Risk Appetites Challenged by Lavrov's Warning about Nuclear Conflict

Overview: The recovery attempt of risk appetites, reflected in the recovery and strong close in US stocks yesterday was dealt a blow by Russia's Foreign Minister's warning of a "serious" danger of nuclear conflict.  In Asia-Pacific, most of the large equity markets advanced.  China was an exception even though the currency snapped a five-day slide following the hike in foreign currency reserve requirements announced yesterday.  Australia's resource companies led the ASX to its largest loss (~2%) since Russia's invasion of Ukraine two months ago.  European shares are trying to stabilize after the Stoxx 600 fell by 3.6% over the past two sessions. US futures are softer.  The US 10-year yield is a few basis points lower around 2.79%. European benchmark yields are slightly softer. The dollar is mostly firmer, though the Antipodean and yen have edged higher.   The euro's loss has been extended deeper into the $1.06-handle and sterling still struggles to sustain modest upticks.  Among emerging market currencies, several Asia Pacific currencies, in addition to the yuan have traded better.  European currencies are taking the brunt.  Gold closed below $1900 yesterday for the first time since late February and is straddling that area in quiet turnover.  June WTI stabilized after falling to around $95.30 yesterday.  An attempt on the upside stalled in front of $100. US natgas is up 3.5% after yesterday's 2% advance.  Europe's benchmark is off 1.7% after falling nearly 8% over the past two sessions.  Iron ore stabilized, rising by about 1.6% earlier today after dropping almost 9.7% yesterday. Copper is also trying to steady.  It fell by more than 5% Friday-Monday. Poor planting news is helping July wheat rise 2.1% after falling for the past five sessions.  

Asia Pacific

The PBOC cut the reserve requirement for foreign currency deposits in a clear sign of concern about the yuan, which had fallen sharply and was trading near 17-month lows.  The 1% cut was more symbolic than substantive.  It had lifted the reserve requirements twice last year for the first time in a decade and each move was 200 bp.  Ostensibly, the reduced reserve requirements boost the local supply of dollars and other currencies.  The Politburo's quarterly meeting is expected to announce new measures to support the economy and counter the effect of the lockdown.  Some industries are being allowed to re-open in Shanghai, while the lockdown continues, including autos and semiconductor producers.  Universal testing is required in Beijing and some fear that the testing is a prelude to a lockdown.  Some districts have already restricted movement.  

There are four developments in Japan to note.  First, Finance Minister Suzuki denied reports that he discussed the possibility of intervention with US Treasury Secretary Yellen.  The initial press reported from Tokyo said that such a discussion was "likely," but in later reiterations in what seemed like an echo chamber, it become a definite.  Given the assessment by the IMF's regional head that the yen's gains reflected fundamentals, and the US efforts to rein in prices, the bar to intervention is high.  Second, the Japanese labor market improved marginally last month.  The unemployment rate unexpectedly eased to 2.6% from 2.7% and the job-to-application ratio ticked up to 1.22 from 1.21.  Third, the BOJ's defense of the 0.25% 10-year yield cap had it buy JPY921.5 bln today, its largest purchase in nearly four years.  Moreover, it extended its fix-rate purchases for the next two days, which carries it through the BOJ meeting.  Fourth, the government's support measures for the economy are taking shape.  A JPY6.2 trillion (~$48.5 bln) package that will be funded by an additional budget and tapping into the fiscal reserves will be submitted.  The economic objective is to help curb the rise in energy prices, ensure stable food supplies, support small and medium-sized businesses, and help struggling families.  The current Diet session ends in mid-June ahead of the upper house elections.

The dollar made a marginal new five-day low against the Japanese yen near JPY127.35.  Buyers stepped in the middle of the Asia Pacific session and retested the session high around JPY128.20.  It is consolidating in the European morning.  The nearly 20 bp pullback in the US 10-year yield from last week's highs has helped to blunt the upside pressure.  A break of the JPY127.25 area could spur a move toward JPY126.75 initially.  On the upside, the greenback may be capped around JPY128.40.  The Australian dollar has stabilized after falling from about $0.7560 four sessions ago to $0.7135 yesterday.  It needs to rise above $0.7260 now to signal a correction is at hand.  And even then, the $0.7300 area may prove to be formidable resistance.  While the Chinese yuan snapped its losing streak, it still looks fragile and the relative wide range (~CNY6.5275-CNY6.5610) suggests the market remains unsettled.  The dollar traded inside yesterday's range.  The PBOC set the dollar's reference rate today at CNY6.5590, slightly below the median projection (Bloomberg survey) of CNY6.5606.  


