War fears continue to ripple through the capital markets

Overview: Fear of a Russian invasion of Ukraine, spurred by comments from US officials triggered a dramatic market reaction ahead of the weekend, and it has continued today. Risk has come off in many markets. Equities have tumbled. Most of the major bourses in the Asia Pacific region were off 1-2%. Australia was a notable exception as it gold and energy stocks lifted ASX 200. The Stoxx 600 is off around 2.5% near midday in Europe, its third consecutive fall. US futures off about 1% lower. Bond markets are bid. The US 10-year Treasury yield is near 1.92% after poking above 2% last week. European yields are 4-7 bp lower, and the peripheral premium is edging wider. The yen and Swiss franc are firm, while the other majors, led by the Scandis and Antipodeans are around 0.50%-1.0% lower. Emerging market currencies are mostly lower, with central European currencies particularly vulnerable. Gold is consolidating after surging to three-month highs near $1865 before the weekend. Oil edged higher initially, with the March WTI contract rising to almost $95 before steadying. US natural gas prices are snapping a three-day decline to surge 5% today, while Europe's benchmark is almost 10% higher. Iron ore was off around 1% for its first back-to-back loss in a month. Copper is softer after falling 3.3% before the weekend.

Asia Pacific

The Bank of Japan pre-announced its willingness to buy an unlimited about of 10-year bonds at 0.25% today. However, there were no offers for the first such operation in three years. The fall in global yields saw the JGB yield ease slightly. The BOJ's challenge of defending its Yield Curve Control policy is not over. There are also other actions the central bank can take to reinforce its 0.25% cap such as offering to buy at a fixed rate lower than the prevailing market rate. Some upward pressure was seen on the longer-dated bonds, with the 20- and 30-year yields edging higher. Even if the exit from YCC is not imminent, many see it as an ongoing BOJ challenge. Note that the Q4 GDP deflator and the January CPI figures due this week are expected to show deflationary pressures still evident.

The People's Bank of China sets the one-year medium-term lending facility tomorrow. The rate was cut by 10 bp last month to 2.85%. The market is split on whether another cut will be delivered now. A Bloomberg poll found 16 of 27 expect no change, while the others expected a 5-10 bp reduction. The PBOC is encouraging lending, and officials have made it easier for property developers to tap cash from home pre-sales. The cap on loans to develop public housing has also been lifted.

After trading above JPY116 last Thursday and Friday, the dollar is poised to fall through JPY115.00 in Europe. The uptrend line connecting the late January and early February is around JPY114.95. Below there, support is seen in the JPY114.60-JPY114.75 area. The Australian dollar is coming under more selling pressure in the European morning and is being pushed through $0.7100. some selling may be related to the A$1.13 bln option expiring today at $0.7110. Last week's low was near $0.7065. The greenback edged slightly higher against the Chinese yuan but remained in a particularly narrow range within the pre-weekend price action. Yet it was third consecutive session that the dollar traded above CNY6.36 on an intraday basis but was unable to close above. The dollar's reference rate was set at CNY6.3664, a little above expectations (CNY6.3661, Bloomberg survey).

Europe

Over the past few days, a handful of ECB officials have pushed back against speculation of a rate hike near mid-year: Lagarde, Lane, Rehn, Visco, and Makhlouf. Next month's meeting is still important. There will updated forecasts and forward guidance, but the guidance in December, including the sequence (bond buying continues under APP until shortly before the first rate hike, and APP will be stepped up after the buying under the PEPP effort concluded next month). Officials do not see a wage impact but may seek faster access to wage data (suggested Visco).

