Much Ado About Everything

US equities were weaker Tuesday, S&P down 0.7%. US10yr yields up 5bps to 3.93%. UK10yr gilts are down 3bps to 4.43%, but 30yr yields are up another 11bps to 4.78%.

Despite the sticker shock on 30yr Gilt yields, BoE Governor Bailey described the gilt market as “calmer” and confirmed the Bank of England (BoE) intervention would end this week: “My message to (pension) funds is you’ve got three days left” before liquidity support ends on Friday.

US equities wavered and then dropped on headlines that the BoE was stepping away, which rattled markets in an extension of this week’s risk-off price action.

I keep hearing this was all expected, but even if expected or not, cable still took it on the chin heading sub 1.10 in a straight line.

The IMF cut global growth forecasts for next year to 2.7% from 2.9% just as investors prepare themselves for the US earning season. Any hint of weaker results here due to the central bank’s aggressive policies hitting bottom lines will almost certainly cause a further sell-off. 

In line with most market participants’ views, The IMF cited tight monetary policy, the slowdown in China and the war in Ukraine as factors contributing to the change in its outlook.

OIL 

Oil is struggling on the back of the IMF growth downgrade, China lockdowns and US hard-landing worries.

Crude prices have tanked, mainly affected by concerns about Chinese demand. Covid cases are picking up in the country, and the Chinese Communist Party’s newspaper, the People’s Daily, ran a commentary saying the Covid Zero policy is “sustainable,” indicating that the country is likely to keep following it if not double down to prevent post-Golden Week Covid spreaders.

Buyers of crude oil last week hoped for a soft Covid policy pivot from China, but those hopes were crushed.

Cross-asset volatility is running relatively high again. Despite fundamentals auguring higher for oil and a rather hefty production cut OPEC backstop, any breakdown in risk assets may continue to hurt oil prices until some semblance of bottom forms in risk assets.

So, a hot CPI and even a dreary US earning season could negatively impact oil markets.

FOREX 

Outside of the BoE headline volatility around the pound, currency markets were relatively mute overnight ahead of a critical CPI and US earnings. Traders appear hedged and are likely awaiting CPI as the next catalyst before “dialling for more dollars.”

G-10

There are ample reasons to stay long safe-have dollars amid the current market fragility, but positioning is likely a factor here.

GBP

Despite earlier announcements that Gilt purchases would halt on Friday, the market seemed to be clinging to the hope that they would continue. Andrew Bailey, BOE Governor, put an end to this speculation and made it noticeably clear investors should prepare themselves for Friday and the conclusion of bond buying by the BOE. Hence GBPUSD is trading sub 1.10 into the Asia Open as traders position for heightened volatility to pick up as the BoE steps aside.

Bailey knows precisely what pension funds have on the books, so I doubt the BoE would step aside if they knew doing so would cause a catastrophe.

And at least they did not allow the rug to get ripped from under pension funds. But stepping away as the buyer of last resort is not great for risk or sterling.

At the end of the day, UK economic issues, fiscal irresponsibility, and a hawkish Fed will linger. So do not be surprised by a pickup in GBP volatility and for a continued move lower as well.

Indeed, The Old Lady of Threadneedle Street faces a daunting task on November 3 in raising rates enough to deal with the UK inflation threat without causing global tumult.

Asia FX

Markets are exceptionally long dollars, which is probably a good thing as it could temper demand for fear of a US data flow long USD squeeze. It is going to happen; it always does.

Mixed signals from the PBoC could keep local traders honest ahead of the Party Congress. On the one hand, we had a higher USDCNY fix. In contrast, on the not-so-invisible hand of verbal intervention, the PBoC reiterated it would prevent significant fluctuations in exchange rates. From my chair, it feels more than smoothing currency moves rather than warning FX traders about a possible line in the sand.

Look for Asia FX to trade very beta to CNH ahead of the Party Congress starting October 16

GOLD 

Gold is having a whippy time, torn between growth and inflation risks, higher real rates, and the strong dollar. But there continue to be lots of uncertainty around US economic growth, inflation and hence the path for US rates. Still, gold’s upside potential is significantly more significant than the downside risks, given that the odds of a recession outweigh those of a soft landing. And in a more severe recession scenario, where the Fed would be forced to cut rates substantially, gold could trade back over $2000 in the coming years.

Originally published by Stephen Innes, Managing Partner, SPI ASSET MANAGEMENT