Mild Sanctions Spur Relief Rally

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Photo by Christian Lue on Unsplash

The market appears to be judging the initial salvo of sanctions against Russia for formally recognizing the separatist regions in Ukraine as modest at best and has preceded to take on more risk. Tokyo markets were on holiday but the other major equity markets in the region rallied and the MSCI Asia Pacific Index rose for the first time in four sessions. Led by consumer discretionary, materials, and staples sectors, the Stoxx 600 is rising for a second session. US futures are 0.65%-1.0% higher. The NASDAQ has a four-day losing streak in tow. Benchmark bond yields are firmer. The US 10-year yield is up about three basis points to 1.97%. European yields are narrowly mixed. Australia and New Zealand benchmark yields rose 7-9 bp, reflecting some catch-up, but also the Reserve Bank of New Zealand's rate hike and more aggressive forward guidance. The more robust appetite for risk is helping lift the dollar-bloc and Scandi currencies, while the Japanese yen is flat. Most emerging market currencies are firmer, but the Russian rouble is off about 1%, after advancing a little more than 1% yesterday. Gold’s appeal has diminished after trading a little through $1914 yesterday and may be vulnerable to test the recent lows near $1885. Crude oil is consolidating. In the past two sessions, the April WTI contract has traded between roughly $87.50 and $95.00. It is hovering around the middle of that range (~$91.50). US natgas prices are a little softer, but Europe's benchmark has jumped over 12%. Iron ore prices rose almost 2% earlier today, while copper's three days fall maybe snapped today. 

Asia Pacific

As widely expected, the Reserve Bank of New Zealand hikes its cash target rate by 25 bp to 1.0%. Officials expected the key rate to stand at 2.50% in 12-month, but now sees a peak at 3.25% by the end of next year, 75 bp higher than previously. It also announced that it will begin a gradual reduction of its balance sheet in July by selling NZ$5 bln per fiscal year. In addition, it will not reinvest proceeds from maturing holdings. The hawkish posture was underscored by the acknowledgment that the 25 bp hike was "finely balanced" and that the RBNZ is raises rates quicker, if required. Some observers see the comment as a hint of a 50 bp move in May. New Zealand is experiencing an Omicron wave while the economy is strong. Unemployment stood at a record low of 3.2% in Q4 21, and inflation is running just below 6%. That said, the RBNZ projects growth of about 5.3% in the year through next month, while it cut is growth forecast for the next fiscal year to 2.9% vs. 4.2%.

Australia reported Q4 21 wages growth of 0.7% after a 0.6% increase in Q3 21. The year-over-year rate edged up to 2.3% from 2.2% and missing the median forecast in Bloomberg's survey of 2.4%. The market's initial reaction was to take the three-year yield down six basis points and the Australian dollar wobbled. The Reserve Bank of Australia meets next week. The market looks for a rate hike around the middle of the year, but the central bank is less sanguine. Governor Lowe has allowed for a rate hike before the end of the year, if wages continue to accelerate.

The dollar bounced off of JPY114.50 yesterday and settled a little above JPY115.00. The yen is sidelined today, with Tokyo out. The dollar has trading in less than a 20-pip range and has been unable so far to take out yesterday's high near JPY115.25. Rising US yields and equities would seem to favor a stronger greenback. The Australian dollar closed above $0.7200 for the first time yesterday in a month and follow-through buying has lifted it to nearly $0.7270, its highest level since January 20. A band of resistance is seen between $0.7280 and $0.7315, the high for the year so far. At the end of January, the Aussie had fallen below its lower Bollinger Band, and now it is toying with the upper Band (~$0.7265). The intraday momentum indicators are stretched. The greenback fell to new four-lows against the Chinese yuan today (~CNY6.3140). The low from early 2018 was CNY6.24-CNY6.25, but there is talk of a move toward CNY6.20. Even though a couple of large US asset managers have reduced their exposure, foreign demand remains strong. On top of its large trade surplus, foreign portfolio investment flows are robust. The PBOC again set the dollar's reference rate weaker than the bank models (Bloomberg survey) projected: CNY6.3313 vs. CNY6.3330.

