You don’t bring a MIG-21 to a gunfight

Prepared by Jeff Halley, Senior Market Analyst

You don’t bring a MIG-21 to a gunfight

 Geopolitical tensions ratcheted higher yesterday with Pakistan F-16 fighters shooting down an Indian MIG-21 over Kashmir and capturing the pilot after the Pakistan aircraft had themselves crossed into Indian airspace and conducted retaliatory airstrikes. It’s likely India was caught off guard, failing to anticipate Pakistan’s response to their air raid earlier in the week. The MiG-21 is an obsolete 1950’s vintage Soviet fighter, and you most certainly do not send them up, outnumbered, to intercept modern American F-16s. As the saying goes, you don’t bring a knife to a gunfight.

With politicians on both nuclear-armed sides making soothing comments overnight, the trick will be finding a mutually face-saving path to de-escalate the situation. Of course, this will be much easier said than done, and the potential for hostilities to ratchet higher remains very high.

Almost unnoticed, Pakistan also closed their entire airspace, which is part of the primary aircraft “superhighway in the sky” for flights between Asia and Europe. The knock-on effects are already being felt with some Singapore Airlines’ European flights adding refuelling stops and Thai Airways cancelling many European-bound flights for example. Many airlines are scrambling to find alternative – albeit more expensive – routes between Asia and Europe as a result. If escalating tensions were to force a closure of Indian airspace as well, the disruption would be enormous, and European and Asian airline stocks would be the first to feel the heat.

Elsewhere, Federal Reserve Chairman Powell’s second day of testimony on the Hill passed without incident as he signalled patience and the end of Fed balance sheet reduction this year. US Trade Representative Robert Lighthizer told the markets a US-China trade deal hasn’t been agreed yet bringing some reality back to euphoric markets post-Trump’s tariff extension, despite the fact Lighthizer also announced both sides had agreed on an enforcement process.

The markets were pinned by ebbs and flows as investors elected to stay on the sidelines until the bigger picture clarified. Wall Street limped to a nondescript close, with the S&P closing down a miserly 0.1% and the US dollar broadly steady against most G7 and regional currencies.

The day will become more interesting in Asia, with the release of the official China Manufacturing PMI at 0900 Beijing time, and median forecasts suggest 49.5. A miss lower could see local stocks and currencies come under pressure. The Trump-Kim summit continues in Vietnam, but realistically we expect nothing market-moving to come from it unless the President takes to social media.

The US GDP will be the highlight of the day, with median forecasts at 2.20%. A miss either way will see increased volatility in stock and currency markets as traders reassess interest rate forecasts.

FX

GBP continued its march higher, rising 100 points to 1.3350 in intra-day trading before closing lower at a still-positive 1.3300. The markets are pricing in that fact that a Brexit no-deal appears doubtful, while it seems likely we’ll see an extension of Article 50 following PM May’s outline of Parliament’s voting options overnight. I won’t get into the nitty gritty but to paraphrase Robert Lighthizer, a deal isn’t done yet. Being long sterling at these lofty levels remains a potentially perilous trade.

Regional markets will follow North America’s lead and open quietly overnight awaiting the China PMI data. A big miss to the downside could see regional currencies come under pressure.

Equities

Regional bourses will await China’s PMI data and, much like currencies, may slip into the red on a downside miss. China stocks are also expecting an announcement this week regarding an increase in weighting from 0.7% to 2.8% in the MSCI Emerging Markets Index. China stocks could rise if the announcement is made, potentially resulting in a wave of buying from international passive index funds.

Oil

Official US Crude inventories fell a massive 8.65 million barrels overnight, pushing Brent up 1.90% to USD66.60 per barrel and raising WTI 1.80% to USD57.00 a barrel. Plunging shipments from Saudi Arabia are keeping the squeeze on US refineries starved of Venezuelan crude. For now, OPEC’s production cut strategy is continuing to work, and price action is positive on both contracts – a theme that should flow into Asian trading.

Gold

Gold fell 10 dollars to USD1,320.00 an ounce overnight as stale long positioning and a lack of clarity on the macro-economic front took its toll. Traders should beware of escalating tensions between India and Pakistan, which could cause gold to move higher, perhaps rather quickly. In the bigger picture, despite gold’s overnight set back, the longer-term technical view remains positive.

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