Mechanical Correlations Break Down

Mechanical Correlations Break Down

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


It looks like we are in for a bit of a chop-fest in financial markets for the rest of the week, until Friday’s US Non-Farm Payrolls gives the street some clarity on the Federal Reserve taper. Asian equity markets have followed US markets South today, with US fiscal policy encompassing the debt ceiling and the soon to be trimmed $3.5 trillion spending plan fraying nerves, although oddly, US yields edged higher overnight. Non-transient inflation leading to interest rate rises bashed technology stocks overnight as well, although I’d argue the world being long to the gunnels of them since March 2020 is probably the underlying driver.


OPEC+ was probably the biggest cause of volatility, as the grouping refused to bow to pressure from the likes of the United States and India to pump more oil. OPEC+ left their 400,000 bpd per month increases unchanged. Various reasons were promulgated including fears of fourth wave shutdown, a valid point, the rise in prices being a natural gas and coal issue, not oil. Again, a valid point. And that seasonal factors in Q4 usually temper oil consumption anyway, a marginal point that unsurprisingly, came from Russia.


Whichever way you cut it; it was bullish for oil which surged to seven year highs. Rains in China and India appear to be affecting coal mining there deepening the supply woes of both giants and there just isn’t enough natural gas on the spot market to satisfy demand. Europe could probably alleviate its situation if it bowed to Russian requests and got on with certifying Nord Stream 2. But with winter on the horizon in the Northern hemisphere, long-term weather forecasts are going to get a lot of attention this year.


Assuming the energy squeeze is the new normal, it is hard to see transient inflation being as transient as the worlds central bankers are forecasting/hoping it will be. The effect will be felt throughout the worlds supply chains. Tightening monetary policy in response to inflation not being as transient as hoped isn’t really an option for most countries. This isn’t a wage/price spiral. It is extraneous inputs to which monetary policy will have limited impact. The best solution to high prices is high prices, although citizens going cold due a combination of poor government planning/incompetence/stubbornness/strategic naivety/ intellectual arrogance/political stupidity/scare-mongering media, is inexcusable.


That doesn’t mean that central banks will do nothing and perhaps the most likely response will be tapering quantitative easing. That might explain why the US Dollar headed lower overnight, despite risk sentiment rising, energy prices rising, US yields rising and stock markets tumbling. Notably, the Eurozone and Britain could do just that while leaving interest rates at zero. Even Japan could, wait, please pause momentarily while Japan-slap myself back to reality. Realistically, though, it is the Federal Reserve that is on the taper track to start tapering in December, as long as the US Non-Farm Payrolls this Friday play the game and print at 500,000 or above.


Given the combination of US fiscal uncertainty, shaky stock markets, ballooning commodity prices, QE tapering by the Fed pushing up US yields, and the fact that the world’s energy markets are mostly priced and transacted in US Dollars, the retreat of the greenback is odd indeed and I believe temporary. That trend appears to be reasserting itself already in Asia today.


One central bank that won’t be moving rates today is the Reserve Bank of Australia. The RBA announcement later this morning should be a non-event leaving rates at record lows while retaining the right to fence-sit on adjusting monetary policy depending on how the game plays out. The Reserve Bank of New Zealand tomorrow will almost certainly raise rates by 0.25%, but it will be the statement that matters. Against the background of Covid-19 jumping the fence and a government swing to “living with it,” will this be a dovish hike, or a hawkish hike. The RBNZ has itchy trigger fingers, but I don’t rule out some RBA-style fence sitting which will take the edge of any NZD rallies.


Mainland China remains on holiday today but another smaller China developer, the ironically named Fantasia missed repaying a $205.7 million bond yesterday. Thankfully, the counterparty is another China property giant, Country Garden, so the fallout should be limited. It probably isn’t what was envisaged when economists and sustainability gnomes talked about the circular economy though. Evergrande shares, to my best knowledge, remain suspended in Hong Kong ahead of an announcement of a pending sale of another part of the carcass. For today though, China’s property nerves have been subsumed in the noise from the US and the post-OPEC+ disappointment.


Similarly, that same noise has drowned out any response in Japanese markets to Economy Minister Yamagiwa’s announcement that he is preparing an economic package before the year end. Some sort of box of fiscal goodies was expected and had been priced into the Nikkei 225 after former Prime Minister Suga announcement his intention to step down. After 20+ years of such sequels, it could be that viewer fatigue is also setting in.


