Shenzhen lockdown muddies economic waters

Monday’s these days usually present a confusing picture to investors, and this one is no different. Reuters is reporting that both Ukraine and Russia appear to be making progress towards substantive negotiations. That gave some parts of Asia an excuse to tentatively buy equities this morning and has seen oil fall, with the chance of bottom-fishing the Ukraine war just too tempting.


Offsetting that was Russian missile strikes in Western Ukraine over the weekend that were very close to the Polish border, and reports from American officials that Russia was asking China for military aid, since denied by Chinese officials. If true, it would be a serious sign that all is not well in the Russian industrial-military complex and could explain the shift by the Russians outlined in the Reuters reporting above. China, for its part, will need to tread carefully, with the US and Europe being its largest export customers. Political doctrines or not, money talks and China is facing economic challenges of its own it may not want to exacerbate for the sake of Putin.


China itself has announced a complete lockdown of 17.5 million people in its coastal city Shenzhen, a major tech-hub and port city to fight rising Covid-19 cases. Adjacent Hong Kong announced that 300,000 people were in isolation or quarantine as its Covid nightmare continues. Foxconn, a major Apple supplier, has already announced factory suspensions in Shenzhen and if the port also has to close, we can throw more supply chain disruptions into the global mix. Oil’s fall this morning may also be partly due to expectations that China’s domestic consumption could temporarily fall due to Covid lockdowns.


With that in mind, oil’s fall today is even more surprising after Iranian missiles rained down on a target in Iraq. Allegedly in retaliation for an Israeli attack in Syria earlier this week on suspected Republican Guards leaders there, but also perhaps linked to frustrations about the stalled nuclear agreement. Last-minute Russian demands threaten to scuttle the entire thing, making the fall in oil prices today even more surprising.


US Consumer Confidence data was weaker than expected on Friday, suggesting that the stagflationary wave sweeping the world from the Ukraine conflict is having an immediate impact. That won’t be the last we hear on that front with cost-of-living increases rising sharply around the world, provoking disgruntlement amongst consumers. Asian currencies are under pressure today and going forward, those pressures will be amplified as Asia’s central banks will be reluctant to hike with the Fed.

Fed likely to implement 1/4 point hike


As if things couldn’t get more complicated, the US Federal Reserve’s FOMC announces its latest interest rate decision this week. A 0.25% rate hike is locked and loaded, and despite the noise, I believe that the Fed is still cautious and 0.50% is off the table. What might not be, though, is a faster path of rate hikes to normalise monetary policy. The US yield curve continues to flatten and if the FOMC is hawkish, could shift higher in entirety and flatten and head towards inversion, signalling potentially, a future recession.


Stagflation is a nasty beast, and there are no painless options for central banks when it happens. Do nothing and your currency is likely to fall, exacerbating imported inflation. Hike rates and support the currency, but slow or stop growth. Each central bank will have to choose its own path, but my reading thus far will be that Europe and Asia will hold rates fast, China will attempt a targeted easing, while the US and the Commonwealth countries, including Australia, will hike. That will be good for the US dollar, bad for the euro and Asian FX, while to say the environment for equities anywhere will be challenging in 2022, is an understatement.


The FOMC will clearly be the economic data highlight of the week, even as the short-term financial markets continue to chase their tails on Ukraine developments. But China will also announce its one-year medium-term lending facility rate (MLF) sometime this week, which could feature a cut. It releases Retail Sales and Industrial Production tomorrow. Indonesia and Taiwan’s central banks announce policy decisions after the FOMC on Thursday. China and India release trade balances tomorrow, with Singapore releasing Non-Oil Exports. Finally, Australia releases unemployment data on Thursday as well, with strong jobs gains perhaps the last piece of the puzzle needed by the RBA to drop its ultra-dovish stance. The RBA Governor said last week that preparing for higher interest rates would be a sensible precaution. Tuesday and Thursday will be peak-data days for Asia this week.


Finally, the Bank of England announces its latest policy decision on Thursday, followed by the Bank of Japan on Friday. The Bank of Japan will hold its nerve, but the Bank of England will almost certainly follow the FOMC and hike by 0.25%.


Geopolitics will continue to dominate the market and the list of headlines from around the world today made me not even want to get out of bed. One thing I am sure of is that the algo and retail fast-money gnomes of the financial markets are going to buy risk heavily at the first concrete signs of Ukraine-Russia settlement progress. That is likely to be a sucker’s rally, though, because behind the scenes, the stagflationary wave sweeping the world, and the new cold war, are quietly eroding the foundations of the global recovery. The pain will be felt unevenly, and I’d hate to be a politician fighting an election this year, although resource-heavy countries should fare better than most. You could almost construct a case for getting bullish Latin America again on that basis. Almost…


As I have stated ad nauseam, volatility will be the winner in H1 2022, not market direction. Although I expect more last stands from the “buy-everything” HODL gnomes. Alas, after 14 years of central banks creating inequality in the world, all good things must come to an end. Given the risk profile of this week, a sensible investor with a longer-term view, and without a need to get spanked by Mistress Whip-Saw, might choose to watch the fun and games from the sidelines.


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Jeffrey Halley

Jeffrey Halley

Senior Market Analyst, Asia Pacific, from 2016 to August 2022
With more than 30 years of FX experience – from spot/margin trading and NDFs through to currency options and futures – Jeffrey Halley was 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 and Channel News Asia as well as in leading print publications such as 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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