (some economists call this cost-push inflation, the “bad” type of inflation) and that central banks will thus become more hawkish, even though inflationary pressures are actually contributing to worsening of economic conditions. As noted, central bank tightening is bad for equity valuations, while supply chain disruptions and worsening economic conditions are bad for earnings growth forecasts – a toxic mix for equity prices.
Yesterday saw the release of global Service PMI surveys for September which showed heightened inflationary pressures amid a combination of supply chain disruptions and labour shortages, but the main contributor to the rise in inflation fears on the day was an extraordinary surge in global natural gas prices. In the UK and Europe, natural gas futures were up around 20% (to fresh record highs, needless to say). Since the low in February, UK Nat Gas futures are up more than 600% and gains on the mainland are of a similar margin. Analysts at Deutsche Bank pointed out that UK inflation index-linked bonds are pricing for RPI in the UK to reach 7.0% YoY in April, when Ofgem are next scheduled to hike the price cap on consumer gas prices. There was also a survey released yesterday by the UK Chamber of Commerce showing that a record proportion of UK companies are planning to raise prices. Similar evidence of the pricing power and intentions to raise consumer-end prices have also been seen across other countries, most notably in the US. All the concern about inflation is unsurprisingly being reflected in market-derived measures of inflation expectations; 10-year breakeven inflation expectations in the UK have risen to roughly 4.0%, which puts it at its highest since the mid-1980s, while Eurozone 5-year inflation swaps are at their highest levels since 2015 around 1.85%. 5-year break-even inflation expectations in the US are climbed back above 2.70% yesterday for the first time since August and look set to test pre-summer highs in the upper 2.70s%. Commodity strategists are warnings that natural gas prices may well see further upside ahead of the winter amid concerns that cold conditions in the northern hemisphere could result in an outright shortage – if so, this would likely maintain upward pressure on other energy prices (like coal and crude oil) which could well push inflation expectations higher.
In terms of the performance of other asset classes; the rise in inflation expectations has been driving developed country bond yields higher in most places; 10-year yields in the US hit fresh multi-month highs above 1.55% this morning, as did German 10-year yields at -0.15%. UK 10-year yields, meanwhile, continue to see the most extreme surge and are now above 1.10%, a more than 30bps jump prior to the most recent BoE rate decision on the 23rd of September. 10bps of this 30bps rise in nominal yields you could attribute to the more hawkish than expected BoE (which may hike as soon as Q1 2022) – we can say this because since the 23rd of September, inflation-linked (real) 10-year yields are up 10bps to -2.85% from around -2.95%. But the other 20bps is all inflation expectations rising for the reasons detailed above. Bond yields remain vulnerable to further rallies into the end of the week if 1) energy prices continue to surge and 2) US jobs data (ADP today, weekly jobless claims tomorrow and NFP on Friday) further solidifies expectations for a QE tapering announcement from the Fed in November.
Turning to commodities; crude oil prices are mixed with Brent continuing to surge and up another more than 1.0% on the session to above $82.00 per barrel for the first time since 2018, while front-month WTI futures are nursing modest losses of about half a percent, perhaps weighed by a surprise build in US crude oil inventories (according to weekly API data out last night) and news that the Saudis had surprisingly dropped their official selling price (OSP). From a technical perspective, WTI looks very nicely supported for now at current levels in the $78.00s, with support in the form of the previous annual high from back in July likely to act as support. US Nat Gas prices, meanwhile, are down about 2.0% this morning amid what is likely some profit-taking, with prices having “only” surged about 10% yesterday, half of the magnitude of moves seen in Europe. The recent surge in prices has unsurprisingly cause disquiet in Europe and EU politicians are calling for an “investigation” (how that would help the near-term outlook for prices is unclear). Some fingers are being pointed at Russia for not exporting enough to the rest of Europe, though reports suggest that Gazprom has been fulfilling its long-term contracts as scheduled. Russian President Putin was on the wires this morning talking about how he nonetheless sees disbalance in European markets and that Russia is thus responding by increasing exports. Whether this is going to be “too-little-too-late” for European energy markets this winter remains to be seen. Outside of energy markets, industrial metals are mostly lower, as are precious metals, reflecting a combination of a risk-averse tone to broader market trade (with equities deeply in the red) and a strong US dollar.