Finally, RBA aside, the data calendar remains mostly second tier today. Sentiment is driving markets, as it will until Friday. The calendar is littered with European Services and Composite PMIs, but it is the US ISM Services PMI and associated sub-indexes that will garner the most attention. A number above or below 54.50 will elicit the usual short-term taper/no-taper market reactions.


Asian stock markets follow Wall Street South.


A post-OPEC+ spike in oil prices, US fiscal fears, notably the debt ceiling, US political infighting, growth fears, inflation fears, rate fears; take your pick overnight as it sent Wall Street plummeting. Technology giants, in particular, took a beating, justified by their sensitivity to potentially higher US interest rates resulting from a Fed taper or a US government debt default. I am more in the camp that the introduction of more two-way pricing risks is a new reality for most investors after a rampant 18-month bull market pumped up unlimited free central bank money.


Whatever it was shaking Wall Street, the session was ugly with the S&P 500 tumbling by 1.30%, the tech-heavy Nasdaq slumping by 2.14%, and the Dow Jones falling a comparatively modest 0.93%. Some short-covering has lifted Nasdaq futures 0.25% higher in Asia, suggesting a lot of the selling overnight was fast-money speculators, while S&P and Dow futures remain unchanged.


The negative sentiment has spilled into Asia, especially Japan, whose stocks had been on an equally fiscal-stimulus-is-coming speculative bull market of late. The Nikkei 225 has been pummelled, falling by 2.40% today, while the South Korean Kospi is 1.70% lower. Mainland China markets are closed but the Hang Seng is showing surprising resilience, being only 0.05% lower. Hopes that more Evergrande asset sales are in the offing could be lifting sentiment temporarily there.


Regionally, Singapore has fallen by 0.90% with Taipei surprisingly, climbing 0.10% and Kuala Lumpur by 0.20%, likely supported by rising oil prices. Jakarta is 0.30% lower with Bangkok down 0.15% and Manilla by 0.35%. Australian markets are lower also ahead of the RBA policy decision, the ASX 200 and All Ordinaries down 0.45% and 0.85% respectively.


As ever, the Asian markets subject to the most speculative zeal and with more tech-heavy makeups have taken the biggest hits today. The more resource and growth-centric ASEAN markets being relatively sheltered by comparison.


I am expecting global stock markets to wildly chase their tails this week, lost on the noise and swings of market sentiment until, hopefully, the US Non-Farm Payrolls restores some directional order on Friday. The game of blink surrounding the mid-month debt ceiling legislation deadline is introducing a heightened uncertainty. Although if a cliff is driven off, the Fed will surely be there to open the spigots once again, never bad for stock markets. I’m not sure when both major parties in the US decided their job was to deliberately sabotage each other’s efforts on every level, instead of being reasoned opponents, but there we have it.


I’ve called it before and been wrong each time, but the charts on the S&P 500, Nasdaq and Dow Jones have all made multi-day breakdown below their support lines that data back to March 2020. That doesn’t mean we are facing Armageddon, even 10-15% falls still leave all three in longer-term bull markets. And some two-way price action is long overdue, if only to remove the cancer of the meme stock. The breaks lower could well be false, and I for would prefer to see some weekly closes below the 200-day moving averages before really calling for deeper corrections. We are not there yet.


The US Dollar falls overnight once again.


If anyone needed evidence that markets are chasing their tails at the moment, it would be currency markets. The US Dollar fell once again overnight even as oil prices surged, and uncertainty increased on a number of fronts. Even more odd was that US yields actually edged higher overnight, a rare divergence these days. The US Dollar index fell 0.30% to 93.80.


Normal service appears to be resuming though in Asia, with the dollar index surging 0.20% higher to 93.98. A weaker US Dollar is inconsistent with heightened event fears in the markets, a Fed taper, or still surging energy prices, almost all of which are priced and transacted in US Dollars. Asia seems to agree, and it is notable that energy-price-taking Asian currencies are mostly lower today.


Overnight EUR/USD failed ahead of resistance at 1.1650 and has sunk back to 1.1600 in Asian time. A noisy 1.1550 to 1.1650 range beckons until Friday. Similarly, GBP/USD failed ahead of critical resistance at 1.3610, retreating to 1.3595 in Asia. GBP/USD looks the more vulnerable of the two. With US yields only slightly higher overnight, USD/JPY did nothing, edging up 10 points to 111.10 today.


