EMEA Morning Briefing: Stocks to fall again as Treasury yields climb further
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The surge in Treasury yields will likely hit European stocks again on Wednesday. In Asia, there were widespread losses for equities, with Treasury yields and oil extending their rallies. Elsewhere, the dollar and gold fell slightly.
European stocks face deeper losses on Wednesday as bond yields continued to rise and investors worry about whether the Federal Reserve will raise interest rates faster and more aggressively than expected.
All three major U.S. stock indexes closed sharply lower on Tuesday, with losses led by the Nasdaq, as the high-growth tech sector fell under pressure from rising Treasury yields and investors began to digest a busy week for corporate earnings. Asian markets followed the losses early Wednesday.
“We are looking at a year in a totally different monetary environment,” said Sam Solem, portfolio manager for Intrepid Private Wealth. “Everyone is trying to digest what three to four Fed rate hikes look like this year.”
Yield-sensitive technology and other growth stocks weighed on the Nasdaq, but “all is not gloomy there, as mergers and acquisitions activity is going well, and ongoing vaccination efforts by governments Westerners mean the slowdown in US and global data could be short-lived,” ThinkMarkets analyst Fawad Razaqzada said in a note.
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BHP’s iron ore output was better than expected, but its copper, metallurgical coal and thermal coal output all fell short of expectations, RBC Capital Markets said.
“BHP’s result is likely to lead to modest consensus downgrades, although lower copper output from SGO [Spence Growth Option] could help fix prices in what remains a very tight underlying market,” RBC said. She added that with iron ore generating such a large portion of BHP’s cash flow, the impact of its Q2 operational report should be relatively muted.
Attention will quickly turn to votes on the miner’s stock unification, which are due to take place on Thursday. RBC expects the plan to pass, “but we also point out that there is a potential asymmetric advantage in maintaining the Limited line over the PLC line if the votes do not pass.”
Fund managers have drastically reduced allocations to tech stocks and shifted to banking stocks as the prospect of higher interest rates and quantitative easing is seen as the main tail risk for markets, according to Bank of America’s monthly fund manager survey for January.
Fund managers reduced their net overweight in tech stocks to just 1% in January, the lowest level since December 2008, while the net overweight allocation to banks rose to 41%, approaching the all-time high of October 2017, BofA said.
“Investors have become more cyclical [i.e. banks, materials] in relation to history while [they are] very underweight assets that are vulnerable to rising interest rates.”
Rumors of a 50 basis point rate hike continue to ripple through the markets as the Fed makes its hawkish turn aimed at lowering inflation.
Bill Nelson, a former senior central banker now with the industry group Bank Policy Institute, said the Fed “needs to prepare the public for the possibility of a 50 basis point tightening in March.” He said the big move might have to happen because the Fed is lagging on getting inflation under control, and that might have some value in reshaping market expectations toward a serious policy stance to bring inflation down.
Investors expect inflation to fall in 2022 and not rise, according to BofA’s January survey of fund managers.
A majority of investors surveyed said they thought inflation would be transitory and a net inflation of 48% predicted lower inflation, the highest since 2009. Meanwhile, investors are favoring commodities , with the survey showing a record net 31% overweight in commodities, with the net overweight in equities also reaching 55%.
Investors are now more overweight equities relative to bonds than at any time since February 2011, BofA said. Investors are moving from credit to commodities, from growth to value, from technology to banks, but not from stocks to bonds, or from developed markets to emerging markets.
Turkey’s pursuit of the “new economic model”, embraced by President Recep Tayyip Erdogan, will likely mean low real interest rates and a still weak lira, but also a shift towards capital controls, Jason Tuvey of Capital Economics.
Erdogan seeks to boost exports, investment and employment by maintaining low interest rates and a competitive local currency. But it’s a “dangerous policy mix,” Tuvey added.
Sharp falls in the pound risk entrenching inflation at very high levels, while fiscal and banking risks increase, with large dollar deposits posing a particularly big risk, he says. In Tuvey’s view, two scenarios could trigger a return to orthodox politics: re-emerging tensions in the banking sector and a major shift in the political landscape.
