By Jeffrey Halley, Senior Market Analyst, Asia Pacific, OANDA,
Long-time readers will know that Mrs Halley is fond of “communicating,” or talking in another parlance. They will also know that the communications often involve a monologue requiring me to “listen,” something I have become adept at doing, along with tactical grunts and nodding of my head. When the talking becomes two-way, the words “emotionally underdeveloped Kiwi male” potato often emerge in the conversation, a badge I wear with secret pride. (Making my pronouns he/him/potato, I guess?)
Secretly, of course, this Kiwi potato knows that communications are essential, and I do make an effort in an emotionally underdeveloped, non-woke, sort of way. But, of course, as many husbands may know, meeting those comms expectations can be the equivalent of climbing to the summit of Mt Everest without oxygen, clad only in boardshorts and wearing jandals.
Financial markets experienced the consequences of a communication failure overnight, which will be felt equally, if not worse, in Asia today. The Federal Reserve’s FOMC meeting held a nasty surprise for investors; the dot plots of future rate hikes abruptly shifted forward en masse to 2023. And Fed Chairman Jerome Powell said that the time was coming for a talk about starting to talk about beginning to talk about quantitative easing tapering.
Mr Powell’s pleas to take the abrupt shift in the dot plots “with a grain of salt” fell on deaf airs as US yields rose, the US Dollar spiked, equities fell, while gold and Bitcoin were stretchered off injured. With Fed officials having spent the weeks and months ahead of last night’s FOMC meeting beating the inflation is transitory, it’s all about the labour market, nothing to see here, move along mantra, the FOMC really did spoof financial markets overnight.
I am wondering if Chairman Powell was blindsided by the FOMC members himself, which makes the whole situation even worse. The FOMC minutes will make fascinating reading this time around because dissension in the ranks will make the entire surprise overnight look even worse.
In a world that has become addicted to bottomless amounts of zero per cent money from the world’s central banks over the last 12 years, and even more so over the past year, I have always doubted a taper-tantrum sequel could be avoided. It was always just a case of how bad the tantrum would be. The price action in Asia today suggests nervously cautious rather than a panicked charge for the exit door. I would suggest that sentiment is fragile, though. Buying the dip has worked handsomely over the past year, and I have no doubt the buy-the-dippers will be out today. Things could be different this time, though, and rather than trying to catch a falling boulder, buying on the way back up, if that is how it plays out, could be the wiser strategy.
If indeed we are reaching peak asset price inflation, much of Asia could be left in a conundrum. Apart from the yield-seeking oceans of capital that have reached into the furthermost corners of Asia’s financial markets, which might start looking unappealing and suddenly less liquid, much of Asia is out of sync with the US recovery and potentially its monetary policy.
If US yields rise, lifting the US Dollar ever higher, those implied dirty pegs to the greenback will come under stress. Especially so because interest rates in Asia at rock bottom levels as well. You can either burn through your foreign reserves and sell US Dollars, of which, admittedly, Asia has accumulated an enormous war chest of. Or you can lift interest rates to defend your currency.
The problem with much of Asia and ASEAN is that they are not yet ready to begin tightening as much of the region is still unvaccinated and marking time for better times ahead. The last thing they need right now is higher rates. If the shift in FOMC tone leads to an ongoing reversal of the buy-everything trade, Asian bonds, equities, and currencies could come under sustained pressure. The long-forgotten adage of an emerging market being a market you can’t emerge from in an emergency still holds true.
Taiwan and Indonesia’s central banks announce their latest policy decisions today, and Japan does tomorrow. All three will remain unchanged but will now have food for thought. Of the three, Indonesia faces the biggest conundrum going forward if we have seen peak-Fed. With a large amount of foreign-denominated debt and still weak domestic demand, the last thing the Bank of Indonesia needs right now is to contemplate higher future rates to protect the Rupiah. Covid-19 cases are rising here as well after the Eid holiday, with more robust control measures a possibility. Indonesia, Malaysia, the Philippines, Thailand and India won’t look special in this scenario, although India has accumulated enormous foreign reserves to buffer any pain.
Both the Australian and New Zealand currencies were sold heavily overnight as proxies for risk-sentiment and Asia. But both have earned a respite this morning after impressive data releases. New Zealand Q1 GDP blew forecasts out of the water with the data showing a broad-based recovery, tourism and Auckland lockdowns aside. Australian Employment for May staged an equally impressive rebound after a soft April. Employment rose by 115,200 jobs, and more importantly, full-time jobs rose by 97,500. Ominously, the yield curves in both Antipodeans firmed post-FOMC, highlighting the reach of the Fed. Higher yields and impressive data may only provide a temporary reprieve for the currencies.