The ECB's Lagarde seemed clear when she appeared on US television over the weekend.  She said that the bond purchases would end in Q3 and there was a high probability of them ending early in the quarter.  With over half of the eurozone's inflation stemming from energy prices (in March energy prices contributed around 4.4 percentage points to the 7.4% headline rate, Lagarde did not seem to be in a hurry to hike rates.  Lagarde also noted that the Covid response in EMU focused on protecting jobs/employment, while in the US the government replaced lost income via transfer payments.  Hawks are pushing for an early rate hike (July), but it does not seem that a consensus has formed yet.  Others seem to want to wait for September when the forecasts are updated.  The swaps market has priced in about a 20 bp hike in July and another 55 bp before the end of the year.  This seems to be aggressive. 

While the Fed's balance sheet was expanded primarily through asset purchases, the ECB's balance sheet also grew by extending loans.  The TLTROs amounted to around 2.2 trillion euros.  The last of the loans expire in March 2024, but banks are thought likely to repay early.  Some suggest a trillion euros could be repaid in later this year and into early 2023.  

Hungary is expected lift its bank rate by 100 bp today for the second consecutive month.  If delivered it would stand at 5.4%.  The central bank appears to be trying to close the gap between the bank rate and the one-week deposit rate, which become the key rate.  It stands at 6.15% and is expected to be raised later this week by 30 bp.  

The euro dipped below $1.07 yesterday for the first time since March 2020 and today it fell deeper into the $1.06 territory.  The low in late Asian/early European turnover was slightly below $1.0675.  It has caught a little bid in late European morning turnover, but the immediate cap looks to be around $1.0725, where an 815 mln euro option expires today.  Recall that the low set in the early days of the pandemic was near $1.0635.  Sterling is also struggling to stabilize after yesterday's plunge that took it briefly below $1.27 for the first time since September 2020.  The pound has risen in only one session of the past nine counting today's losses.  A convincing break of $1.27 targets the $1.25 area.


There is a full slate of US economic reports today.  March durable goods orders and shipments may help economists fine-tune Q1 GDP forecasts.  The first official estimate will be released at the end on Thursday.  House prices (February) and new homes sales (March) are also due.  The Conference Board announces the results of its consumer survey and the Richmond Fed's April manufacturing survey is due.  

However, barring some shock, the data is unlikely to matter much to the Fed.  It is convinced of the economic resilience, the strength of the labor market, and that prices pressures are way too high.  The "expeditious" course, the language that several Fed officials have used, signals a campaign to bring the target rate to neutral.  While the risk of a 75 bp move is not very strong, the Fed funds market is pricing in 50 bp hikes at the next three meetings and leans strongly in that direction at the fourth meeting in September.  Separately, note the heavy Treasury issuance starting today (~$165 bln in coupons to be sold this week), and what appears to be among the busiest weeks of the year for state and local government issuance as well.  

The Bank of Canada Governor Macklem leaned against the speculation of a 75 bp hike in his testimony before Parliament yesterday.  The central bank hiked by 50 bp earlier this month for the first time in 20 years.  Macklem also seemed committed to bringing the target rate into the neutral range, which is seen between 2% and 3%.  The swaps market has the year-end target rate around 2.9%.  

Mexico reports February retail sales.  Economists (median, Bloomberg survey) expected a 0.8% gain after a 0.6% rise in January.  The data is too old to have much impact.  Mexican President AMLO has promised to unveil new anti-inflation proposals next week.  With inflation still accelerating, and the Fed tightening set to accelerate, Banxico is under pressure to hike rates more the 50 bp moves delivered at the last three meetings.  It meets again on May 12.  

The US dollar pulled back to around CAD1.2685 earlier today after peaking slightly above CAD1.2775 yesterday.  However, the risk-off mood has seen the greenback return bid and recorded the session high in the European morning near CAD1.2750.  This is just above the upper Bollinger Band.  The performance of the US stock market is arguably the number one driver of the Canadian dollar today. The greenback has forged a shelf around MXN20.16.  If that is the lower end of the range, then the MXN20.50 is at upper end.  Chinese demand for commodities is being undermined by the lockdowns and this has spurred profit-taking in the Latam currencies broadly, for which the peso sometimes acts as a proxy.  The US dollar is rising for the third time in four sessions against the peso.  The Brazilian real, which had been the market's darling fell 3.75% before the weekend and another 1.7% yesterday.  The dollar tested resistance yesterday near BRL4.95.  The next target is the BRL5.00-BRL5.02 area. 


Risk Appetites Challenged by Lavrov's Warning about Nuclear Conflict Risk Appetites Challenged by Lavrov's Warning about Nuclear Conflict Reviewed by Marc Chandler on April 26, 2022 Rating: 5
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