Mechanical correlations break down

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 USD 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 world’s central bankers are forecasting/hoping it will be. The effect will be felt throughout the world’s 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 I 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.

RBA, RBNZ in spotlight

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 USD 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 of 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.

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