Photo by ALEXANDRE LALLEMAND on Unsplash

Overview

Strong US equity gains yesterday helped lift Asia Pacific markets today. Tokyo led the move with a nearly 4% gain in the Nikkei. Taiwan and Korea rose more than 2%, while most other bourses gained more than 1%. However, the US warning that Russia may use chemical or biological weapons after Moscow accused Ukraine of the same has seen risk retreat in Europe. After surging 4.7% yesterday, the Stoxx 600 is off around 1.1%, bbenchmark yields are off 2-3 bp, and the euro has been pushed lower after approaching $1.11 yesterday in its biggest gain since March 2020. US futures are around 0.5-0.8% lower, while the 10-year Treasury yield is off two basis points to around 1.93%. Several Asia Pacific benchmark yields, including China, Australia, and South Korea are at new highs for the year. The Australian and New Zealand dollars are proving resilient, while most of the other major currencies are softer. Emerging market currencies are mixed. Central European currencies mostly lower, including the Hungarian forint despite a 50 bp increase in the one-week deposit rate (now 5.85%). The JP Morgan Emerging Market Currency Index is firmer for the third consecutive session, though still lower on the week. Gold peaked near $2070 on Tuesday and approached $1970 today before finding support and returning to $2000. April WTI surged to $130 on Monday and hit a low near $103 yesterday. It is trading near $113 near midday in Europe. US natural gas is posting its first gain in this week and is up about 1.5%. Europe's benchmark tumbled almost 30% yesterday. An attempt to recover in early dealings today faltered, leaving it little changed. Iron ore slipped for a third session as it pares Monday's nearly 6% jump. Copper is up small for the first time this week. The US Department of Agriculture boosted its assessment of the wheat supply (helped by Australia and India). May wheat is off nearly 1% today after a 6.6% fall yesterday. It could be wheat's first weekly loss since early February.

Asia Pacific

China has widened the band for the yuan-rouble exchange rate. The band was doubled to 10% from 5%. The US dollar is allowed to trade in a 2% band around the reference rate and rarely moves outside of a 1% band. There is much talk about how sanctions on the Russia's central bank will encourage a move to the yuan as a reserve asset. Some also have argued that the introduction of a digital yuan will also boost its reserve status. Maybe, but it seems unlikely. Of course, Russia may increase it yuan holdings, but it had appeared to largely have done so already. The lack of convertibility and transparency, and limited depth of the central government bond market seem to be significant hurdles.

Foreign investors sold JPY910 bln of Japanese equities last week, the most since the middle of last September. Offshore investors have been large sellers of Taiwan and South Korean shares this year. Today was only the second day that foreign investors did not sell Taiwanese shares in three weeks. They have sold as much this year already as they did all of last year (~$15.6 bln). Foreign investors bought about $3.6 bln of Indian shares last year and have sold about $14.2 bln this year through Tuesday. Even news that conservative candidate Yoon was elected as South Korea's new president was unable to deter foreign selling of local shares today. The $354 mln sale today brings this year's divesture to $5.5 bln. Last year foreign investors sold almost $23 bln of South Korean equities. 

There had been some ideas that with the pandemic easing, fiscal deficit would be reduced. This may still happen but a new bout of military Keynesianism may blunt it. Australia announced a A$38 bln (~$28 bln) increase in defense spending. Separately, note that Debelle, Deputy Governor of the Reserve Bank of Australia unexpectedly tendered his resignation, effective next week. Debelle was thought to be a possible successor to Governor Lowe, whose term ends in September 2023. Some suspect Lowe will be offered a second term.

The dollar rose above JPY116 for the first time since February 11 when the US warned that Russia could attack Ukraine at any moment. It knocked on it yesterday, and regional trading did not take it out until late in the session. The greenback reached JPY116.20 before retreating. It found new buyers near JPY115.80. The multi-year high seen in January and February was JPY116.35. The Australian dollar is firm but remains as it did yesterday within Tuesday's range (~$0.7245-$0.7350). The week's high was set on Monday by $0.7440. The session low was set early in the Asia Pacific session slightly below $0.7290. Recall that the Aussie has a five-week rally in tow that is at risk. It settled last week near $0.7370. The greenback is up 0.1% against the Chinese yuan. It is not much, but if sustained, it would be the biggest advance since the middle of last week. Moreover, it could be the highest close for the dollar since in almost three weeks. The PBOC set the dollar's reference rate at CNY6.3105. The median projection in Bloomberg survey looked for CNY6.3066.

Europe

The ECB meeting is front and center. It faced policy challenges before Russia invaded Ukraine and it is in more difficult straits now. Price pressures are likely to increase and growth slower than it would have been. On February 10, the day before the US warned that Russian could attack at any moment, the swaps market had priced in about 50 bp in hikes this year. Now, roughly 25 bp has been discounted.

