“Reduced operations” sparks Neville Chamberlain relief rally

Ukraine talks send equities up, dollar down

I mentioned yesterday that even the slightest hint of any good news emerging from the Ukraine-Russia talks would spark a relief rally. So, it came to pass as Russia offered to “reduce operations” in the north of Ukraine around Kyiv. The effects were immediate, European equities rallied aggressively, oil and gold fell and so did the US dollar. The fact that a reduction in operations is not a ceasefire was a concept too far for the street to grasp, nobody wants to miss out on selling “peak Ukraine.”

Notably, both oil and gold retraced all their losses in double quick time, helped along by lower US API Crude Inventories in oil’s case, and a lower US dollar and US yields in gold’s case. Asian equities are also jumping on board today as well, rallying across the region. The fact that Russia is redeploying its forces to the East and South to concentrate operations there, while digging in around Kyiv is not much of an olive branch, assuming you can take Russia at its words. I have long given up smacking my head against the wall over the intellectual banality of the equity markets. The “peak-Ukraine” FOMO rally could well carry on into the end of the week.

Although the fact that nothing has actually changed was lost on the equity space, it certainly hasn’t been in the energy space. OPEC+ are unlikely to spring any surprises today on production. US data last night was impressive. Case-Shiller House Prices rose more than expected, and the JOLTS Job Openings for February stayed elevated at 11.266 million. No signs there regarding the doom and gloom recession we’ll talk about in the next paragraph. Data is indicating Americans are moving around again (in fossil fuel-powered vehicles) at pre-pandemic levels. Taken in totality, there is no reason to be getting bearish on oil right now.

The fun and games continue in the US yield curve as well, with my inbox filled today with questions along the lines of what time tomorrow will the recession start? The culprit was a momentary inversion of the 2’s-10’s yield curve. I am tempted to say 11:45 New York time but a more reasoned discourse is warranted.

First of all, there are recessions and then there are recessions. Some are mild, some are not. We have no idea if a recession in the US will be mild or ugly if the yield curve moves to inversion. The data released overnight isn’t screaming recession, the opposite in fact. A strong Non-Farm Payrolls on Friday won’t back up the recession argument either. Markets also try to price in the future, and not the present. If you trade equities, that is a perpetually bullish nirvana forever.

Forecasters have been falling over themselves as to who can price the most 50 bps hikes from the Fed this year. As recently as December, hardly any of them were, like the Fed themselves. So perhaps they’re not as clever as everyone thinks they are. I suspect it has caused a lot of herd-like stampeding in the bond market, though, which may, or may not, be a large part of the reason for the moves in bond yields we are seeing now, not economic Armageddon. There is no doubt the Fed is now behind the inflation curve and faces a credibility issue, and fears that they will repeat the mistake the other way are valid, I grant you.

One thing to note is that the Fed, along with other central banks, has been quantitatively easing on and off for over a decade. They will start selling those holdings in the next couple of months, and depending on what they sell, it could start pushing 10 to 30-year rates higher, going some way to pushing the curve back to positive. All those years of quantitative easing might also change the mechanical linkage between inverted yield curves and recessions as well, we just don’t know yet.

Unfortunately, the by-product of near-constant quantitative easing over the last decade or so (forever if you’re the Bank of Japan) in the United States and Europe is whole generations of financial people who believe the cost of capital is zero, the risk free rate of return is near zero, and that central banks will ease and QE at the first sign of trouble, making investing risk free. I’m sorry to say that the return of structural inflation after a 20-year holiday means some sort of reality check is upon the world. The swing from globalisation to national supply chain resilience will nudge that process even more.

In an inflationary environment, central banks cannot use QE to net present value the wealth of our children to pimp up asset prices today anymore. The moves in the US yield curve may be part of those new reality growing pains. Look on the bright side, the Fed, ECB, and BOJ have been QE-ing for over a decade and have managed to meander through. The Reserve Bank of New Zealand did it for less than two years and made a complete mess of it, engineering Norwegian prices and Nigerian wages. A few years of juicy inflation will also have the benefit of deflating the huge pandemic debts that governments around the world have accumulated in real terms. Much like the Fed did with hapless war bond buyers after WW2. In the meantime, take a deep breath, and calm down.

In other news, Australia’s federal budget overnight contained the expected pre-election goodies. It wasn’t market moving, and likely isn’t going to be enough to move the needle on a defeat in May for Scott Morrison’s government. I am told there is no truth to the rumour that ScoMo will be holidaying in Hawaii on election day.

New Zealand Building Permits surprised to the upside today, with February permits rising by 10.50%. More tellingly, ANZ Business Confidence remained at the bottom of the Kermadec Trench at -41.90. You literally can’t buy plasterboard in New Zealand to build those permitted buildings, and the builders will all move to Australia anyway soon. That, along with massive prices rises, the financing squeeze and higher rates from the RBNZ will shortly squash consumer confidence as well. It’s not hard to see why Australian equities and AUD/NZD are outperforming.

Japan Retail Sales fell by -0.80%, the third month of losses. Omicron restrictions continue to dampen consumption, with the imported price rises and geopolitics will make the BOJ’s job even more difficult. The BOJ has extended its JGB bid right along the curve today, to cap 10-year rates at 0.25%. It is working well, and USD/JPY has collapsed to 122.00 in the last 24 hours. Beware of central banks bearing gifts though, much of the yen rally could be due to repatriation ahead of the financial year-end tomorrow. Helped along by a fall in US yields overnight. Come Friday, or early next week, though, the new financial year could see those repatriation flows reverse and head back offshore once again.

The rest of the day’s calendar is quiet, with only German Inflation to distract Europe from geopolitical developments. Things get more exciting in the US where ADP Employment is released. A number well above 450K will see markets repricing Friday’s Non-Farms higher, along with some more FED hikes I suppose. It also releases Corporate Profits, Final Q4 GDP and Real and Core PCE Prices. All of it has upside risks that could see US yields move higher. Equities will likely construct a bullish case no matter what the data says.

Tomorrow in Asia, things get much more interesting as South Korean Industrial Production and Retail Sales, Japan Industrial Production, and official China Manufacturing and Non-Manufacturing PMIs are released. The China data will have a very binary outcome. Strong numbers equal lower risk of China slowdown equals buy Asian equities. Weak numbers equal panic over China’s slowdown and covid-zero equals sell Asian equities, especially China. Only a surprise from OPEC+ or developments in Eastern Europe will trump that.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Jeffrey Halley

Jeffrey Halley

Senior Market Analyst, Asia Pacific
With more than 30 years of FX experience – from spot/margin trading and NDFs through to currency options and futures – Jeffrey Halley is OANDA’s senior market analyst for Asia Pacific, responsible for providing timely and relevant macro analysis covering a wide range of asset classes. He has previously worked with leading institutions such as Saxo Capital Markets, DynexCorp Currency Portfolio Management, IG, IFX, Fimat Internationale Banque, HSBC and Barclays. A highly sought-after analyst, Jeffrey has appeared on a wide range of global news channels including Bloomberg, BBC, Reuters, CNBC, MSN, Sky TV, Channel News Asia as well as in leading print publications including the New York Times and The Wall Street Journal, among others. He was born in New Zealand and holds an MBA from the Cass Business School.
Jeffrey Halley
Jeffrey Halley

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