Singapore Q1 Unemployment fell to 2.90% today, while its May Trade Balance rose to $5.754 billion. Singapore Inc’s export sector continues to underpin the City-state recovery, but the domestic demand is murkier. Singapore is in Covid-19 restrictions at the moment. Yesterday, the government said it was reassessing the reopening schedule thanks to the elusiveness of the virus this time around. Therefore, the positive data is unlikely to give Singapore equities much of a tailwind.
China announced more measure to control commodity prices yesterday, including releasing essential industrial metals from its strategic reserves onto the domestic market. As a net importer of basically everything, a semi-disguised buyers strike will only delay the outcome of a battle it can’t win. Nevertheless, it was enough to send metal prices tumbling yesterday, notably copper.
Following on from its intervention in big-tech, an anti-trust probe into Didi Chuxing is apparently imminent, virtual currencies and shadow banking. Thus, it appears that China is becoming more interventionist and less free-market for the foreseeable future. It also suggests that the leadership has deeper concerns about China recovery and leverage in the economy. Whether that shifts the PBOC from its liquidity tightening stance is too soon to say, but China equities are likely to lag for a while, especially if the FOMC language change takes root globally.
Equity markets soften in Asia
The moves in the FOMC dot plots and language change, despite the rear-guard action by Jerome Powell, saw equity markets fall into negative territory on Wall Street overnight. The S&P 500 lost 0.54%, with the Nasdaq easing by 0.24%, while the Dow Jones retreated by 0.77%. Although futures on all three have recovered some early Asian losses, they remain around 0.40% lower in after-market trading.
By contrast, Asia’s reaction has been relatively subdued, possibly because investors in parts of the region appeared to reduce exposure this week ahead of the FOMC. Unsurprisingly, this week’s most effervescent Asian markets, Japan and South Korea have suffered the most. The Nikkei 225 is 1.30% lower, while the Kospi has fallen by 0.50%, with the fall of the Won post-FOMC limiting the damage to South Korean exporters.
China, by contrast, is in positive territory despite Reuters reporting that China has begun an anti-trust probe into Didi Chuxing, China’s ride-hailing champion, which is planning a US IPO. (That could be part of the answer) The Shanghai Composite is up 0.15% today, with the CSI 300 jumping 0.50%, while Hong Kong has risen 0.20%. The China-induced fall in commodity prices is price supportive, but post-FOMC, the price action smells of China’s “national team” buying equities. That makes sense, given the government’s interventionist tone elsewhere at the moment.
Across the region, Singapore is down by 0.25%, Kuala Lumpur by 0.45%, Jakarta by 0.35% and Taipei by 0.35%. Bangkok is unchanged after the government announced tourism reopening intentions yesterday. Data is supporting Singapore markets, and the same appears to be the case in Australia. The huge employment rebound and a dovish speech by the RBA Governor mean the ASX 200 is down just 0.10% while the All Ordinaries remains 0.35% in the red.
If Asia is in wait-and-see mode, the overnight developments will likely reverse Europe’s positive overnight session. Whether this is a dip to buy into for equities or the start of an FOMC-induced correction lower will depend on the mood of the gnomes of Wall Street this evening and if the Tao of the FOMO still rings true. Should an FOMC tantrum ensue, banking equities will likely be the only winners as higher interest rates are their happy place.
FOMC sends US Dollar sharply higher
The US Dollar rose sharply overnight after the FOMC members brought forward rate hike expectations, and their language changed to a less dovish stance. As a result, the dollar index leapt 1.0% higher to 91.40, where it remains in Asia this morning. That leaves the index just shy of the April/ May highs around 91.45 and its 200-day moving average (DMA) at 91.51. A daily close above the latter will signal further gains to 91.80, possibly extending to 92.50.
The overnight US Dollar rally has left many of the major currencies at interesting levels with the potential for more downside ahead. EUR/USD has fallen 1.10% as of this morning, to 1.1995, an important daily support level. The fall overnight took out the 100-DMA, and its 200-DMA is right here at 1.1994. Further losses signal a deeper retreat that could reach the 1.1800 regions in the first instance.
GBP/USD fell 0.70% overnight on its way to 1.3995, closing below significant support at 1.4000. That is an ominous development for Sterling, and it should now target its 100-DMA at 1.3940 and risks falling to 1.3800.
