Air pockets are getting easier to find these days

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MARKETS

US stocks fell on Tuesday, with the S&P down 1.3%. US 10-year yields rose 15 basis points to 2.55% after Fed Governor Brainard quoted Paul Volcker on runaway inflation and called for a rapid reduction in the Fed’s balance sheet (see below). 2-year yields rose 9 bps, bringing the 2-10 year back into slightly positive territory. German 10-year bunds up 11 basis points to 0.61%. Oil is down 1.7%.

Stocks sold off after future Fed Vice Chairman Lael Brainard made more hawkish comments than expected on the pace of balance sheet liquidation, pushing the 10-year UST yield higher.

Nothing is absolute proof, but it all hinges on the Federal Reserve being on track for an aggressive short-term rate hike. So, with the hawkish Fed back on the heels of stock investors, US stocks fell overnight.

Financials posted a relative outperformance (at the margin) despite the movement of risk aversion in the band. Massive US 10y +16bp movement and steepening 2s10s overshadow stagflation-tilt concerns towards the rest of the band.

Meanwhile, the market might have been looking for Fed Governor Brainard to at least make more balanced remarks – instead, they were on the hawkish end of the spectrum for someone like Brainard. She wasn’t too belligerent, but she didn’t offer anything for doves to cling to either.

Liquidity remains low and no one seems willing to take the other side as air pockets are getting easier to find these days.

OIL

Reports suggest the EU plans to propose a mandatory phase-out of coal imports from Russia, with details still under discussion. The EU should also ban most Russian trucks and ships from entering the bloc.

Oil is a little lower as the market interprets the proposed sanctions only on coal while leaders remain divided on the management of Russian crude. However, US National Security Advisor Jake Sullivan also said Washington would announce new sanctions against Russia this week, including more oil sanctions.

A call for a coordinated release of the SPR by the United States last week fell on deaf ears, with no OECD countries joining the initiative so far. Although Japan’s industry minister said details of the IEA-led reserve release are still being worked out, keeping a cap on oil prices.

FOREX

Central banks continue to try to distinguish between fighting inflationary supply shocks on the one hand and not exacerbating growth or demand shocks. Europe appears to have the greatest difficulty balancing the two, so Thursday’s ECB minutes will be on point. They follow the latest FOMC minutes due later today. On this call and given Vice Chairman Leal Brainard’s comments yesterday as a plate warmer, we should expect some hawkish minutes from the FOMC where a faster pace of the balance sheet run-off will be at center of concerns.

USD

The AU rates market underperformed in the wake of a less dovish RBA

Economists now expect an RBA rate hike in May or June. Still, a shrug for traders, as the AUD has been one of the best performing currencies in the G10 over the past month, reflecting improving terms of trade and more aggressive pricing from the RBA , with a cash rate of around 3.25% at the end of 2023.

However, the rates markets are now questioning themselves, and for good reason. A cash rate of 3.25% would raise the mortgage repayment share of a new borrower’s income to an equal record high of 35% (70% pre-tax) and drive house prices down, consequently driving the economy in recession and triggering an RBA “stop on”

Luckily for AUD bulls, the rising rate channel is just one of the long elements of the AUD trade. Still, the terms of trade are an important driver and should support the AUD in the dips, especially with China looking to shift policy leverage favorable to commodities.

JPY

BoJ Governor Kuroda’s comments to the Japanese parliament overnight that recent exchange rate movements appear rapid saw USDJPY sell off from 122.80/90 to a low of 122.375 before finding base and to bounce back. Official comments may elicit a knee-jerk reaction on the spot, but the risk of any BoJ policy change or actual intervention in the currency markets is limited.

As US yields and energy prices continue to climb, USDJPY should remain supported on any dips.

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