The dollar fell slightly in Asia but retained most of Tuesday’s gains after Treasury yields rose.
The yen also weakened against most G-10 and Asian currencies on expectations that interest rates in Japan could remain low while those in other countries could rise. The Bank of Japan is unlikely to start tightening monetary policy in the foreseeable future, despite announcing a change in its inflation risk assessment on Tuesday, the ABC said.
Consequently, nominal rate differentials between the US and Japan may support further USD/JPY gains, with the CBA forecasting the currency pair to rise towards 120.50 by the end of 2022.
China’s central bank could take more actions, including currency purchases, to limit yuan appreciation, Nomura said, referring to comments from PBOC officials at Tuesday’s news conference.
Vice Governor Liu said the central bank would not allow one-way movements in the yuan’s exchange rate, the brokerage noted, citing news reports. The PBOC again appears to be sending a clear signal that the exchange rate has been too strong and is aiming to prevent the exchange rate from strengthening further, Nomura said.
In theory, the PBOC will likely stabilize the yuan in the face of massive inflows, the brokerage added.
Treasury yields continued to climb after hitting their highest levels in about two years on Tuesday as investors returned from a three-day vacation in the United States, factoring in the risk that the Federal Reserve could offer a hike in interest rate by half a point in March.
The yield on the 2-year Treasury, more sensitive to Fed rate expectations, held above the 1% threshold for the first time since February 2020. The 10-year yield climbed above 1.8% to reach its highest since January 2020.
Beyond the magnitude of the first rate hike, some corners of the market are also pricing in the prospect of a faster-than-expected reduction in bond purchases by the Fed than the current March period, which could end in February or completely halt in January, although an abrupt halt to the January 25-26 Fed meeting is considered unlikely.
“It’s all about the Fed,” Brean Capital’s Scott Buchta wrote in a note. “The market is quickly starting to reposition itself for higher inflation rates and a more aggressive Fed,” with the probability of a March hike now at 100%. Meanwhile, “expectations are growing for a faster reduction in QE purchases [i.e. wind down in Feb, or stop completely in January].”
The 0% level is a key level for 10-year German Bund yields that should emerge as resistance, Schroders said.
At the 0% yield level, buyers entered earlier, pushing yields lower, said James Ringer, a member of Schroders’ fixed income team.
On sentiment and positioning, many investors expect the 10-year Bund yield to rise significantly past the 0% barrier, Ringer added. He agrees in principle, but thinks it’s not imminent.
“I think ultimately they will be right, but I see some resistance around 0%.”
Crude’s rally extended into early Wednesday as geopolitical tensions remained front and center after an attack on an Abu Dhabi oil facility by Iran-backed Houthi militants from Yemen.
“The fact that the Houthis are now able to detonate explosives at oil facilities in Abu Dhabi must raise blood pressure on the Nymex,” Michael Lynch, president of Strategic Energy & Economic Research (SEER), told Reuters. MarketWatch.
ANZ added that Libya’s deteriorating political stability has seen oil production suffer, while the likelihood of an Iran nuclear deal in the near term has fallen sharply.
Meanwhile, global oil demand could remain resilient despite an increase in cases of the Omicron variant, the ABC said. “So far, OPEC has been correct in saying that the impact of the Omicron variant should be mild and short-lived.”
Gold dipped into the red at the start of the Asian session, caught between rising Treasury yields and continued demand for a safe haven.
The further rise in yields could weigh on prices for the non-performing precious metal, while global economic risks posed by Omicron could support some safe-haven buying, analysts said.
Copper prices were slightly higher, supported by demand from the green energy transition and the push towards electric vehicles, ING said.
The continued recovery of the large internal combustion engine vehicle market is also supporting copper demand in China, ING added. This helps to offset some of the weakness due to the slowdown in the country’s real estate sector.
“We believe China should remain a major growth driver for metals exposed to the energy transition.”
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January 19, 2022 00:40 ET (05:40 GMT)
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