Risk Premiums Vanish and Reappear

Risk Premiums Vanish and Reappear

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

 

Concerns over Evergrande and international contagion effects vanished overnight in a session that was notable for the unwinding of risk premia in the US Dollar and gold. Fed Chairman Powell said the risks would be contained in China with the press running stories today say the government had apparently told local governments to prepare for an Evergrande collapse.

 

None of that seemed to matter however as Wall Street hit the buy button until it broke with US stocks rallying powerfully. In another unusual development, despite markets being “comfortable” with the impending Fed taper which likely starts at the year end, US bond yields also rose substantially across the curve overnight. Clearly some parts of the market are more comfortable than others. We have, of course, been led down the higher US yield path before, only for it to be a box canyon. If a rise in US yields is sustained though, it will be interesting to see how long the Tina-massive can keep forcing equities higher.

 

The US build back better bill and debt ceiling saga continue to rumble along in the background, gone but not forgotten. I have a feeling that the passage of both is a story with more still to give. The US Budget Committee is meeting this weekend regarding the $3.50 trillion bill and developments on that front, or the debt ceiling could yet cause some Monday morning volatility. That might explain gold’s recovery in part this morning. We also have a veritable crowned bar of Fed speakers to come today, including Chairman Powell.

 

This weekend also sees the German federal election. Although there is much noise surrounding the outcome, the possible coalition permutations are labyrinth and will almost certainly not be clarified on Monday, or next week. The election may be good for some intra-day volatility in the Euro on Monday morning Asia time, but not much else.

 

The PBOC has injected another CNY 120 billion via the 14-day repo again today, and this time, it appears to be soothing Evergrande nerves. That is despite offshore US bond holders reporting that they have not received their coupon payments, due yesterday, and reports of missed salary payments at their EV subsidiary. Gold, once again, appears to be the preferred method of hedging that weekend risk with Asian investors today.

 

The Turkish Lira (TRY) become TRY-my-patience with investors overnight after the central bank unexpectedly cuts rates, despite inflation being near 20%. USD/TRY rose 1.22% to 8.7700 on the latest dose of Erdogan-omics and has 9.00 written all over it once 8.800 breaks. In contrast, a slightly hawkish tone to the Bank of England p0olicy decision saw Sterling leap in overnight trading as markets rushed to price in an early 2022 rate hike.  

 

Japan’s Core Inflation rose to, errrr, 0.00% this morning, with headline Inflation holding steady at -0.20%. This appears to be a cause for celebration in Japanese markets who take what they can get after 20 years. Jibun Service Flash PMI for September also rebounded to 47.4, still contractionary, but less so than previously. The Nikkei is on fire today after Japan returned from holiday so even less bad news would be good news in a market like this.

 

Singapore Industrial Production should recovery into positive territory later today, but it, and Malaysian Inflation will be of only passing interest to local markets, myopically focussed on developments in China. With an election on Sunday, Germany’s IFO Business Climate data today is likely to meet the same fate. US markets are in buy everything mode as the week closes, and only some hawkish words from Mr Powell or his fellow Fed Presidents is likely to make the Tina’s turner to the downside.

 

Asian equities shows a modest North/South divide.

 

Fading Evergrande concerns and remarks from Powell about the high bar to rate hikes left New York in taper-be-damned mode overnight, with stocks rising powerfully. The S&P 500 rose by 1.27%, while the tech-heavy Nasdaq recorded a 1.04% with the cyclical-heavy Dow Jones leaping by 1.47%, probably being the most sensitive of the big three to future US rate hikes. The rally was even more impressive given that US yields also firmed notably overnight, reinforcing that you ignore buy-the-dip at your peril.

 

Asian markets are having a very mixed day with SU futures maintaining their gains. There is a real North/South divide in Asian markets today. Japan is playing catchup and then some, after returning from holiday. The Nikkei 225 has powered 2.0% higher with the FOMO gnomes, like New York, out in force. The Kospi, by contrast is unchanged, perhaps weighed by North Korea refusing to engage with President Moon’s call to officially end the Korean War. Taipei, by contrast, has leapt 1.0% higher.

 

On mainland China, the PBOC’s dollop of liquidity today, totalling CNY 120 billion, appears to have settled Evergrande nerves. The broader Shanghai Composite is flat but the narrower Shanghai 50, containing soe behemoths, is up by 0.60%. The CSI 300 has also rallied by 0.55% while Hong Kong is flat. China markets look keen to engage in a contained Evergrande story, but just can’t pull the trigger completely. Of the three main indices, Hong Kong is the most vulnerable as Evergrande is listed there. The nascent recovery in China markets remains at the mercy of their being no new negative Evergrande headlines.

 

Further south, ASEAN markets are maintaining a very cautious stance despite the impressive rallies in the US overnight. Clearly weekend US political and Evergrande risks are causing a sense of cautious pragmatism, and rightly so. Singapore is down 0.15%, with Kuala Lumpur falling 0.50% and Jakarta remaining unchanged.

