The weekender: Hawks screech and markets recoil

Stephen Innes SPI Asset Management

Markets

Without tier-one economic data to help steer markets, US stocks ended lower last week as investors contemplated how much economic pain central banks might need to inflict to tamp down the stubborn last leg of inflation. And as the screeches of central bank hawks sounded across global trading rooms, markets began fretting about a hard landing and recession concerns.

It's not often that the Bank Of England influences broader risk sentiment, but last week's surprise 50bp move did exactly that and brought any thoughts of curve steeping to an abrupt halt.

As we head towards the last week of June -- and the first half of 2023 -- investors seem to be positioned with a bit more trepidation than they have for most of the past 8+ weeks as markets digest the strong run-up in stocks we have seen. And after such a strong move, stocks appear more susceptible to even the slightest shift in sentiment. All the while, the level of risk-free yields makes investing in equities a less attractive relative proposition than it has been for much of the past few years.

And even from our less bearish view, we do see signs of concerns around the narrow breadth of the market and extremely high valuations in AI Tech, suggesting a drawdown risk is elevated in this more hawkish than expected central bank environment.

Looking ahead, sentiment around the earnings power of AI initiatives may be key to sustaining the first-half market rally. And in 2H23, we are likely to learn more about how much companies will need to invest in AI and machine learning platforms to compete, which companies are emerging as AI leaders, and which companies have models that can be readily monetized. All of this may contribute to some single stock volatility -- volatility that, admittedly, we have not seen much of with the recent rally as the VIX sits down near 13 today -- its lowest level since before the pandemic hit in 2020.

Oil markets

Oil prices ended the week precipitously lower as the jab-cross combination of hawkish central banks and a sharp slowdown in global activity data darkened the view.

Record SPR releases and upside surprises from US and sanctioned producers have boosted oil supply, while higher interest rates have weighed on demand. Toss in a lower growth trajectory for China for a bearish measure, then compound that the lack of meaningful stimulus on the horizon does paint a more bearish backdrop.

The monetary policy response to higher energy and consumer price inflation has weighed oil demand—higher interest rates have negatively impacted OECD GDP growth, keeping Oil's primary driver well below potential.

At the same time, supply beats from sanctioned economies are unlikely to reverse and could keep a lid on any price rally over the near term.

Looking at the next few months, the SPR should turn into moderate tailwinds as the SPR gradually refills. The US Department of Energy has awarded contracts to deliver 3mb of crude Oil to the SPR in August. It has launched a solicitation for another 3mb for delivery in September.

Overall we see more of the same range trade mentality engulfing markets into Q3 as oil trading becomes less interesting in a heavily intervened market.

Forex markets

The Ringgit

Over the past month, the Malaysian Ringgit has underperformed ASEAN peers alongside the CNY. That joined-at-the-hip affinity reflects deep trade ties and that policymaker focus is often on the MYR/CNY cross rate.

China is Malaysia's largest trading partner. Bank Negara Malaysia appears relatively content with MYR weakness vs the Dollar, as the MYR/CNY cross has stayed within a relatively narrow range of 1.52-1.60 over the past 12 months. FX reserves have remained steady at around USD115bn this year (compared to a USD12bn drop in 2022, likely reflecting intervention).

Furthermore, despite a significant increase in the balance of trade of goods and services since early 2021, the current account in USD terms has declined due to a large increase in outward FDI and investment income outflows. Notably, Malaysia is one of the few markets in the region that has seen net foreign equity outflows this year of around USD800mn. In contrast, China, Korea, Taiwan, India, and Indonesia have all seen inflows. Suggestion some lingering domestic political risk is hurting the outlook

Given expectations of further moderate weakness in the CNY and no clear catalyst for improving portfolio flows, we now expect USD/MYR to trade near 4.80 into year-end.

G-10

There seems to be a bit of a hawkish hangover as early warning signs with the EUR and GBP coming off the boil suggest that the market is starting to question whether ECB and BOE policymakers would be up to the inflation challenge as activity data wanes.

Author

Stephen Innes

SPI Asset Management

With more than 25 years of experience, Stephen has a deep-seated knowledge of G10 and Asian currency markets as well as precious metal and oil markets.

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