Rising fear sentiment in Asia has pushed AUD/USD and NZD.USD lower, unwinding some of their overnight gains. The RBA, as I write, has left rates unchanged with no notable deviations from the previous statement. AUD./USD has fallen 0.20% to 0.7270 and has failed numerous times to recapture 0.7325 over the past few days. NZD/USD is 0.40% lower today to 0.6940. With Covid-19 cases outside Auckland edging higher, and the government abandoning its Covid zero strategy, Kiwi remains vulnerable. If the RBNZ doesn’t come to the party tomorrow and hike, or if global risk sentiment worsens, NZD/USD could well retest 0.6850 and 0.6800 this week.


In contrast to US Dollar weakness versus the major currencies, Asian currencies have spent overnight and today on the back foot. The deteriorating risk atmosphere in the US, and surging oil prices were never likely to be Asia FX’s friend and notably, USD/INR rose 0.60% overnight, climbing 0.10% to 74.585 today. With a high exposure to energy prices across the board, and thus a need to by more Dollars as they rise, the USD/INR remains on course for a retest of 75.000, especially if the RBI holds policy unchanged on Friday.


Elsewhere, USD/PHP continues to find mysterious resistance each time if nears 51.00 and I suspect the BSP is selling Dollars up there. High domestic inflation, an economy in recession a rising US Dollar and energy prices will be no friend to the Peso eventually. Offshore USD/CNH is also rising as is USD/KRW. Only the energy-associated MYR and IDR are showing some resilience, holding at 4.1800 and 14,250.00 for now. You get the feeling it is only a matter of time before both resume their sell-offs. As price-takers, Asia FX is vulnerable to energy price inflation and that’s the nub of it.


It is hard to reconcile a weaker US Dollar with the goings on in the world, and I expect that reality to reassert itself this week. A stronger US Non-Farm Payrolls will lock and load the Fed taper and be another tailwind for US Dollar strength. The rest of the week, however, is likely to be characterised by no small amount of intra-day volatility as the street chases its tail on daily sentiment swings ahead of the Friday data.


OPEC+ sends oil higher.


OPEC+ held fast to their 400,000 bpd per month production increase schedule at their meeting yesterday with various excuses, official and unofficial promulgated, including a Covid 4th wave, seasonal factors, natural gas distorting oil prices and giving “certainty” by not responding to short-term market inputs. Whichever and whatever you chose to accept, the net result sent Brent crude to 3-year highs.


Brent crude surged higher by 2.75% to $81.30, and WTI charged 2.50% higher to $77.60 a barrel. With Mainland China still away, trading has been muted in Asia. Both contracts have made modest gains, Brent rising 0.30% to $81.60 and WTI rising 0.25% to $77.80 a barrel. Natural gas prices have risen by 1.0% in Asia this morning, and with weather-related coal production disruptions likely in India and China, it is hard to construct a bearish case for oil. In all likelihood, buyers will be lining up on dips now, meaning any sell-offs, no matter how violent, will be short-lived in duration. Winter is coming.


Brent crude will find plenty of support on dips to $79.00 and $76.00 a barrel and after clearing the overnight high around 82.00, should have the 2018 high around $87.00 a barrel in its sights. WTI will be well supported on dips to $75.00 a barrel with resistance at $78.50. The charts suggest that a rally to $84.00 a barrel is not out of the question once $78.50 is convincingly overcome.


The only caveat on further immediate rallies is that the relative strength indexes (RSIs) on both contracts have entered overnight territory. That may signal some daily pullbacks this week but does not change the underlying bullish case for oil.


Gold struggles for direction.


Gold rose 0.45% to $1769.50 overnight as the US Dollar weakened. However, a rising US Dollar in Asia has seen gold give back all those gains, falling by 0. 62% to $1758.50 an ounce. It is clear that now, gold remains mostly an inverse US Dollar play, with a dollop of risk-hedging buying providing occasional support.


I am expecting gold to find support on dips to $1750.00 this week, as investor inflation and US fiscal fears increase. Ahead of the Non-Farms I am looking at a choppy $1750.00 to $1785.00 range. None of that will save gold if the US Non-Farm Payrolls are firm on Friday, putting the Fed taper, and higher US yields back in play.


Gold has support at $1750.00 followed by a double bottom at $1722.00 an ounce. Initial resistance is at $1780.00/ $1785.00 an ounce. Gold will face far more formidable resistance in the $1800.00 to $1808.00 an ounce zone, technical resistance and housing the 100 and 200-day moving averages.


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

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