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Markets Flirt With The Inflation Trade

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inflation

By Jeffrey Halley, Senior Market Analyst, Asia Pacific, OANDA

Seemingly, the sharp rise in US yields this week has sparked a move from growth to value, or as I put it, from the Nasdaq to the Dow Jones. Whether it lasts is another thing altogether, with such rotations running out of steam over the past 18 months, without really ever gathering momentum. Still, a couple of things are “different this time,” namely the omicron variant is rapidly being repriced as omi-gone. Secondly, the Federal Reserve has commenced tapering its QE and will likely start hiking soon after the mid-year.

US yields should keep rising, not a certainty and the world has been led to water many a time over the past 18 months on this front. The reason? You can buy a 10-year Japan JGB and earn 0.0%, or a 10-year Bund and earn maybe -0.40% but buy a US 10-year note and you’ll earn 1.60% right now. What’s not to like if you are a pension fund manager in Europe or Japan with ageing populations who will all require a pension?  Slap in $120 billion a month of buying from the Fed alongside them, it’s hardly a surprise that being a US bond vigilante has become a tough job.

The overnight data from the US didn’t really support the premise either. The Jolts Job Openings dropped by around 0.50 million to 10.562 mio, while quits jumped to 4.50 mio. The ISM Manufacturing PMI fell to 58.7, while the Manufacturing Employment, New Orders and Manufacturing Prices sub-indexes all eased. None of that data was inflationary, more people were working, even as labour market turnover increased, but mostly in jobs, people hate, restaurants/food service, delivery and warehouses. PMIs, prices and orders eased but that can be accounted for by holiday seasonality and Omicron’s incredible spread, forcing many workers to self-isolate.

The overnight US data is likely to be an outlier, but don’t count out the growth versus value trade just yet, and a US Non-Farm Payrolls number on Friday under 400,000 jobs added could give the Fed Funds hike-a-nistas pause for thought. I do believe that higher US rates, a higher US Dollar, and tighter monetary policy will be the bride to make an honest man of big tech, but full confirmation will only come later in Q1. And even then, I am expecting technology to experience more two-way price action, not beat a full retreat, although if you are a pimped up SPAC, this year may not be your year. Inverting SPAC and inserting an R after the C would sum it up best in my mind. Always beware of investment bankers bearing gifts, I’ve been saying his for 20 years, and still, no one listens.

A similar pattern is emerging in Asia today as well, with the North-East Asian heavyweights of China, Japan and South Korea struggling for friends today, while the more value-stock-heavy markets of South-East Asia are generally doing better. Keep a cautious and risk-averse eye on China over the next couple of days. Shares of Huarong Asset Management, a poster child of China corporate governance, returned to the market today after a 9-month suspension. Wearing a fresh $6.6 bio government bailout, they promptly fell by 50% in Hong Kong. Another champion of corporate governance, Evergrande, faces potential redemptions of a CNY 4.50 bio bond from investors this weekend.

The China property sector remains a slow-moving lava flow, burning everything, it touches. That pain now switches to domestic investors and unsurprisingly, Evergrande is meeting investors from the 7th-10th to try and extend the put option. As I’ve said before, beware investment bankers bearing gifts, or in this case telling you to buy the dip; and remember, there’s never just one cockroach.

Asia follows New York’s value versus growth.

Overnight, Wall Street went looking for the winners in an inflationary environment and as a result, loaded up on the Dow Jones at the expense of the Nasdaq, mostly on the premise the Fed inflation hunting will resume as the global recovery bids omicron goodbye. The S&P 500 was almost unchanged at -0.06%, but the Nasdaq tumbled by 1.33%, while the Dow Jones added 0.58%. In Asia, all three indexes have retreated, down around 0.25%. A fire at the worlds most critical semiconductor machine manufacturer, Dutch company ASML, could be weighing on sentiment.

Extreme ultra-violet lithography systems aside, Asian markets have split in roughly the same direction as New York today. The Nikkei 225 is unchanged, having reversed earlier losses, but the South Korean Kospi is 1.30% lower and Taipei is down by 0.35%. The ASML fire potentially weighs more on the latter two.

China markets are also in retreat on pre-Chinese-New-Year funding fears, China property developers, US-listed technology groups and Huarong with no signs from the PBOC that it intends to ease the funding crunch as it keeps money tight via the daily repo. The Shanghai Composite is down 0.85% with the CSI 300 easing 0.65% lower. Hong Kong is down 0.75% today.

