Traders bet Ukraine conflict will slow central bank tightening
Bond yields retreat, breathing life back into tech stocks
FX market caught between different forces, oil prices keep rising
Risky trades bounce back
The talks about a ceasefire in Ukraine concluded without an agreement yesterday and the bombardment of major cities unfortunately seems to have intensified. Russian authorities tried to fight the crippling economic sanctions by doubling interest rates to 20% and introducing capital controls, but the rouble still imploded and every sign points to a bloodbath when Russian equities are allowed to trade again.
That said, the mood in global markets has started to improve. The tech-loaded Nasdaq even managed to close higher yesterday, with a little help from sinking bond yields. Investors have concluded that even though the conflict in Ukraine will raise energy prices and perhaps inflation itself, that will not translate into more aggressive tightening by global central banks.
This debate has been raging for a while now - how do you respond as a central bank to the risk of higher inflation but slower economic growth? The verdict seems to be that you just cannot respond. If anything, the Fed and the ECB might be inclined to raise rates at a slower clip, knowing the energy-driven inflation spike will be temporary and fearful not to choke economic growth.
At least, this is the calculation many traders have made. Yields on government bonds in America and Europe have fallen considerably as rate hike bets were pared back, breathing life back into riskier plays like equities, especially in speculative ‘growth’ stocks that got annihilated in recent months.
FX market split
With bond yields declining almost in lockstep across different regions, the effects in the FX arena have not been dramatic. Currency trading is a relative game after all, so if both European and American yields are falling at a similar pace, euro/dollar is unlikely to respond much.
But there are exceptions. One example is the Japanese yen. Since the Bank of Japan remains committed to its yield curve control strategy, the yen tends to shine whenever foreign yields retreat as its interest rate disadvantage narrows. This is probably why the yen is trading higher today, defying the burden of higher oil prices on Japan’s economy.
The commodity-linked currencies are also showing strength. Economies like Australia and New Zealand depend on their raw material exports, so they stand to benefit when commodity prices boom, even though their currencies usually trade as proxies for risk sentiment.
Still, it is a strange combination seeing the Japanese yen rallying in tandem with commodity currencies - it just doesn’t happen very often.
Oil prices and Biden’s speech
Meanwhile, the Reserve Bank of Australia revealed nothing new when it concluded its meeting earlier today. The aussie fell initially in the absence of any tightening signals, but rebounded soon enough with commodity sentiment.
The rest of the session includes inflation data out of Germany and the annual State of the Union address by the American president. He is expected to address the recent conflict in Ukraine, although any remarks on inflation and energy prices may be more relevant for markets. Speaking of energy prices, the rally has resumed.
WTI crude oil is currently knocking on the door of the $100/barrel region and if it cracks above, there isn’t much resistance standing in the way until $105. Fears of prolonged Russian sanctions are running the show right now and unless OPEC throws the market a lifeline tomorrow or the Iran deal closes, it’s difficult to envision a turnaround.