Photo by Tim Mossholder on Unsplash

Overview

Yields are surging. Canada and Australia's two-year yields have jumped 20 bp, with the US yield is up 10 bp to 2.37% ahead of the $50 bln sale later today. The US 10-year yield has risen a more modest three basis points to 2.50%, flattening the 2-10-year yields curve. The 5–30-year curve has inverted for the first time since 2016. European 10-year benchmark yields have risen 3-7 bp. Tech stocks helped power the Hang Seng and Australia eked out a small gain, but most of equity markets in the Asia Pacific region sold off for third consecutive session. Led by financials, utilities, and communication, the Stoxx 600 has risen by about 0.75% in the European morning. US futures are trading with a heavier bias. The greenback is firm, with the yen again under the most pressure. It is trading briefly above JPY125 in late morning activity in Europe, before pulling back. The Australian dollar is the only major currency higher on the day. Emerging market currencies are mostly lower. The South Korean won, and Thai baht are hardest hit alongside the Polish zloty. The jump in yields is take some shine off gold, which reached $1966 last week. It is now straddling the $1930 area. The $1900 area may offer important support. The lockdown in Shanghai is sparking concerns about oil demand. May WTI is off almost 4% after last week's 10.5% rally. There is also speculation (hope) that OPEC+ agree to boost output at this week's meeting. US natural gas prices are little changed after rising in every session last week. Europe's benchmark has risen by a little more than 8% today after falling 2.4% last week. Iron ore is a little firmer, while copper is falling for the third session in a row. May wheat is offered, giving back 2.4% after last week's 3.6% a rally.

Asia Pacific

The Bank of Japan entered the market to reinforce the 0.25% cap of the 10-year yield. Its first offer to buy an unlimited amount of bonds failed to draw any interest. The second attempt had to buy JPY64.5 bln (~$525 mln). The BOJ recognizes it is engaged in a struggle now and has pre-announced will be there for the next three sessions. Separately, we note that according to the latest Nikkei poll, support for Prime Minister Kishida has risen six percentage points to 61%, with high marks given for handling the Russia's invasion of Ukraine.

On the one hand, China rejects the sanction regime against Russia, it says, because it is being imposed with a UN resolution. On the other hand, reports suggest the Beijing and mainland companies are asking US officials for clarification with the idea in mind to understand what is permitted. China and India purchases, for example, of Russian oil is not violating the sanctions.

There was thought that China would abandon its strict zero-Covid course. Some suggested that the easing of restrictions in Hong Kong could be a prelude to a change by Beijing. However, that does not appear to be the case. Yesterday, Beijing announced a lockdown of Shanghai, China's largest city (population estimated around 25 mln). The eastern half of city will be locked down for four days starting today. This covers the financial district. The purpose is mass testing. The western half of the city will be locked down as of April 1. Residents will be barred from leaving home and public transportation and ride-hailing services will be halted. A record 5500 cases were said to have been reported on Saturday. Recall that earlier this month, Shenzhen, an important tech hub was locked down.

China is taking a new initiative though that has not been widely reported. It appears that China and the Solomon Islands are close to a security pact. The leaked documents suggest that the pact could lead to a Chinese military presence there. Solomon Islands did not confirm the leaked details but did acknowledge that it was broadening out its security arrangements and China would be included in the changes. This is a blow to Australia, which had seemingly secured the strategically located country into the Western alliance. Solomon Islands had abandoned Huawei in 2018 and struck an agreement with Australia to build a 2500-mile internet cable to it. Last year, Australia sent some police to help quell riots in Honiara, the capital of the Solomon Islands, over economic problems, and anti-Chinese sentiment. Yet, China has been making inroads. For example, in 2019, Honiara dropped its recognition of Taiwan. The US has acted belatedly. Its embassy was closed in 1993 and not re-opened until last month. As the map here shows, a Chinese presence in the Solomon Islands would compromise Australia's security.

The BOJ's defense of its Yield Curve Control policy in the face of surging global yields and especially US rates keeps the yen on the defensive. The yen edged higher at the end of last week for the first time in six sessions, but its loss have accelerated today. As we have noted the last significant high was in 2015 and then the greenback reached about JPY125.85. The notable high before that was in 2002, a little above JPY135. The Australian dollar is firm. It posted a marginal new five-month high near $0.7540. It is approaching last October's high by $0.7550. It is the fifth consecutive advance, if sustained, and it would be the nineth gain in the past 10 sessions. The positive terms-of-trade shock seems to the be chief driver. A pre-election due first thing Wednesday in Canberra is expected to include a cut in the fuel tax for six months, support for first-time home buyers, and boost funds for roads and rails. The election is expected to be called by late May. The greenback gapped higher against the Chinese yuan, reaching a little more than CNY6.3810, but has subsequently trended lower to fill the nearly fill the gap (the pre-weekend high) by CNY6.3680. The PBOC's reference rate for the dollar was lower than the Bloomberg survey anticipated (CNY6.3732 vs. CNY6.3740).