In ASEAN though, Singapore has eased 0.25%, but Kuala Lumpur is 0.20% higher and Bangkok is up 0.30%, with Jakarta and Manila unchanged. Most exchanges having given back intra-day gains. Australian markets are lower after jumping the gun on the value trade earlier this week with some stellar gains so far. The easing of the S&P 500 and Nasdaq overnight and today has prompted some profit-taking down under. The ASX 200 and All Ordinaries are 0.35% lower.

Europe is likely to find gains hard to find initially with Asia’s mixed momentum subsiding and turning to a more generally cautious note. If the fire damage at ASML’s Berlin factory is minimal, that could be enough to encourage the bulls back again as none likes the thought of a drawn-out semiconductor shortage.

A mixed US Dollar performance.

The US Dollar had a mixed night, rising versus the major currencies and the Asian currency grouping, as firm US bond yields sparked yield differential nerves. Conversely, the same post-omicron sentiment propelling stock markets and bond yields higher had a positive effect on the usual sentiment barometers. Sterling, and the Canadian, Australian and New Zealand Dollars all having a good night.

The dollar index rose 0.06% overnight, only to give it all back in Asia, where it is trading net-unchanged for the last 24 hours at 96.24. A break of 95.50 or 96.50 will signal the index’s next directional move, although if US yields stay firm, the greenback looks set to continue to outperform in the major currency space. EUR/USD remained steady at 1.1295, as did USD/JPY at 116.00, while positive comments from the UK Prime Minister that Britain could weather the omicron storm without shutting down lifted GBP/USD to 1.3530, where it remains in Asia. A close above 1.3560 potentially signals a rally to 1.3800.

Although the AUD, NZD and CAD retraced some of their losses overnight, they are almost unchanged at 0.7235, 0.6805 and 1.2715, leaving all three roughly mid-range for the week. 0.7180 and 0.7280, 0.6750 and 0.6850, and 1.2600 and 1.2800 are the breakout levels to watch for. Sentiment swings continue to rule the direction of the three amigos.

In Asia, the rise in US yields seems to be spooking some Asian currencies, with the US Dollar rally pushing a number of pairs towards line-in-the-sand levels with their respective central banks. USD/KRW is at 1198.00 approaching 1200.00. USD/PHP has risen up through 51.00 to 51.10, USD/IDR is at 14,350 approaching 14.500.00 and USD/MYR looks set to test 4.2000. The Yuan, Baht and Indian Rupee continue to outperform. For the rest, it will be interesting to see if their respective central banks step out of the shadows and start offering US Dollars again. In a rising US interest rate environment, this will be a quandary they will be asked numerous times in 2022. If the Asian central banks stay side-lined, USD/Asia could be about to move sharply higher, assuming US yields hold their gains.

OPEC+ can’t dent oil.

Oil prices rallied overnight, despite OPEC+ announcing its pre-planned 400,000 bpd increase in monthly production. The omicron is omi-gone trade continued to hold sway, with its brighter outlook for world growth and oil consumption lifting oil prices, aided by larger than expected drawdown from private US API Crude Inventories.

Brent crude rose by 1.60% to $80.15 overnight, with WTI climbing by 1.60% as well to $77.20 a barrel. Some spec-drive long-covering has seen Brent ease back to $79.85, and WTI ease back to $76.80 a barrel. In the bigger picture the fall today looks corrective and if sentiment holds up and official US Crude Inventories fall tonight, oil should resume its upward march.

Brent crude has support at $78.60 and $77.75 barrel, its 100-day moving average (DMA). It has resistance here at $80.00, and then $82.00 a barrel. WTI has support at $75.75 and then $74.75, it’s 100-DMA. It has stout resistance at $77.50 barrel, and then $79.30.

Gold’s shows some fighting spirit.

With US yields and the US Dollar holding their gains but trading sideways, gold some fighting spirit, or perhaps blind optimism, to carve out a decent gain overnight. Gold rose by 0.75% to $1815.00 an ounce, where it remains in Asia. As ever, gold tends to run for cover at the first sign of trouble, so I would not say that gold has “weathered the storm” for one instant.

Gold has resistance at $1830.00 and $1840.00 an ounce, although it would be a huge surprise if we saw those levels this week. Support lies at $1798.00, which held once again overnight, followed by $1790.00 and $1780.00 an ounce. $1790.00 to $1820.00 is my call for the range this week.