On which note, the trade-weighted Dollar Index (DXY) is pushing on back towards the highs it printed around 94.50 at the end of September, boosted amid elevated demand for safe-haven currencies in the current environment that is also benefitting the yen. USD and JPY are thus the best-performing currencies in the G10 this morning, followed not that far behind by fellow safe haven the Swiss franc. Losses for the rest of the G10 currencies on the day versus the buck range between about 0.4% to 1.0%, with the more risk-sensitive currencies, generally performing worse. The NZD is the worst performer despite the RBNZ proceeding as expected with a well-flagged and widely expected 25bps rate hike (taking their OCR to 0.5%), thus making the RBNZ the second G10 central bank (after the Norges Bank) to begin hiking in the post-pandemic era. In terms of the specifics of the meeting; the RBNZ stated that further tightening of monetary policy would be appropriate to reign in upside inflation and housing sector instability risks, but (as many had suspected) said that such tightening would be dependent on the medium-term outlook for New Zealand’s economy at the time (i.e. the bank saying it will take a data-dependent approach to rate hikes). Thus, expectations for further tightening haven’t really shifted much in wake of the meeting (money markets are pricing a further 100bps of rate hikes by the end of 2022) and some traders are saying this morning’s losses in the kiwi could be down to post-RBNZ profit-taking, or a “sell the fact” reaction. NZDUSD has slipped back from above 0.6950 to current levels under the 0.6900 mark, though remains above last week’s lows close to 0.6850.
EURUSD has meanwhile eked out a fresh annual low under the 1.1550 level this morning in a mostly dollar-driven move (though aforementioned weakness in German Industrial Order data may not be helping) and looks odds on the test key support in the form of the March 2020 high at 1.1500 before the end of the week. GBPUSD, meanwhile, has slipped back under 1.3600 again, but is holding up better than most of its non-safe haven peers despite alarming moves in UK yields and inflation expectations, perhaps amid confidence that the BoE will mount an appropriate policy response. For now, risks of worsening UK/EU tensions (regarding the NI protocol and fishing, with the French to announce a response to the UK’s stingy issuance of fishing licenses to French boats on the 15th of October) are being ignored.
In terms of the rest of the session, focus will be on the release of ADP’s estimate of US employment change in September at 1315BST, which has had a hit and miss record since the pandemic when it comes to accurate predictions of the official NFP number (which is out on Friday). Nonetheless, it will contribute to how markets calibrate their expectations for Friday’s key official jobs report. However, as already mentioned this week, market participants are placing less emphasis on the outcome of the September jobs report as most suspect the Fed’s decision to announce a QE taper in November (likely to conclude sometime in mid-2022) is a “done deal”. Some have suggested that the jobs report would have to be “awful” (i.e. a big negative number) for the Fed to delay its QE taper. Otherwise, US markets will be focused on speeches from FOMC member Bostic at 1400BST and then again at 1630BST, as well as on official US crude oil inventory numbers at 1530BST. Meanwhile, it is worth keeping an eye on events in Washington; there will be another debt ceiling suspension vote in the Senate today which will fail again amid still united Republican opposition. Remember that the deadline to raise or suspend the ceiling is the 18th of October, according to Treasury Secretary Yellen. Look out for any signs of progress towards a compromise on the overall size of President Biden’s social care package (progressive democrats have been pushing for a more than $3T package, while moderate Senate Democrats with the “final say” have been pushing for something closer to half the size). An agreement here is likely needed soon as the debt ceiling would also be dealt with as part of the same bill.