Europe

In an unexpected turn of event, Germany's Economic Minister Habeck, a member of the Green Party, suggested that he is open to re-examining the decision to close the county's remaining three nuclear plants later this year. Previously, the Greens and Habeck ruled out this option. Still, the surge in energy prices and the belated efforts to reduce its dependence on Russia is pushing the pragmatic Greens (realos) in this direction. Merkel's push to close the nuclear energy plants after Japan's nuclear accident in 2011 resulting in increased reliance on Russia and spurred the Nord Stream 2 pipeline. 

Among the scenarios that were bandied about before Russia's invasion of Ukraine was that it could pursue a limited objective of securing the entire regional claims Donetsk and Luhansk. Since the war began, Western sources has played up different scenario, one of total occupation of Ukraine. The narrative it tells now is that after having suffered some significant setbacks, for which the higher range of estimates suggest Russia has lost as many soldiers (15k) in Ukraine as it did in 10 years in Afghanistan. Russia admits to less than a tenth of those estimated deaths in Ukraine. Even taking into account the number of injuries inflicted, the number of lower that the bottom of NATO's range (7k). It is quite clear that both sides have it in their interest to, shall we say, see what they want. Still, the point now is that Russia's 1st Deputy General of the Chief of Staff suggested Russian forces will focus on the gaining the full control of the Luhansk, for which it may be nearly there, and Donetsk, which is thought to be a little more than half secured. The idea is that when the territory is militarily secure, a referendum would be held to formally join Russia. Strategically, a land-bridge to Crimea will also be secured.

The euro was sold to an eight-day low near $1.0945 after holding above $1.0960 last week. It popped up in early European turnover to the session of just below $1.10. That is an important level in the coming days, with large options expiring there. The nearly 585 mln euro expiry today is the smallest. Tomorrow's expiring options are for almost 2.5 bln euros and the same Wednesday ahead of Thursday's nearly 2.9 bln euro expirations. If the upside is blocked, look for a test on $1.09 and below there is this month's low slightly ahead of $1.08. Sterling is testing last week's low by $1.3120. A break targets the $1.3070 area, and possibly $1.30, which was seen in the middle of the month. It last traded below there in late 2020, when it found a base around $1.2880.

America

The US Treasury indicated that Russia could use frozen funds to make debt payments until May 25. Next Monday, there is a $2.2 bln debt servicing payment due. Some covenants allow for the rouble payments, but these reportedly do not. After May 25, it needs to raise money other ways, including selling its oil and gas. Over the weekend, President Biden implied relations with Russia cannot be normalized while Putin is in control. It was later walked back by Secretary of State Blinken. However, within the US claiming Putin is a war criminal, it is hard not to conclude that the US seeks regime change. Some might find the US assertion of war crimes more powerful and compelling if Washington or Moscow were signatory members of the International Court of Justice. If you are keeping records of such things, Beijing is not a member either. The ICJ does not have authority over non-members.

President Biden is struggling in the polls. His support is around 40%, near the levels that Trump experienced at the same time of his presidency. One poll found that some 70% have little confidence in his handling of Russia and the war. This suggests that his base has also softened. Meanwhile, Biden is expected to unveil new budget proposals, which will include record spending for "peace" time. He is expected to formally endorse the previous Senate Democrat proposal for a "billionaires' tax) that would be extended to unrealized gains. It is said to raise $360 bln over the next 10 years. At the same time, without the Covid-related spending and income replaces, the budget deficit will be projected to fall. The median forecast in Bloomberg's survey has the budget deficit falling to 5.1% of GDP this year form 10.8% last. Lastly, there seems to be a misunderstanding about trend growth in the US. Some observers talk about a growth recession as the most likely or best outcome that can be anticipated. Yet the 2% pace or so bandied about can hardly be called a "growth recession” because for the Fed this would simply be a return to trend growth. The Fed estimates that the long-term growth rate is 1.8%-2.0%.

On tap today is the US February advanced goods trade balance. It was a record deficit in January. Wholesale and retail inventories are also due. Retail inventories rose by an average of 2.3% a month in Q4 21. They are expected to have risen by about 1.4% after January's 1.9% increase. Wholesale inventories rose by an average of 2.2% in Q4 21. They are rising at about half that pace in the first two months of Q1 22. We have noted that the inventory cycle is maturing, and it will not provide the tailwind as it did previously, and especially in Q4 21. The Dallas manufacturing survey is expected to have soften a little.

The US dollar has a nine-day drop in tow against the Canadian dollar coming into today's session. It is pinned near the pre-weekend low around CAD1.2465. It has not been above CAD1.2505 today. We anticipate some near-term consolidation that could see the greenback trade toward CAD1.2520-CAD1.2540. The US dollar is poised to snap an 11-day slide against the Mexican peso. During that run, the greenback fell from around MXN21.06 to about MXN19.91. It has been up to MXN20.12 today and since then it has found support ahead of MXN20.00. We suspect near-term potential extends into the MXN20.20-MXN20.22 area.