 

Australian markets are also in the red although there appears to be a lack of concrete drivers behind the negativity. Reports that China may be looking for more ways to cap commodity prices and a more pragmatic view to Evergrande may be weighing on sentiment. The IMF downgraded its growth forecast for Australia for 2021 but upgraded its 2022 one. The ASX 200 and All Ordinaries are limping into the weekend down 0.40%.

 

Europe piggy=backed the US higher overnight, but with a mixed day in Asia and plenty of weekend risk ahead, not least the German elections, I expect European markets to open flat to slightly negative this afternoon. US markets will be at the mercy of the big line-up of Fed speakers and debt ceiling/spending developments.

 

The US Dollar haven premium vanishes.

 

Overnight markets were unusual in that US yields jumped higher, as did stocks, but the US Dollar sunk by quite some distance. The dollar index tumbled 0.38% to 93.08, unwinding the previous days gains. Some have put it down to Powell’s post-FOMC comments that the bar to rate hikes is high, but I believe his comments saying Evergrande fallout is mostly limited to domestic China caused New York to unwind the haven premium built in over this week. A rate hike by Norway, and seemingly hawkish tones from the Bank of England may also have added headwinds, with the Pound rallying, dragging the Euro higher. Notably, the risk-correlated Australian and New Zealand Dollars also had big rallies overnight, further supporting the risk-premia unwind thesis.

 

GBP/USD leapt 0.76% higher to 1.3720 after the BOE statement caused investors to bring forward rate hike expectations to early 2022. I suspect the market may have overdone the rally with GBP/USD tracing out a double top at 1.3750. If clearer heads prevail and markets decide to head into the weekend with caution, GBP/USD could reverse course. Support at the head and shoulders neckline near 1.3600 remains critical support. EUR/USD also rallied, climbing 0.43% to 1.1740 where it remains sharply unchanged in Asia. With a German election this weekend, EUR/USD is likely to run out of steam ahead of 1.1800, and failure of 1.1650 will signal a large directional downside move.

 

With Evergrande risk premia subsiding, the risk-centric AUD and NZD both rallied impressively overnight. AUD/USD rose 0.77% to 0.7295 and NZD/USD rose 0.95% to 0.7060 where both remain in a sideways Asian session. 07220 and 0.6980 remain important support levels, with failure signalling potentially 200 points of losses. The ability of the antipodeans to maintain gains rests on whether risk sentiment remains positive. Both will probably head south again on negative China or US headlines.

 

The PBOC, once again, announced a neutral fix for USD/CNY this morning, with the PBOC liquidity injection not flowing through to Yuan weakness. That continues to be a supportive factor for Asian currencies which rallied broadly overnight. However, the rally was more due to a weaker US Dollar and not change in sentiment towards the region and its vulnerability to fallout from China. As such, and swing in sentiment to the downside will probably see the overnight gains unwind just as quickly.

 

Oil’s rally continues.

 

The fall in US crude inventories, surging natural gas prices, OPEC+ production struggles, a slow return of pre-Ida US production, and most importantly, a weaker US Dollar, continue to support oil prices which had another impressive overnight rally. Brent crude and WTI jumped 1.80% higher to $77.25 and $73.25 a barrel.

 

With more negative stories about the impact of gas shortages coming out of the UK and Europe each day, and with Asian buyers bidding up spot gas cargoes, oil prices are likely to remain firm as a gas substitute. Any large sell-offs due to speculative zeal are likely to be very short in duration and followed by an equally aggressive bounce. Oil prices have crept 10 cents higher in Asia, and as usual, Asian buyers are reluctant to chase prices higher, although I expect them to be out in force on any large price dips.

 

Brent crude now has $78.00 in its sights which opens the path to a test of $80.00 a barrel. Support is at $77.00 and $76.10 a barrel initially.  WTI has resistance at $74.25 and $75.50 a barrel. Support appears at $73.00 and $71.70 a barrel. One note of caution for the oil rally is that the relative strength indexes (RSIs) on both contracts are approaching overbought levels. Oil may trade sideways over the next few sessions to consolidate gains, rather than immediately power to new highs from here.

 

Risk-premia unwind torpedo’s gold.

 

Gold prices slumped overnight despite the US Dollar also tumbling as investors hurriedly unwound Evergrande risk premia after soothing words from Jerome Powell. Gold slumped by 1.45% to $1742.00 an ounce. In Asia, weekend risk hedging by local investors has seen gold rise 0.50% to $1751.50 an ounce.

 

Much of gold’s recent rally has been built of increasing fear gauges led by our friends in China. It is unlikely that the Evergrande saga is past “peak-fear,” and we are probably only one headline from another haven rally. As such, gold is not likely to capitulate lower this week. Notably, support at $1740.00 an ounce held fast overnight. However, unless Evergrande turns into a contagion mess, gold is unlikely to gain enough momentum to recapture $1800.00 an ounce.

 

I continue to believe that any gold rally this week to run out of momentum in the $1780.00 zone, and that $1740.00 an ounce continues to support. A daily close below $1740.00 signals further losses to $1680.00 next week.

 

 


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

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