Last year, the Bank of England unveiled its balance sheet strategy. It would recycle the maturing proceeds of its bond holdings until the base rate reached 0.50%. It would not actively sell its holdings until the base rate was at 1.0%. At the time, the swaps market did not envision the 1% level being reaching for several years. Now the market is pricing in about a 75% chance that it is reached at the March 17 MPC meeting. At the end of last week, reports indicated that the BOE was talking with the Debt Management Office about handling the active sales. The central bank owns GBP875 bln of Gilts (~$1.2 trillion). The BOE is unlikely to begin selling off its holdings as soon as it is able. Pill, the BOE's Chief Economist, recently explained that the 1% base rates is not a trigger for action but the beginning of the discussion.

Ahead of the weekend, Fitch cut Turkey's sovereign credit rating to B+ from BB- and retained a negative outlook. It was a catch-up move. S&P has Turkey as a B+ credit since August 2018. It changed its outlook to negative last December. Moody's B2 equivalent was adopted in September 2020 and maintains its negative outlook. With high inflation and widening current account deficit (despite the massive devaluation), the risk is of additional downgrades. DBRS gives Turkey a high BB rating, which is the highest of the speculative category. It has been there since July 2016 and seems a bit dated. The central bank cut the one-week repo rate by 500 bp in the last four months of 2021 to bring it to 14%. It was left there in January and is expected to remain so when the central bank meets February 17.

The euro is under pressure. It is testing the $1.1300 area, which is around the middle of its recent range. The (61.8%) retracement of its rally from late January is near $1.1265. There is an option for 635 mln euros at $1.1240 that expires today. Resistance now is seen in the $1.1325-$1.1350 area. Sterling has largely been confined to a $1.35-$1.36 range since February 1. While shallow intrasession penetration has been seen, the range has held on a closing basis. Today, it has found bids slightly below $1.3500. Immediate resistance now is seen around $1.3540-$1.3560.

America

The sell-off in the US 10- year that followed the stronger than expected January CPI (7.5% vs. median forecast in Bloomberg's survey of 7.3%) and the Fed's Bullard comments were unwound in response to the US claim that the long-warned of Russian attack on Ukraine could take place in the coming days. The US 2-year yield surged more than 21 bp on the CPI/Bullard and fell back nearly eight basis points on the elevated geopolitical tension. Some have argued that the market misunderstood Bullard, though he seemed to be fairly clear about the key issue: Favors 100 bp increase in the next three meetings and wants to begin the unwinding of the balance sheet quickly and aggressively. He will be on CNBC at 8:30 am ET today. One should not be surprised if he does not walk make his arguments. He has consistently been consistently among the most hawkish of Fed official.

The trucker-led protest that disrupted Ottawa, Canadian production, and trade with the US appeared to end over the weekend. Several automakers, including GM, Ford, Stellantis, and Toyota cut production. Of note, Canada raised an objection some of the funding for the protest may have been funded via US financial institutions. The Ambassador Bridge has re-opened, but Canadian officials warn against non-essential travel. Similarly inspired demonstrations have been seen to varying extents in several European countries, including France, Netherlands, Switzerland, Austria, and Belgium. There are some reports of a like-minded demonstration in Washington DC around the March 1 State of the Union address.

The risk-off moment and the deepening Canadian discount to the US on two-year money are helping lift the US dollar toward the upper end of its recent range against the Canadian dollar. The CAD1.28 area has capped the greenback since early January when it briefly traded around CAD1.2815 on an intrasession basis. Above there, the CAD1.2845-CAD1.2855 may offer resistance. Initial support is around CAD1.2720-CAD1.2740. Note that around $2.2 bln in options expire tomorrow in the CAD1.2695-CAD1.2700 area. The greenback jumped from around MXN20.3645 to MXN20.64 in the flurry before the weekend. However, like most emerging market currencies today, the peso seems sidelined. Still, the geopolitical overhang argues against a return to the 200-day moving average (~MXN20.33) it was testing in the second half of last week. The risk-off may weigh a bit more on Brazil, which has been one of the strongest emerging market currencies this month. It traded at its best level since September last week (~BRL5.1750) before the pre-weekend sell-off. The US dollar faces resistance near BRL5.30.