War and peace: The repetitive cat-and-mouse game

It is a lighter start to the APAC session this week, with markets in China and Taiwan closed for a holiday; however, the Russia-Ukraine conflict continues to be the primary driver of markets. Still, more indirectly than ever before, the implications on inflation, commodity prices, and liquidity are now more relevant than direct military conflict in market perception. These effects have created a toxic and uncertain environment where active investor participation is often limited.

Risk sentiment over the past week has been inconsistent; market signals could be characterized by a repetitive cat-and-mouse game whereby headlines initially emerge around the progress in ceasefire talks before being typically walked down by Russian officials who deny the odds of any close peace deal. But Russian Risks are offset by a limited rise in real yields and a drop in equity market volatility. And with earnings season only two weeks out, stable profit expectations could help stocks.

 The broader macro narrative remains unchanged; however, sentiment is becoming more bearish as recession fears grow and more folks latch on to their favourite part of the yield curve to predict recessions.

Frustrated seems to be the best way to describe the trading community. Yet, the market has proven to be more resilient than expected in the face of an increasingly hawkish Fed.

Finally, the coming weeks may reveal the permissibility behind these ceasefire talks and the continuous effects of economic sanctions on Russia and its financial existence, giving more purpose and direction to many of the meandering flows in F.X.

Oil

This morning, oil is opening slightly lower in Asia after a media report suggests the Houthi group agreed to a 60-day truce with Saudi Arabia that temporarily reduces one potential supply disruption source. Still, the fragile detente does little to alleviate the absence of Russian oil.

With OPEC sticking to the current mantra that geopolitical developments rather than fundamentals cause recent volatility, the IEA members will have to do the bulk of the heavy lifting to intervene and backfill a portion of Russian supply loss for now. But with Iran negotiations still a work in progress, this buys a bit more time for talks and OPEC quotas to catch up and production cuts to unwind.

It seems like a lot of speculative top-end juice has been squeezed out of the market, and traders are waiting for a headline to jump on.

 Unfortunately, for energy consumers and in the absence of more OPEC production, demand collapse and recession are the only price lowering mechanisms currently available in a world devoid of inventory buffers, suggesting prices will remain sticky for a while as the release of U.S. and IEA inventories is not an endless supply source for the coming years.

Forex

USD/JPY

The easiest thing to do is raise policy rates to stem the yen weakness. But this looks easier said than done, especially since Kuroda commented on March 18 that the BoJ would not start normalizing its policy regardless of the expected rise in CPI inflation to around 2%.

The verbal intervention has started, but any form of  F.X. intervention does not have lasting legs and typically only offers a better level to sell JPY unless accompanied by a policy twist. With that in mind, all eyes are on the next BoJ policy meeting on April 28. But in the meantime, unless there is a shift lower in U.S. front-end rates, we should expect a weaker JPY glide path.

USD/CAD

Higher oil prices had generated hawkish risks to the Bank of Canada's monetary policy glide path. The Fed's intensified hawkish stance and Canadian GDP growth for February encouraged the BoC's policy to resolve. Before the strong GDP report, the BoC considered a 50bp hike in April so it would be a huge surprise if they did not deliver on cue.