Ominous Dark Clouds

GLOBAL MARKETS

US stocks are trading lower again as stronger-than-expected macro releases are being set against a bunch of slightly weaker earnings updates.

On the growth front, investors are digesting that business sentiment and the US housing market may be finding a bottom, but rate hikes ominously that the labour market remains tight. The Philly Fed index came in at -8.9 – still in contractionary territory but much better than the -13.7 we saw a month ago.

While historically, such better growth data may have been universally positively embraced by markets. However, with inflation still running hot these days, better growth does not always induce the feedback one might typically expect in risk assets.

But the biggest concern for economy watchers overnight is consumer credit health. DFS reported that delinquency rates on credit cards rose 42bp QoQ to 2.53%.

Rising credit card defaults are typically associated with deteriorating economic conditions. Consumers increasingly place more of their financial life on credit card loans, and eventually, the interest burden leaves them less money to spend on the stuff that fuels economic expansion.

In Asia, the US recession contagion risk could hold sentiment back as investors continue to assess Japan’s monetary policy, given they are the last holdout of countries still stimulating its economy. But, as importantly, we are on the cusp of the Lunar New Year, which typically sees Asia investors dial things back, but in this day of online access, are traders and investors ever far from their mobile application?

Beyond the macro, investors are also digesting today a bunch of earnings releases that are collectively underwhelming.

BOTTOM LINE:

The risk-off sentiment that slowly permeated US trading on Wednesday continues to hang over markets like an ominous dark cloud as high valuation, an unreliable growth trajectory, and a higher for longer rate regime makes for an unstable trading environment as we progress into 2023.

If we need any reminder of a dish that is best served cold: Fed’s Brainard: “Time” and “resolve” are needed to lower inflation to 2% and need a “sufficiently restrictive” policy for some time. Still, it is “possible to cool prices without significant job loss.” The full effect of rate hikes “lies ahead.”

FOREX

Even though USDJPY is trading beta to risk sentiment, the strong yen story has been left unchallenged by the BoJ’s steady hand – and we look for markets to favour yen strength as costs of BoJ’s YCC policy continue to mount.

The Euro is trading moderately higher after the December ECB minutes reinforced the hawkish message in the post-meeting press conference. While pulling few punches, ECB’s Legarde: Inflation, “whichever way you look at it, is way too high,” ECB will “stay the course until we have moved into restrictive territory for long enough to return inflation to 2% in a timely manner”.

Since the leadership in FX is being created outside US fundamentals, not least by improved EUR area and China growth stories, the King Dollar seal of approval will continue to fade as the China economic recovery story increases pace as we move through Q1.

The MYR had a strong close yesterday as the market perceived the BNM holding pat on interest rates signalling the end of the rate hike cycle as pro-growth.

GOLD

Any day is a good day to buy gold in this environment, and not too surprisingly, with recession overburden filling the landscape amid steady state demand from EM financial institutions providing the ultimate backstop, gold was in high demand overnight even though the US dollar traded relatively range bound.

OIL

Discussions are starting to revolve around the February 5th EU embargo on Russian refined petroleum products, where one would expect Russian production to wane, given a lack of tankers to redirect oil following the upcoming embargo. While most oil market participants have fully digested China reopening at this current level of industrial and consumer consumption, the consensus is that demand will get much better once consumer shifts into high gear.

However, it is the level of demand (versus supply) which matters for commodity prices; on the back of bullish China reopening impulse and likely drop in Russian supply, oil prices could be catching an early flyer on the EU products embargo updraft.

While consensus expectations are still for Russian declines, the market is unlikely to price this scenario fully.