Asia Open: Looking through a higher rate environment

Markets

Lower yields have been a significant driver of stock market sentiment, so for today and ahead of "FEDSPEAK" this week, investors are trying to work out calculus around a Fed that is being given the room to keep rates higher for longer.

The move up in stocks that we have seen this year has been accompanied by a movement down in 10-year Treasury yields, which started the year up near 3.80%. But Friday's strong Payrolls report is driving a 12bp jump in yields today, suggesting the tailwind of lower rates on stock valuations may not last for much longer.

Interestingly, markets still appear willing to look through the higher rate environment. Higher rates, being driven by better growth, is a different narrative than the one we had last year: higher rates being caused by monetary tightening (i.e., the Fed). And Friday's Payrolls report and ISM Services survey were unequivocally bullish for the growth outlook.

But everyone is curious to see what post-payrolls Fedspeak brings.

More fundamentally, the Fed is getting down to the nitty-gritty with core services inflation ex-housing as the final crux in its inflation fight. Perhaps the market figures it's just a matter of time before that breaks lower too. 

Indeed, we saw clear evidence of cooling wage inflation last week in the private service sector, measured by the Employment Cost Index, but a blow-out payrolls report called it all back into question on Friday. Soft landing? What about no landing?

Oil prices

Brent has sold off 10% in 5 trading days to just $80/bbl as investors upgrade their expectations for surprisingly firm Russian production, ahead of today's EU ban on refined products, as diesel margins are falling sharply. 

In addition, the collapse in natural gas prices incentivizes switching back from oil to gas. 

Finally, with macro-investors expressing the broader disinflation theme through oil prices, there was likely a rush to hedging last week after the US inventory build, which was likely the final nail in the coffin.

We now believe that Russian supply and switching from oil to gas will offset the China surge in demand for this quarter.