Markets
A lower-than-expected US inflation print and a softening of Covid policy in China continue to lead risk assets.
China remained a hot topic with support for the property market via 16 measures and an RMB250 bn bond sale program support reaffirming the view that property sales and starts should stabilize in the next few months and rebound sequentially.
With improved clarity on the direction of covid policy and some potential easing in the US Fed policy rate in 2023, the upbeat narrative in global markets is building.
Whether such a positive outlook in China holds or not remains to be seen given the numerous fits and starts in China though foreign buying in Chinese equities continued in earnest overnight with even greater flows on the Northbound Connect, surpassing Friday’s very elevated net buying
Another Federal Reserve governor flags a likely slowing of the rate hikes, which suggests a move to a 50bp hike in December is locked in. According to Reuters, Lael Brainard says it is probably appropriate to “soon” move to a slower hike pace. The softer CPI inflation last week suggests core PCE might also slow and that goods inflation within CPI is finally starting to turn.
If a sea change has arrived from an inflation perspective, given the length of shorts in the market, a significant amount of short cover will continue to drive flow among Hedge Funds.
The combination of underweight equity positioning & the short momentum unwind, given Tech’s more significant weight in SPX, could continue to drive risk higher. The magnitude of the move in the market neutral factor suggests there’s more unwind to go here, yielding more tactical upside risk to SPX.
Rather than chase equities higher, cagey investors are waiting to set shorts – I think the window for highs is from now to the Thanksgiving day weekend – so time to start piecing in the downside now.
OIL
Oil investors were likely too optimistic about China’s reopening story. Given the rise in Omicron cases ahead of flu season, I would not be surprised to see another major Chinese city implementing lockdowns again. Suggesting a meaningful reopening, which is definable as a permanent end to snap lockdowns and other domestic mobility curbs, could still be 9 + months away.
While China’s policy pivot will help limit downside fears of a protracted economic slump, it does not eliminate the immediate demand hit from the current snap lockdowns.
Although broader markets are looking through lockdowns, mobility restrictions still negatively impact oil prices trading here and now.
FOREX
Although my book is finally at risk-neutral in FX land, what a long dollar-strange trip it’s been because reflecting on this year, it’s certainly been one for the record books. However, as 2023 draws close, the markets are poised to head into a new phase as the dollar peaked
The Fed’s relentless push towards tightening and fears of a US hard landing have diminished. And China’s uncompromising pursuit of zero COVID has given way to more progressive policy evolution – related to loosening covid restrictions and measures to support the real estate market – helping drive USD selective downside. And as the US dollar safe-haven premium continues to erode, USD dollar selling should turn universal.
With the dollar “Volker Risk” moving in reverse and the Chinese Politburo shifting towards a “living with COVID” approach, USDCNH should trade tangentially to the reopening narrative and eventually hit 6.75 in Q1 next year as interest rate differentials begin to erode in the CNH’s favour as the mainland economy picks up and CGB yields move higher. I think USDCNH is the simplest and cleanest way to express a view on the reopening, but given the Yuan’s G-10 magnetic attraction in a scenario where China growth will be the driving factor of CNH strength, overlaying with long G-10 commodity currency exposure should be the second-order of business.
Of course, none of the above developments give the all-clear on global inflation and geopolitical risks. But they realize an exceptional concurrent compression of the risk premium that has driven dollar strength this year as two of the most significant macro and postive USD catalysts give way.
Published by Stephen Innes, Managing Partner, SPI ASSET MANAGEMENT
