Market Briefing: Middle East concerns & spillovers
Market nerves. Concerns about duration of the Middle East conflict & global economy remain. Equities fell, bond yields rose. AUD underperforms.
Risk radar. Situation in Middle East remains in the driver's seat. More volatility likely. Macro headwinds for AUD & NZD still in place.
Global Trends
Developments in the Middle East and energy markets remain in the driver’s seat. Heightened concerns about the state of play and outlook weighed on sentiment at the end of last week. The news flow hasn’t really improved over the past few days with both sides hurling threats at each other which have reinforced worries the conflict (which is entering its 4th week) could be a protracted affair. Over the weekend President Trump set a 48hr deadline for Iran to open the Strait of Hormuz or the US will “obliterate” Iran’s power plants. This saw Iran threaten to close the Strait “completely” and target US/Israeli infrastructure across the region if attacked. Added to that, it is reported the Trump Administration is looking at occupying or blockading Iran’s Kharg Island (this is where ~90% of Iran’s crude oil exports are processed), and there was confirmation the US is sending more warships and troops to the region.
As our chart shows, global energy prices (oil and gas) have jumped up sharply. Brent crude oil is tracking north of ~US$112/brl, while Middle East oil prices are even higher (Oman crude is close to US$163/brl). We would argue that this is an even better and more timely reflection of the supply/conflict risks that are being priced in. US and European equities fell on Friday with the S&P500 shedding ~1.5%. The S&P500 declined ~1.9% last week, its 4th consecutive weekly fall (its worst run in a year). By contrast, the inflation jolt stemming from the surge in energy prices continues to generate a reassessment of the global interest rate outlook. Bond yields across Europe and the US rose on Friday with US yields rising ~11-13bps across the curve. The benchmark US 10yr yield (now ~4.38%) is at its highest point since last September with markets beginning to toy with the idea the US Fed might raise interest rates by year end (this is now deemed to be a ~30% chance, and a long way from the ~2.5 rate cuts baked in about a month ago). In FX, the USD appreciated on Friday with EUR slipping back (now ~$1.1537), GBP losing ground (now ~$1.3309), and USD/JPY up near the top of its range (now ~159.30). Cyclical growth linked currencies like the NZD (now ~$0.5819) and AUD (now ~$0.6999) remain on the backfoot.
As discussed, and observed, over recent weeks, the situation in the Middle East remains fluid and an ongoing source of market volatility. More twists and turns are likely over the period ahead. Sustained high oil/energy prices are a downside risk for global growth and upside risk for inflation. This is normally a challenging environment for cyclical assets that also generates safe-haven demand for the USD. Moreover, due to the US’ switch to becoming a 'net energy exporter' elevated oil prices have also become USD supportive.
Global event radar: Japan CPI (Tues), Global PMIs (Tues), Germany CPI (30th Mar), China PMIs (31 Mar), EZ CPI (31st Mar), US Retail Sales (1st Apr), US Jobs (3rd Apr)
Trans-Tasman Zone
Shaky risk sentiment and a firmer USD on the back of higher energy prices, an upward repricing in global interest rate expectations, and fears of a prolonged conflict in the Middle East exerted downward pressure on the NZD and AUD (see above). At ~$0.5819 the NZD is back near the bottom of its multi-week range and just below its ~1-year average. The AUD (now ~$0.6999) is hovering around the lower end of its more recent range, though from a longer-term standpoint it is still ~2.5% from its multi-year peak. The AUD also underperformed on the cross-rates with falls of ~0.3-0.9% recorded against EUR, JPY, GBP, NZD, and CNH on Friday. There was a bigger ~1.4% decline versus the CAD.
This week in Australia the monthly CPI figures for February are released (Wednesday). The data will give a guide to the inflation pulse heading into the Middle East conflict. The surge in petrol/fuel prices will start to show up in the March CPI figures. And as our chart shows it looks set to mechanically propel headline inflation much higher in March. After that there could be a cascading impact across other parts of the CPI basket like airfares, and stemming from pass-through to prices by firms in fuel-intensive industries such as agriculture, logistics, construction, and manufacturing. Markets are discounting a ~75% chance of another RBA rate hike at the 5 May meeting with ~88bps worth of additional rate rises now factored in by year-end.
