- First significant progress in Russia-Ukraine talks boosts sentiment
- Stocks leap but rally runs out of steam quickly as recession risks loom
- Euro jumps, dollar takes a tumble but yen selloff steadies amid doubts about BoJ policy
Hopes of Ukraine ceasefire rise after latest talks
Russian and Ukrainian negotiators meeting in Turkey made the first meaningful progress to ending the month-long conflict on Tuesday, lifting the mood across financial markets. Ukraine proposed a new security guarantee mechanism in exchange for adopting a neutral stance. But more significantly, Russia said it will reduce its military operations around Ukraine’s capital Kyiv and another city.
The statement was received with scepticism in Washington, with the Pentagon warning that Russian troops may simply be repositioning and regrouping elsewhere rather than withdrawing. The US is even reportedly preparing a fresh round of sanctions against Moscow. Nevertheless, markets took this as a sign of de-escalation as hopes were raised that a ceasefire agreement can be reached, even if the prospect remains a long way off for now.
Talks continue today and investors will be on the lookout for more positive developments as some traders may have gotten a bit ahead of themselves and the rebound in equity markets from the post-war lows is looking overstretched on some measures.
Stocks surge but rally already fading
The S&P 500 ended Tuesday’s session up 1.2%, closing at a two-month high, while tech shares rallied for a second day, pushing the Nasdaq Composite 1.8% higher.
European stocks also made strong gains yesterday and Asian markets closed mostly in positive territory on Wednesday. However, US stock futures were slightly lower at the European open, suggesting the market optimism has gone as far as it can for now.
Stock markets were already recovering well before yesterday’s de-escalation in the war, so it seems the right time for profit-takers to step in. But there’s likely to be some caution as well that’s weighing on equites today amid some recession indicators flashing red.
Recession signs keep lurking
After the brief inversion of the curve between five- and 30-year Treasury yields on Monday, it was the turn of the two year-yield yesterday to momentarily rise above the 10-year yield. That inversion of the latter part of the curve is usually seen as a reliable indicator of recession. Though, investors and Fed policymakers would probably want to see a more extended duration of inversion before panicking.
The Fed has ratcheted up its hawkish rhetoric lately, bolstering expectations that the central bank will hike rates by 50 basis points at the upcoming meetings, as there’s yet to be any slowdown in the spiral in commodity and raw material prices.
However, tightening more aggressively comes at a cost as economic growth would take a hit. The main worry is that if policymakers slam on the brakes too hard, they will not be able to adjust policy quick enough should the additional squeeze on consumers from higher inflation dent demand more than expected.
The other danger from moving too fast is that if there is some kind of a ceasefire soon, energy prices could plummet, lessening the need for a big policy response. Long-term US yields have already pulled back this week from the reduced geopolitical risks and if that trend continues, parts of the yield curve are likely to invert again.
Dollar extends losses, yen defies gravity, euro climbs again
In the currency markets, the US dollar was headed sharply lower for a second day. The dollar index has nosedived after a week-long upswing on receding safe-haven demand. The Japanese yen, however, was on the rise on Wednesday despite a steep drop in Japan’s 10-year yield.
The Bank of Japan has been actively buying Japanese government bonds all week to push the 10-year yield below its upper cap of 0.25%. And even though the Bank had more success today in lowering the yield, there is growing speculation that the current target band is becoming unsustainable.
The argument for maintaining a yield target of zero percent has weakened considerably not just due to soaring price pressures but also from the perspective of the exchange rate. The scale and speed of the yen’s depreciation has taken both the BoJ and Japan’s finance ministry by surprise. So at the very least, a widening of the target band will probably be discussed soon.
The euro was the biggest beneficiary among the major currencies from the progress in the Russia-Ukraine peace negotiations. The single currency jumped more than 1% yesterday and is extending its gains above $1.1150 today.
The pound has also been boosted from the positive Ukraine headlines, though the Bank of England’s dovish tilt is holding back cable’s advances. The Russian rouble has surged too, firming to 76.50 per dollar earlier in the session before pulling back to the 83 per dollar region.
In commodities, oil prices were paring some of yesterday’s losses, while gold was unable to capitalize much from softer US yields and was hovering around $1.920/oz.