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Markets

Markets Today – Cautiously Higher, China, Oil, Gold, Bitcoin

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By Craig Erlam, Senior Market Analyst, UK & EMEA, OANDA

European stock markets moved cautiously higher on Monday as investors were tempted back in after a turbulent start to the year.

It’s been a relatively quiet start to the week, with the US bank holiday naturally weighing on activity. With that in mind, I don’t think we can read too much into today’s advances, especially as they’re occurring alongside rising yields which doesn’t seem particularly sustainable at a time of such anxiety in the markets.

It will be interesting to see if investors are tempted back in now that earnings season is underway. The emergence of omicron may mean that many companies don’t enjoy the kind of performance that was expected before but that doesn’t mean there won’t be plenty of positives to take away.

Of course, there are areas that will naturally chip away at that enthusiasm. Whether that’s margins being squeezed, prices increased or staffing costs, for example, there’ll be plenty for investors to get their heads around as they contend with sky-high valuations and a tricky economy this year.

PBOC cuts rates despite strong growth in 2021

A mixed bag of data overnight from China, where GDP growth exceeded expectations but retail sales fell short and the unemployment rate ticked higher. While the economy is still performing well after far exceeding its growth targets for 2021, many challenges remain, not least the crackdown on the property market that has led to firms defaulting on coupon payments and being forced into negotiations with bondholders.

This explains the PBOC decision overnight to cut interest rates and further easing is expected to follow as the central bank looks to support the economy through a turbulent period.

Oil rally continues as output continues to fall short

Oil prices are edging higher again at the start of the week as it continues its remarkable run since bottoming in early December. It’s up more than 30% over that time and there still appears to be momentum in the move. Kazakhstan has seen its output return to pre-unrest levels but that’s done little to slow the rally in recent sessions.

Ultimately it comes down to the ability of OPEC+ to deliver the 400,000 barrel per day increase that it’s vowed to do each month. The evidence suggests it’s not that straightforward and the group is missing the targets by a large margin after a period of underinvestment and outages. That should continue to be supportive for oil and increase talk of triple-figure prices.

Can gold break key resistance?

Gold is marginally higher on the day after pulling back again late last week. The yellow metal has repeatedly struggled at $1,833 and it would appear it’s having the same struggles this time around as well. It did finally break through here in November but it didn’t last and it seems the psychological barrier is as firm as ever.

That said, it’s impossible to ignore gold at the moment as it continues to rally despite more and more rate hikes being priced in around the world and yields rising in tandem. There could be an argument that we’re seeing safe haven or inflation hedge moves due to the current environment which could become more clear over the coming weeks.

Another run at $40,000?

Bitcoin is down a little over 2% at the start of the week and continues to look vulnerable having failed to bounce back strongly off the recent lows. It appeared to be gathering some upside momentum at times last week but it quickly ran into resistance just shy of $45,000 where it had previously seen support. All eyes are now on $40,000 and whether we’re going to see another run at that major support level.

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Oil Extends Gain Above $86 Per Barrel Amid Tight Supply

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Brent crude oil extended gains above $86.16 per barrel on Monday as global oil investors are projecting that supply will remain tight despite the surge in Libya crude oil production. The increase, they bet would be offset by restraint from top crude oil producers.

Frantic oil buying, driven by supply outages and signs the Omicron coronavirus variant will not be as disruptive to fuel demand as previously feared, has pushed some crude grades to multi-year highs, suggesting the rally in Brent futures could be sustained for a while longer, traders said.

“The bullish sentiment is continuing as (producer group) OPEC+ is not providing enough supply to meet strong global demand,” said Fujitomi Securities analyst Toshitaka Tazawa.

The Organization of the Petroleum Exporting Countries (OPEC) and allies including Russia, together known as OPEC+, are gradually relaxing output cuts implemented when demand collapsed in 2020.

But many smaller producers cannot raise supply and others have been wary of pumping too much oil in case of renewed COVID-19 setbacks.

Meanwhile, Libya’s total oil output is back to 1.2 million barrels per day (bpd), according to National Oil Corp. Libyan output was about 900,000 bpd last week owing to a blockade of western oilfields.

“Libya’s oil production had dropped to a good 700,000 bpd at the start of the year, which had played its part in the price rise,” said Commerzbank analyst Carsten Fritsch.

Concerns over supply constraints outweighed the news of China’s possible oil release from reserves, said Fujitomi’s Tazawa.