We remain of the view that given how much further RBA tightening is already baked into the Australian interest rate curve, the unfavorable situation in the Middle East (which is set to drag on Asian/global growth), and with the negative domestic economic consequences of higher mortgage rates and fuel costs set to show up over coming months, there are more short-term downside than upside risks for the AUD. In our judgement, the back-to-back RBA rate rises delivered (with another likely to be announced in May) and surge in fuel costs mean the outlook for household consumption has deteriorated. Household spending is the largest part of the Australian economy (~52% of GDP), and a slowdown in activity over future months could lead to a weaker jobs markets down the track. Moreover, the AUD is ~2% higher than our ‘fair value’ estimate, and above where various yield/interest rate differentials suggest it should be. In summary, despite its modest pull-back, we believe too many positives are still priced into the AUD. While the higher level of interest rates and wider yield spreads point to a higher average range for the AUD than what we saw the past few years, it doesn't necessarily mean there will be much more AUD appreciation this cycle because of the worsening global/domestic growth trajectory.
AUD & NZD event radar: RBNZ Gov. Breman (Tues), Japan CPI (Tues), Global PMIs (Tues), AU CPI (Weds), Germany CPI (30th Mar), China PMIs (31 Mar), EZ CPI (31st Mar), US Retail Sales (1st Apr), US Jobs (3rd Apr)
AUD levels to watch (support / resistance): 0.6910, 0.6970 / 0.7050, 0.7120
NZD levels to watch (support / resistance): 0.5720, 0.5780 / 0.5840, 0.5890
Market Moves
Peter Dragicevich
Currency Strategist - APAC
Upcoming Events
MONDAY (23rd March)
SGD CPI Inflation (Feb) (4pm)
EUR ECB's Escriva Speaks (7:45pm)
EUR ECB Wage Tracker (8pm)
USD Chicago Fed Index (Feb) (11:30pm)
USD Fed's Miran Speaks (11:45pm)
TUESDAY (24th March)
EUR ECB’s Cipollone Speaks (2am)
EUR ECB’s Lane Speaks (3am)
NZD RBNZ Gov. Breman Speaks (7am)
AUD PMIs (Mar P) (9am)
JPY CPI Inflation (Feb) (10:30am)
JPY PMIs (Mar P) (11:30am)
EUR France PMIs (Mar P) (7:15pm)
EUR Germany PMIs (Mar P) (7:30pm)
EUR PMIs (Mar P) (8pm)
GBP PMIs (Mar P) (8:30pm)
EUR ECB’s Kocher Speaks (9pm)
EUR ECB’s Sleijpen Speaks (11pm)
WEDNESDAY (25th March)
EUR ECB’s Cipollone Speaks (12:30am)
GBP BoE's Pill Speaks (12:30am)
USD PMIs (Mar P) (12:45am)
USD Richmond Fed Index (Mar) (1am)
EUR ECB’s Lane Speaks (2:45am)
NZD RBNZ’s Conway Speaks (9:10am)
AUD CPI Inflation (Feb) (11:30am)
AUD RBA’s Jones Speaks (1:40pm)
GBP CPI Inflation (Feb) (6pm)
EUR ECB Pres. Lagarde Speaks (7:45pm)
EUR ECB Wage Tracker (8pm)
EUR Germany IFO (Mar) (8pm)
EUR ECB’s Lane Speaks (8:15pm)
EUR ECB’s Rehn Speaks (11pm)
GBP BoE’s Greene Speaks (11pm)
USD Import/Export Prices (Feb) (11:30pm)
THURSDAY (26th March)
EUR ECB’s Kocher Speaks (12:45am)
EUR ECB's Villeroy Speaks (3:30am)
USD Fed's Miran Speaks (7:10am)
AUD RBA’s Kent Speaks (9:15am)
EUR ECB’s Guindos Speaks (8pm)
GBP BoE’s Breeden Speaks (8:30pm)
USD Initial Jobless Claims (11:30pm)
FRIDAY (27th March)
GBP BoE’s Taylor Speaks (3am)
CAD BoC’s Rogers Speaks (3am)
GBP BoE’s Greene Speaks (3:30am)
USD Fed's Cook Speaks (7am)
NZD Consumer Confidence (Mar) (8am)
USD Fed’s Jefferson Speaks (10am)
USD Fed's Barr Speaks (10:10am)
GBP Retail Sales (Feb) (6pm)
EUR Spain CPI Inflation (Mar P) (7pm)
SATURDAY (28th March)
USD Fed’s Daly Speaks (2:30am)
USD Fed’s Paulson Speaks (2:40am)
*Note, all times/dates provided are AEDT
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