With no action anticipated, the focus is on what the ECB says and there are two elements here. The first are the new staff forecasts. The contours of the growth forecast will change. In December, it had GDP at 4.2% this year, 2.9% in 2023, and 1.6% in 2024. Growth will likely be pressed out of this year, and perhaps even a little of out next year, but 2024 may be revised higher. Some thought the inflation forecasts were off since they were issued, and the war underscores it. The staff had CPI at 3.2% this year. The risk is twice that. The ECB had CPI falling to 1.8% in 2023 and 2024. While 2024 may be left alone, the 2023 forecast will likely be lifted to above 2%.

The second element of guidance is more direct. It is about the asset purchases. It seems highly unlikely that the ECB will alter the sequencing, which calls for the asset purchases to stop shortly before the first rate hike. So, if the ECB wants to create the space or secure the flexibility to raise rates later this year, it will likely need to signal the Asset Purchase Program will not run indefinitely but could end in Q3 after rising to 40 bln a month in Q2. Of course, Lagarde is bound to emphasize the high degree of uncertainty and the lack of visibility, which is why maximum flexibility is needed.

An informal summit will also be taking place in Versailles today. A topic that has caught the imagination of many participants is the possibility of joint bonds to fund the kind of energy sector and defense efforts that will be needed. France holds the rotating EU presidency and has been sympathetic to such ideas in the past, including the NextGeneration EU bonds (800 bln euros) launched last year to help deal with the pandemic and help build a greener and more digital Europe.

The euro approached $1.08 on Monday and $1.1100 yesterday. It stalled and has not traded above $1.1080 today. It is trading softly in the European morning and has been down to about $1.1025. There are options for 1.8 bln euro at $1.10 that expire today, with the ECB meeting and US CPI still ahead. Russia appears to be signaling that it will continue to attack until its demands are met. The Ukraine government has indicated it can accept neutrality (i.e., NATO has not offered membership) but will not give up any territory. Yet it cannot dislodge Russia from Crimea or the separatist regions. Sterling rose to $1.3190 yesterday and edged a little higher but held below $1.3200 before succumbing to mild selling pressure. It is finding support ahead of $1.3140. Yesterday was the first gain in five sessions. The risk is for a tested of the $1.3100 area.

America

The US reports February CPI today. Everyone accepts that inflation is high and accelerating. The surge in energy, food, and industrial commodity prices means that the peak in inflation will come later and from higher levels than was being discussed a month ago. The 10-year breakeven (the difference between the convention yield and the yield of the inflation-protected security) reached a record high on March 8 near 2.96%. It was near 2.45% before the US warning on February 11 that Russia was prepared to invade Ukraine. Fed Chair Powell offered a rough guide that $10 a barrel increase in oil boosts inflation by 0.2% and shaves 0.1% from growth. It is not clear where oil settles, but for this exercise, let’s say the stabilizes around $110. That would be about a $30 a barrel increase over the past three months. That could translate into a CPI peak closer to 9% and year-over-year growth closer to 3% this year. Recall that in December, the median Fed forecast was for 4% growth and a 2.6% increase in the headline PCE deflator. 

Russia seemingly out-of-the-blue accused Ukraine of housing chemical and biological warfare labs ostensibly for the US. The US warns that this could be used as a justification for Russia's use of similar weapons. Separately, the US has rejected the Polish initiative send its Russian-made planes to Ukraine from a NATO base. The US has taken measures to avoid any pretense Russia may look for to widen the war. It did not put US nuclear forces on higher alert when Russia did, and it postponed an ICBM test as well. Sending planes for a NATO base to Ukraine could risk a confrontation between NATO and Russian forces, something that officials are working hard to avoid. Separately, but not totally unrelated, the US reportedly is considering sanctions against Rosatom, the Russian company that is a major supplier of fuel and technology to power plants. It reportedly accounts for a little more than a third of global uranium enrichment.

In addition to the CPI figures, the US will report weekly jobless claims, the February budget, and Q4 household net worth. Recall that American household net worth rose nearly $2.4 trillion in Q3 21 (1.7%) to $144.7 trillion. Canada and Mexico have light economic calendars today, while Brazil report January retail sales. A small 0.3% gain is expected after a 0.1% decline last December. Brazil will report IPCA inflation tomorrow. It is forecast (median Bloomberg survey) to tick up to 10.47% from 10.38%. The central bank is seen lifting the Selic rate by 100 bp next week to 11.75%. Canada reports February jobs data tomorrow.

The US dollar held below CAD1.29 yesterday and found support at CAD1.28, prior resistance. It slipped a little lower (~CAD1.2790) before rebounding to around CAD1.2840. A $360 mln option at CAD1.28 expires today. The risk-off mood may help underpin the greenback, note that the US 2-year premium over Canada is the most since September 2019 (~16 bp). The US dollar fell nearly 2.2% against the Mexican peso yesterday that stopped a four-day rally. Yesterday's MXN20.8575 low has held and the greenback is testing the MXN21.00 area. Given the risk-off, there is scope to rise toward MXN20.09. Above there, the next target is closer to MXN20.16. The US dollar fell to new lows for the year against the Brazilian real. It traded below BRL5.0 for the first time since last July. Look for the gap (~BRL5.0355-BRL5.0450) to attract prices.