Among the commodity currencies, USD/CAD rose 0.75% to 1.2275 and, after some consolidation, could target 1.2350 initially. AUD/USD and NZD/USD fell 1.0% overnight to 0.7610 and 0.7050, respectively, taking out support at 0.7650 and 0.7110. Today’s blockbuster Australian Employment data has lifted AUD/USD 0.25% higher to 0.7630, while an equally impressive New Zealand GDP has lifted NZD/USD 0.50% higher 0.7088. ANZ Bank is calling for rate hikes to now start in New Zealand in early 2022. However, the recoveries still look modest in the overnight falls’ context, and both need to recapture the previous support levels to maintain upward momentum. If US Dollar strength persists, the rallies will run out of steam, with AUD/USD targeting 0.7535 and possibly 0.7400, while NZD/USD will target 0.7000 and 0.6950. Support for the Kiwi lies just below at 0.7035; it’s 200-DMA.
USD/JPY climbed 0.60% overnight to 111.70 with resistance at 111.00, followed by the 112.00 area. Its fate remains intrinsically tied to the US/Japan rate differential, with the BoJ expected to stay unchanged tomorrow and potentially extending stimulus measures.
As I mentioned earlier, the Indonesian Rupiah is among the more vulnerable Asian currencies to a strong US Dollar and higher US yields. The IDR has weakened 0.53% to 14,330.00 today and is threatening its 200-DMA at 14,350.00. USD/IDR could rise to 14,400.00 this week, particularly with the Bank of Indonesia having no choice but to remain dovish at its policy meeting today.
Asian currencies, in general, are weaker today, with USD/Asia rising across the boards. The Korean Won has fallen to 4.1300 today, with USD/KRW having tested 4.1400 in early trading. The Bank of Korea is unlikely to sit on the side-lines, and I fully expect some “smoothing” to occur if it rises to 4.1400 again. The Philippine Peso is another notable loser, USD/PHP rising 0.70% through its 100 and 200-DMAs to 48.40 today. Watch also for USD/INR if it breaks through 73.80, which could provoke some stop-loss buying, although I expect the Reserve Bank of India won’t let things get out of hand.
China set a weaker than consensus CNY fixing today at 6.4298 while leaving liquidity neutral at the repo. The PBOC has been subtly hinting that it had seen enough CNY appreciation of late. If it uses US Dollar strength to engineer some extra CNY weakness, that is likely to limit the recovery potential of other Asian currencies.
Overall, the moves in currency markets overnight look ominous unless you are bullish on US Dollars. However, we need to see today’s reaction from Europe and the US to confirm whether we are witnessing a medium-term shift in the US Dollar outlook post-FOMC. 2020/2021 has been notable for its many false dawns, and I would not yet discount that possibility.
Oil weathers the FOMC storm
Oil’s strong fundamentals continue to support prices and limited post-FOMC losses overnight. Futures markets remain in backwardation, signaling strong physical demand, and official US Crude Inventories fell by an above expected 7.355 million barrels overnight.
Brent crude tested $75.00 a barrel overnight before retreating on the FOMC surprise and finishing 0.50% lower for the day at $73.85 a barrel. WTI tested $73.00 a barrel before suffering a similar fate, finishing just 0.10% higher at $71.70 a barrel. Prices are hardly changed in Asia, with both contracts rising 0.10% as markets digest the implications of the FOMC meeting outcome.
However, although oil’s fundamentals remain firm, both contracts are now vulnerable to a potentially sharp downward correction to cull excessive speculative longs in the shorter term, especially if we are about to see a period of US Dollar strength. The Relative Strength Indexes (RSI’s) on both contracts have remained in overbought territory. The daily RSI is usually a good indicator of intra-trend corrections when it reaches extreme levels.
Brent crude still has $75.50 and $78.00 in its sights, but a fall through $72.80 could signal a drop extending as far as $71.00 a barrel. WTI has resistance at $75.50, and failure of $71.00 could see $70.00 a barrel retested. Any abrupt sell-off is likely to be violent but short in duration.
Gold crushed under the foot of the FOMC
Gold was crushed overnight by a more hawkish FOMC, leading to fears that US bond yields would rise. Gold fell by over 2.50%, carving through its 200-day moving average at $1840.00, highlighting the extent of speculative long positioning in the market. It also highlighted gold’s sensitivity to a higher US Dollar and US rates.
Gold has staged a modest recovery in Asia, rising $9.00 an ounce to $1822.00 an ounce, but the rally looks more like speculative dip buying and fast money short-covering than a vote of confidence in the yellow metal. This morning’s minuscule recovery by gold should be approached cautiously, as we have yet to see how a change in tone from the Federal Reserve will fully play out in markets.
Gold’s next critical support is the 100-day moving average at $1797.50. A daily close below there will signal a deeper correction is in the prospect that would initially target $1760.00 an ounce. Resistance lies at its 200-DMA today at $1839.50 an ounce. Gold will likely gyrate in a choppy range between $1815.00 and $1825.00 over the Asian session.