The Key Passage to Calmer Waters Is Getting Through Earnings Season Relatively Unscathed

US Markets Fundamental Analyis

US equities rose Thursday, S&P up 2.5%, with gains led by tech after solid earnings from Meta, NASDAQ up 3.1%. JPY broke through 130 against USD after BoJ kept policy on hold, a twenty-year low. US 10yr yields down 1bp to 2.82%.

The S&P 500 Index had its best session since early March on Thursday, reversing weekly losses, as investors grew confident that corporate earnings can endure rapid monetary tightening by the Federal Reserve.

One of the key passages to calmer waters in equities and lower bond volatility is getting through earnings season relatively unscathed. Last night was a modest step forward in that regard.

A big miss on US GDP, down 1.4%qoq saar in Q4, consensus looked for a 1% rise. But details lessen some of the pain: a considerable drag from net exports and a surprise drop in government spending. Still, final sales to private purchasers were up 3.7%, pointing to strong underlying demand.

While USD gets a bit of reprieve from its relentless march higher as US yields stabilize and fall slightly, I don’t feel the disappointing US Q1 advance GDP headline figure will derail Fed momentum overall.

The US dollar bulls will likely come up for air while factoring in risks for a downside surprise to their projections for US core PCE today. If that were to materialize, it would mark a more significant start to the decline in inflation expectation, drive down US yields and likely soften the US dollar. But it may not drift too far from its current axis due to growing downside risks elsewhere, particularly in China and the Eurozone, where RMB weakness and EUR downside continue, and a stronger USD is a tailwind.

Asia Markets Fundamental Analysis

In Asia, the Chinese Politburo will focus on spreading good cheer to Asian markets so expect China to show a more pro-growth policy tone in terms of covid restrictions, the housing market, internet regulation, and consumption boost.

Chinese President Xi’s call for an ‘all-out effort to boost infrastructure for economic stability helped both A- and H-share market sentiment. Traders are positioning for a potential upside ahead of today’s Politburo meeting and the long holiday.

But there are no quick fixes here. China’s property market will remain weak in 2022, with homebuyers lacking confidence in non-SOE developers after recent defaults and being concerned about job security and property prices. While the government looks to keep costs stable in Tier 1&2 cities, price-to-income ratios are among the highest in the world.

Against this backdrop, we should expect further easing to support the market, but significant moves are unlikely given the protracted lockdown scheduled to run through June. There is no point in throwing money at people who are scared to leave their apartment for one reason or another.

I expect more upside to USDCNH; with the Bank of Japan firmly committed to its YCC target via unlimited bond-buying, USDCNH could push higher. China is at a competitive disadvantage to Japan in third markets on a multi-month move higher in CNY/JPY.

With the PBOC also forced to be on an easing path, the similarities to the Bank of Japan have spooked the market and hence probably the main driver of the move above 6.65 in the absence of any other local news. As I mentioned last week’s weaker fix where the PBoC invisible hand wasn’t so hidden, core long dollar positioning looks attractive for a move towards 6.70 and possibly 6.80, but factor in the potential for PBOC measures to calm volatility.

Oil Fundamental Analysis

Russia’s decision to switch off natural gas supplies to Poland and Bulgaria spooked the European energy market and seemed to trigger a call to action by German policymakers.

Crude oil prices have been quietly grinding higher on the report Germany is no longer opposing a ban on Russian oil. Of course, the devil will be in the detail as the EU policymaker tries to engineer a response that will not compensate Russia for the lost EU barrel through higher oil prices. Not to mention all 27 EU governments must approve an oil ban.

If we thought the Fed had an impossible task, perhaps the EU oil puzzle comes in a close second.

Aisa’s focus could shift back to China, where more Covid-19 cases are reported, but policymakers increase screening to avoid Shanghai-type chaos. While the prospect of a further drop in Russian production continues to support.

Gold Fundamental Analysis

Gold traded a bit firmer overnight. A jump in oil prices drove inflation expectations slightly higher while US yields were relatively calm, with stocks stabilizing.

One of the reasons I have not bought this dip was the risk of a downside surprise for US core PCE today. If that were to materialize, it could mark the start of a significant decline in inflation expectations for the remainder of the year. The signal could be conflicting, driving both yields and inflation expectations lower. But with the bullion market singularly focused on inflation, it could hurt gold.

The market remains understandably cautious as the risk of near-term liquidation looms – some unwinding is perfectly understandable as investors adjust their gold exposure to further Fed tightening and real rates threatening to turn positive.