Dollar attracts safe-haven flows as China tightens restrictions
Demand worries deal heavy blow to oil prices, gold retreats too
Stock markets trade sideways, but fundamentals spell trouble
Dollar regains ground
The US dollar spent most of this month on the ropes, pressured by signs that inflation is simmering down and speculation that the Fed is in the final chapters of its tightening cycle. Yet, the reserve currency came back swinging on Monday, regaining lost ground with some help from safe-haven flows.
Hopes that China will relax its covid strategy were crushed over the weekend, after the government tightened restrictions in some major cities to deal with rising caseloads. Hence, the notion of a paradigm shift in China seems to have been premature, especially since the recent rescue package for the embattled property sector did not include enough firepower to turn the tide.
With bets around an imminent Chinese reopening being unwound, a wave of risk aversion swept through global markets. In the FX arena, the currencies that retreated the most were those with high economic exposure to China or a tight correlation to global risk sentiment, such as the Australian and Canadian dollars. Across the risk spectrum, the US dollar was the main beneficiary.
Another crucial week lies ahead, featuring the minutes of the latest Fed meeting and the S&P Global business surveys on Wednesday. The minutes are outdated, since this meeting took place before the bombshell inflation data and we’ve heard from almost every FOMC official since then. Nonetheless, the market always finds a way to react to this release. A message of ‘determination’ could give the dollar a small boost.
Oil slides, gold retreats
It was a hellish week for crude oil, which suffered heavy losses as demand concerns overpowered some supply developments that were favorable for prices. The outlook for global fuel demand continues to deteriorate, with China’s intensifying covid outbreaks and nearly every piece of incoming data pointing to a recession in the Eurozone and United Kingdom.
On the supply side, even though OPEC has announced plans to slash production, it was not enough to nullify the prospect of demand destruction. There is also chatter that Europe is overloaded with oil, as refiners ordered as much as possible ahead of the ban on Russian crude that will come into force early next month.
Staying in the commodity sphere, gold prices are on the retreat, surrendering some of the gains they recorded after US inflation clocked in below expectations. The trading dynamics governing gold shifted this year, with bullion forfeiting its traditional safe-haven qualities and turning into a mirror reflection of the US dollar and real yields. Hence, gold has essentially transformed into a barometer for interest rate expectations, putting its fate in the hands of the Fed.
Wall Street drifts
Stock markets traded sideways last week, as traders sifted through a mountain of clues to decide whether the latest recovery was just another bear market rally or the early phase of a reversal.
There’s a real dichotomy between the equity and bond markets. While stock market valuations and earnings estimates are more consistent with a soft economic landing, the dramatic inversion of the entire yield curve suggests bond traders expect the economy to hit a wall soon.
It’s not just bond investors. Every leading economic indicator is screaming of trouble ahead - business surveys warn that demand is faltering, retailers are swimming in inventory they cannot unload, housing is rolling over, and consumer confidence is in the gutter. With valuation multiples still stretched and earnings estimates for next year out of sync with what these indicators suggest, the stock market storm is probably not over yet.