Sources told Reuters that China plans to release oil reserves around the Lunar New Year holidays between Jan. 31 and Feb. 6 as part of a plan coordinated by the United States to reduce global prices.

Saudi Energy Minister Prince Abdulaziz bin Salman said on Monday that it is the prerogative of the U.S. government whether to release supply from strategic petroleum reserves.

Festering geopolitical threats to supply are also supporting bullish sentiment, analysts said.

U.S. officials voiced fears on Friday that Russia was preparing to attack Ukraine if diplomacy failed. Russia, which has amassed 100,000 troops on Ukraine’s border, released pictures of its forces on the move.

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Markets Today – Inflation, Jobless Claims, Boris Blunder, Oil, Gold, Bitcoin

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outlook

By Craig Erlam, Senior Market Analyst, UK & EMEA, OANDA

It’s been a rollercoaster start to the year and as we head into earnings season, it’s hard to say exactly where investors stand.

Blocking out the January noise is one thing but it’s made far more complicated by omicron, inflation, and the rapid evolution of monetary policy. Yesterday’s reaction to the inflation data was a case in point. The data mostly exceeded expectations, albeit marginally, while headline inflation was a near 40-year high of 7%. And yet the response was broadly positive.

I get that traders were perhaps fearing the worst and, as I’ve referenced before, it does feel like markets are at peak fear on US monetary policy which could make relief rallies more likely. But there is also underlying anxiety in the markets that could make for some volatile price action for the foreseeable future.

Perhaps earnings season will bring some welcome normality to the markets after a period of fear, relief, and speculation. The fourth quarter is expected to have been another strong quarter, although the emergence of omicron will likely have had an impact during the critical holiday period for many companies. Of course, as we’ve seen throughout the pandemic, that will likely have been to the benefit of others.

And while earnings season will provide a distraction, it is happening against an uncertain backdrop for interest rates and inflation which will keep investors on their toes. It does seem that investors are on the edge of what they will tolerate and it won’t take much to push them over the edge. Which will be fine if we are near the peak of inflation, as many expect.

The data today looks a mixed bag on the face of it, with jobless claims coming in a little higher than expected, which may be down to seasonal adjustments. The overall trend remains positive and continues to point to a tight labor market. The PPI data on the other hand will be welcomed, with the headline number slipping to 0.2% month on month. Perhaps a sign of supply-side pressures finally starting to abate which will come as a relief after inflation hit a near-40 year high last month.

Sterling solid as pressure mounts on Boris

It seems impossible to ignore the political soap opera currently taking place in the UK, with Prime Minister Boris Johnson once again in the public firing line after finally admitting to attending an office party in May 2020.

In other circumstances, uncertainty around the top job in the country could bring pressure in the markets but the pound is performing very well. Perhaps that’s a reflection of the controversy that forever surrounds Boris, and we’re all therefore numb to it, or a sign of the environment we’re in that the PM being a resignation risk is further down the list when compared with inflation, interest rates, omicron, energy prices etc.

Oil remains bullish near highs

Oil prices are easing again today after moving back towards seven-year highs in recent weeks. It was given an additional bump yesterday following the release of the EIA data which showed a larger draw than expected. But with crude already trading near its peak, it maybe didn’t carry the same momentum it otherwise would.

The fundamentals continue to look bullish for gold. Temporary disruptions in Kazakhstan and Libya are close to being resolved, with the latter taking a little longer to get fully back online. But OPEC being unable to hit output targets at a time when demand remains strong is ultimately keeping prices elevated and will continue to do so.

A big test for gold

Gold is off a little today but the price remains elevated with key resistance in sight. The yellow metal has remained well supported in recent weeks even as yields around the world continue to rise in anticipation of aggressive tightening from central banks.

It could be argued that the bullish case for gold is its reputation as an inflation hedge, especially given central banks’ recent record for recognizing how severe the situation is. But with inflation likely nearing its peak, that may not last. That said, fear around Fed tightening may also be peaking which could support gold in the short-term and a break through $1,833 could signal further upside to come.

Can bitcoin break key resistance?

Bitcoin is enjoying some relief along with other risk assets and has recaptured $44,000, only a few days after briefly dipping below $40,000. That swift 10% rebound is nothing by bitcoin standards and if it can break $45,500, we could see another sharp move higher as belief starts to grow that the worst of the rout is behind it. It looks like a fragile rebound at the moment but a break of that resistance could change that.

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