One swallow doesn’t a spring make, but a Volcker adjustment is on the cards

US equities were weaker Wednesday, S&P down 1.0%. US 2s10s steepened further, with 10yr yields up 5bps to 2.6%, highest in three years, 2yrs down 5bps to 2.47%. Oil fell 4.7%.

I will not dwell on the FED minutes, as Vice-Chair to be Brainard had already set the table.

After a March reprieve, the global bond market resumed its sell-off and is driving a deterioration in cross-asset risk sentiment, with global tech equities bearing the brunt of the follow-through.

Reducing the balance sheet in an environment of high inflation is a significant source of uncertainty for markets. But to a large degree, equity markets were too high despite the build-up of macro and geopolitical headwinds over the last few weeks, so this is essentially a corrective move to a more rational level.

The main concern seems to be about rates, so we could see a systematic bid return if rates manage to settle in. But if rates volatility stays high, equities could remain under pressure.

The move on US transport stocks overnight is the latest in a laundry list of smoke signals the market is sending on recession concerns. No market economist is calling for a recession with too much momentum in the economy, but the counter to that is it does not mean some of its makings cannot start to show up beforehand.

The big picture went from pricing in a definitive mid-cycle environment a month ago or so to now pricing in a late-cycle probability. Since Covid started, I’ve been harping on about the compressed nature of market cycles, and the latest adjustment took weeks versus the last time; it took a year. Another example of the brutal nature of this ticker tape and the velocity with which major pivots are getting priced.

The point is, just like the 2’s10’s inversion, while we can debate the probability of a recession and whether the Transports move is a signal for this, the viciousness of price actions has forced hands whether or not one believes in them or not.

One swallow doesn’t a spring make; still, this is starting to feel like a market fretting the Fed is behind the curve, and something like the Volcker adjustment is on the cards with that caveat in mind.

OIL

Negative catalysts were lining up overnight as oil prices slid to a three-week low. A surprising bearish to consensus build in US inventories, IEA reserve release, Covid concerns in China and a strong US dollar amid global recession fears deepened the recent oil price rout.

At the heart of the strong USD is a hawkish Fed trying to stave off inflation by driving interest rates higher to slow the US economy. In theory, that should hurt oil prices on the margin.

In addition to the enormous global reserves release, demand destruction and recession are currently the only price-lowering mechanism in a world devoid of inventory buffers. Some folks checked one or both of those boxes overnight with recessionary smoke signals dotting the horizon.

China’s omicron outbreak is spreading much faster than previous virus strains, and authorities, not ready to switch to a different strategy, are still trying to contain outbreaks by implementing strict controls. In light of that, Oil traders continue to downgrade their mainland demand forecasts.

Also hurting oil are reports The European Union will not ban Russian oil imports for now and will focus on the far easier task of cutting out less valuable coal instead, despite evidence of apparent war crimes committed by President Vladimir Putin’s forces in Ukraine.

The psychological and critical technical support at Brent Crude ( CO1) $100 could come into focus today.

FOREX

Fed Governor Brainard’s speech on Tuesday, where she mentioned the potential for “rapid” balance sheet run-off, was the catalyst for a broad USD rally.

EURUSD pushed down through the key 1.0940/50 pivot, and USDJPY managed to break up through 123.00/20. Given the current state of US interest rates via the Fed hawkishness channel, the US dollar is more apt to consolidate than correct lower from current levels.

If you look solely at equities, you’d think we were back to the ‘policy mistake’ trade. We’re not seeing that flattening/back-end Eurodollar rally that would accompany that trade. Instead, back-end Eurodollars are under pressure, and 5s30s are noticeably steeper. This US dollar rally is even more entrenched due to the fixed-income market reaction.

Higher US yields are very much to the liking of the greenback.

Eur

On the other side of the pond, there are some concerns about the outcome of the French presidential elections. For now, it looks like EURUSD will struggle to bounce.

Aud

Down under, the AUD continues to struggle after a less dovish pivot by the RBA.

The hawkish FED has taken the short-term momentum out of the move higher for now. But compounding the AUD issues is China’s very porous risk environment and the market starting to fret about global recession risk. The AUD dive into the plunge pool is exacerbated by the early onset stages of an FOMC trigger taper tantrum where demand for the US dollar could reign supreme.

From Stephen Innes, Managing Partner at SPI Asset Management