Asia open: Conviction sags while possibly flying in the dark

Markets

US stocks are trading lower again Wednesday as investors digest a stronger-than-expected August durable goods report and an accompanying rise in 10-year Treasury yields, which crested 4.6%. 

Day in and day out, the ongoing reality of higher-for-longer interest rates sets in deeper as the Fed's messaging strengthens on “The Street.”

Gone are the days when the market was pricing in rate cuts in the relatively near future. The 10-year Treasury yields are running above 4.6% this week, the highest level since just before the financial crisis broke open in 2007. Two-year yields have also pushed to new highs, reaching the highest since 2006, and the market is now not pricing in a full Fed rate cut until the end of next year.

Indeed, the markets are suffering a bad case of yield curve indigestion with no Pepto Bismal in sight. The math is straightforward: The forward earnings yield on the S&P 500 is currently at 5.5%, and the <90 bps spread versus 10-year Treasuries is the lowest since the early 2000s. The days of easy buy-and-hold markets based on the luscious 3-to-6 ppt spreads above Treasuries in the post-financial crisis era look gone, and a regime change for valuations is obviously well underway. 

The repricing of central bank reactions rather than improved growth prospects has been the primary driver behind the recent bear steepening of the yield. As a result, risky assets, particularly long-duration stocks, have struggled to absorb these rate increases, especially with razor-thin valuation margin for error.

As financial markets adapt to an environment characterized by the expectation of prolonged higher interest rates, the dynamics around data releases are evolving.

Concerns have shifted towards the possibility that more robust economic data may lead the Federal Reserve to continue raising rates or at least refrain from cutting them back from their current elevated levels soon.

Indeed, the correlation between equity prices and bond yields has returned negative, reflecting the "good news is bad news" sentiment in the US.

The continuing surge in oil prices adds a layer of complexity to the economic landscape. At the very least, it will mitigate the disinflationary trend and likely prolong a period of elevated interest rates. In this environment, central banks will face a challenging task in balancing the objectives of promoting economic growth and managing inflation. The decisions on future interest rates will not solely depend on these two variables. Still, they will also be influenced by the central banks' credibility and ability to navigate these intricacies effectively. Maintaining confidence in their policy actions and communication will be crucial for central banks to help consumers and investors navigate this complex terrain.

Looking towards next week, we might be entering a colossal data vacuum as the Federal government is likely to shut down starting this weekend. With the Fed and investors in 100 % data-dependent mode, now is probably not the best time to fly in the dark. 

Finally, macro participants' current conviction and risk deployment feel about as low as they have been all year; now the question becomes, will the final 3 months of the year offer some hope for a juicy bullish trend that folks can sink their teeth into? 

China

Stocks in Asia were buoyed yesterday after the release of an encouraging post-MPC statement from China's central bank, ensuring that the PBoC would continuously support economic growth. While this verbal support gave some momentary ballast to Chinese assets - With the two primary risk sentiment wrecking balls, higher U.S. yields and an unstoppable dollar rally swinging freely and set to unleash a reign of financial market terror on Asian assets, one should be highly open-minded to the increased probability of another sell-off. Indeed, with the significant debt accumulation at the local government and corporate levels over the past decade and the growing risk of financial blow-up, I find the bull thesis very challenging in China.

Oil

Time spreads don't lie; WTI's six-month calendar spread surged more than $1.90 to a $9.75-bbl 15-month high on supply concerns, driving higher the prompt scarcity premium, which meant the intersession rally was on.

Oil futures gained momentum during Wednesday's active New York morning trading session. This surge came in response to the weekly release of U.S. oil inventory statistics, indicating a reduction in commercial and strategic crude stocks. Notably, the inventory level at Cushing measured south of 22 million barrels (bbl), below what is estimated to be the upper limit of the minimum operating level for Oklahoma's tank farm. This data release played a significant role in driving the upward movement in oil futures prices.

According to the Energy Information Administration's report, crude stocks at Cushing experienced a significant drawdown of 943,000 barrels during the week ending on September 22. This brought the inventory level to a 15-month low of 21.958 million barrels per day (bpd). This drawdown marks the seventh consecutive week of stock reduction at the tank farm, which serves as the delivery point for West Texas Intermediate (WTI) crude oil. Over these seven weeks, inventories at Cushing have been reduced by 12.681 million barrels, representing a 36.6% decrease since early August.

As a result of these continuous drawdowns, crude oil stocks at Cushing now stand at 28.1% of their total capacity. However, it's worth noting that 16 million barrels, which comprise 17% of the total capacity, are reserved for use by Cushing's operating company, as reported by the EIA. Industry insiders have suggested that operational challenges at the tank farm could arise when inventory levels fall below the 22 million barrel mark. The sludge at the bottom of the tank has a higher viscosity and is tougher to draw out of the tanks.

And despite the ongoing property developer crisis in China, it is doing little to dent the services sector's thirst for oil.

China's demand for oil has found support in its record levels of internal mobility. This is evident through various indicators, such as robust congestion data in urban areas and increased domestic flight activity. These signs of high internal mobility suggest that economic activities within the country remain strong, contributing to the sustained demand for oil. Increased mobility often corresponds with greater consumption of fuel for vehicles and transportation, which can significantly impact a nation's overall oil demand.

Forex

The Japanese Yen's future trajectory will continue to be heavily influenced by broader macroeconomic factors, particularly the outlook for the U.S. economy. Medium-term forecasts suggest the possibility of higher interest rates in the U.S. for an extended period, alongside robust economic growth, which can typically weaken the Yen's strength. This scenario becomes more pronounced when the US dollar is king.

Considering these factors and the prevailing consensus for an ongoing dovish policy outlook from the Bank of Japan (BoJ), there is a potential for the USD/JPY currency pair to trend higher over the next three months, possibly reaching 155. However, it's crucial to consider the possibility of verbal intervention by Japanese authorities, as seen with Finance Minister Suzuki's warnings about the currency ahead of the last BoJ decision. While the risk of actual intervention or a shift in BoJ policy remains elevated above the 150 mark, it may be more likely to occur in response to a rapid move beyond 152 rather than a gradual ascent. The Yen's future movements will continue to be shaped by a delicate interplay of U.S. economic factors and BoJ policy considerations. But the reality is this is Foreign Exchange, and anything can happen.