Europe

The threat of devastating sanctions on Russia looks wide of the mark. The measures announced are being judged to be mild. For example, the US prohibition of buying Russian bonds in the secondary market complement the restrictions in the primary market, but it does not impact current holdings. At the end of last year, US investors held about $14 bln in long-term Russian bonds. The sanctions on a few elites may be inconvenient but hardly significant. The largest Russian banks were not targeted, but a few state-owned banks were. Some sanctions by the UK seemed to target some that the US had previously sanctioned. We suspect that these moves were among the more modest measures that Russia had anticipated. At the same time, reports suggest that Russian forces were already in the separatist regions, so outside formally recognizing the separatist regions, it is not clear yet what has materially changed on the ground. This appears to be dividing the risk assessment, with some in Europe not seeing it as an invasion.

Austria's central bank chief Holzmann, a noted hawk, is pushing two initiatives. First, he continues to argue in favor of hiking rates while the bond buying continues. ECB President Lagarde has pushed against this sequencing. Recall that the BOE had briefly toyed with hiking amid QE but ultimately finished its bond buying before hiking rates. Second, Holzmann saw a possibility of a hike at the end of the summer and another one before year end. A Reuters survey found a median expectation for the ECB's bond buying to wind down in Q3 and a hike in Q3/Q4.

Since the US warning on February 11 that Russian military action was imminent, the euro has chopped in a $1.1280-$1.1400 trading range. It tested the lower end yesterday before recovering. Follow-through buying lifted the single currency to almost $1.1360 in the European morning. Yesterday's high was a slightly above $1.1365. The intrasession momentum indicators are over-extended, suggesting the upside will likely be limited in the North American morning. Sterling found support yesterday around $1.3530 and recovered to test $1.36. It is pushing higher today but the market seems hesitant to challenge the recent highs in the $1.3640 area. Here too the intraday momentum indicators are stretched. Initial support is seen around $1.3580.

America

The US economic calendar is light today. The weekly mortgage applications report and the Fed's Daly late in the US session are the highlights. Treasury also sell a two-year floating rate note ($22 bln) and five-year notes ($53 bln). Yesterday's $52 bln sale of two-year notes was well received. The sale was covered 2.64x and indirect bidder took down almost 2/3 and direct bidders almost a fifth. Dealers were absorbed a little more than 15%, the least many years. Meanwhile, the US 2-10-year yield curve continued to flatten. It fell through 39 bp for the first time in two years yesterday. Recall that near 78 bp at the end of last year. It peaked at the end of March 2021 a little below 160 bp. It was a near 130 bp at recently as last October.

Like the US, Canada also has a light economic diary today. However, Mexico and Brazil are busier. Mexico reports the biweekly CPI reading through the middle of February. This measure of inflation has drifted lower since the end of last November. However, it remains ins above 7% and the downdraft is expected to have ended after falling to 7.01% at the end of January. The median projection in the Bloomberg survey looks for 7.17%, which would be the high so far this year. Mexico also reports December retail sales. A 0.3% rise is expected after a 0.9% increase in November. Banxico does not meet for a month and the market leans toward a 25 bp hike after two 50 bp hikes in a row.

Brazil reported its IPCA inflation measure. It fell from 10.73% in November 2021 to 10.20% in January 2022. After two months of improvement, prices are expected to have risen by 10.63% this month (median in the Bloomberg survey). The Selic rate stands at 10.75% and the swaps market is pricing in another 200-225 bp hikes in the next six months, and some are looking at the first cut either late this year or early next year. Meanwhile, foreign inflows into Brazil's equity market remains strong (~BRL64 bln or ~$12.7 bln over the past two months). The Bovespa is one of the best performing equity markets this year, up 7.7% through yesterday and year-to-date the Brazilian real is the strongest currency in the world, rising by about 10.2% coming into today.

The US dollar approached the upper end of this month's range against the Canadian dollar near CAD1.28. It has come back offered today in line with the stronger risk appetites. It is testing the CAD1.27 area. The lower end of the recent range is around CAD1.2660. The Bank of Canada meets next week, and swaps market has a nearly 70% chance of a 50 bp hike discounted. It may also an announcement that it will allow its balance sheets to gradually fall starting in April or May. The greenback settled below the 200-day moving average against the Mexican peso for the fifth consecutive session yesterday. It is sitting just above the low for the year set last week near MXN20.2360. There is little on the charts until closer to last October's low near MXN20.12. On the upside, the MXN20.28 may offer initial resistance.

Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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