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April 2022 monthly

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Russia's invasion of Ukraine and the unprecedented sanctions and private sector decoupling are unleashing forces that slow growth and exacerbate price pressures. As a result, the geopolitical crisis has become a key force shaping the economic climate. Commodity prices, energy, metals, and foodstuff have skyrocketed.  The public health crisis in Europe, the US, and Canada is easing, but parts of Asia are still in a highly contagious vortex. The shuttering of economically large parts of China is weighing on growth and threatening to disrupt supply chains.   

US and European equity indices sold off for the first two months of the year but stabilized and rebounded last month. However, the MSCI Asia Pacific Index fell for the third consecutive month.  Official comments from China seemed to signal a significant policy shift and spurred some buying, but the CSI 300 still fell nearly 8% in March. Helped by a weaker yen, which bolsters the value of foreign income (not only profits, but coupons, dividends, royalties, profits, and licensing fees) more than exports per see, helped lift the Nikkei by almost 5% to lead the G7 equity markets. 

Equities performed well in the face of the sharp jump in yields. The 10-year Treasury yield rose 50 bp in March, the most in six years, to finish slightly below 2.35%. European benchmark yields mainly were 30-40 bp higher. The dollar value of the negative-yielding bonds in the world (Japan and Europe) fell below $3.0 trillion, the least in six years. It stood at $11.3 trillion at the end of last year. Germany's 2-year yield briefly rose above zero for the first time since 2014 but finished March with a negative yield of a little more than seven basis points. Even at this late date, one still has to pay Portugal, among others, for lending to it for two years.

Interest rates have not only surged, but the yield curves (2-10-year) have flattened further in the US and Canada. In the US, the curve finished last year near 80 bp. It halved in January and February and briefly inverted in late March. Other parts of the coupon curve are inverted. The 2-10-year Canadian curve peaked in early January near 65 bp and is less than 15 bp at the end of Q1 22.  The UK curve fell below five basis points in mid-February. Since then, however, it steepened back to more than 30 bp, slightly above where it finished last year. It ended March near 25 bp. New Zealand's curve, to round out the G10 that have hiked rates with deep bond markets (excludes Norway), was wandering between 40-50 bp most of the month before breaking down at the end of the month to 33 bp. It was near 45 bp at the end of 2021.  

West Texas Intermediate crude oil was trading around $90 a barrel before the Russian invasion and jumped to nearly $126.50 before easing. However, using the 20-day moving average to smooth out some noise, it rose by 18.5% in March 15%, or about $17 a barrel. The Federal Reserve Chair offered a rule of thumb in recent testimony. A $10 increase in oil price boosts inflation by about 0.2% and cuts growth by 0.1%. Europe is more exposed. The 20-day moving average of the natural gas benchmark has risen by nearly 60% since the war began. And the 20-day average price of natural gas in Europe had already increased by more than 40% since the end of last year. 

At the end of March, the Biden administration announced that it would sell around a million barrels of oil a day from its Strategic Petroleum Reserve for the next six months. This more than replaces the amount of Russian oil the US has been buying.  In early April, other large oil-consumer nations may join.  The earlier coordinated release amounted to 60 mln barrels, with the US providing half.  A more ambitious effort is needed.  At the same time, the Covid-related lockdowns in China and higher prices may reduce some demand. 

Fiscal policy may not be as restrictive as previously indicated, and perhaps, an important partial offset to the tightening impulses from rates and energy. In Europe, some Covid-related stimulus will be replaced by energy subsidies, the investment necessary to decouple from Russia, and military expenditures. Japan's Prime Minister Kishida seems increasingly likely to propose a supplemental budget before the July election after the Covid restrictions and earthquake disrupted economic activity. Australia's  Liberal/National proposed budget includes a six-month cut in the fuel excise tax, support for first-time home buyers, and an increase in road and rail spending.  

Many US states are considering cutting the gasoline tax, and federal action is possible. It might make for good politics, but it is poor economic and environmental policy. Also, in the US, the federal gasoline tax finances the Highway Fund, which seems a bit like eating one's own corn seed. At the end of March, the Biden administration announced a 180 mln barrel drawdown of its Strategic  Petroleum Reserves over the next six months or roughly 1 mln barrels a day. . It hopes that other countries make similar moves. 

Monetary policy is in flux. The risk is that with price pressures elevated and rising, the US, UK, Canada, and New Zealand may accelerate the pace of rate hikes. As a result, the odds have shifted in favor of 50 bp moves. The swaps market leans to a 50 bp hike by the RBNZ on April 12, followed by a similar move by the Bank of Canada the following day. The Federal Reserve and the Bank of England meet next in May. A 50 bp move is well discounted, but the market is divided about the BOE. After the 25 bp hike in March, the officials tempered expectations by saying that  further tightening "might be" appropriate."  After the February hike, it said higher rates were "likely."  Norway has also signaled a more aggressive tightening course.  

The swaps market has brought forward the first ECB move to July from October. However, this would still require ending the bond-buying earlier or changing the sequencing (stop bond buying before hiking rates). The ECB could push back against such expectations at its April 14 meeting. The market also sees the Reserve Bank of Australia moving in June. Previously, the swaps market had priced in an August hike. Sweden's Riksbank acknowledged that it will hike rates earlier than previously indicated (2024). The swaps market is pricing in a hike in September and November, though some banks see the April 28 meeting as possible. It will likely wind down its bond-buying efforts sooner. 

The US response to Russia's invasion of Ukraine has boosted confidence in American leadership in most NATO countries despite the handling of the withdrawal from Afghanistan, according to a Gallup survey. In 20 of the 27 members survey, Gallup reported a double-digit increase in the US. Lithuania was the country that showed a decline in approval (to 22% from 28%). On the other hand, President Biden's domestic approval rating fell to its lowest level yet in the latest survey (March 21-22) by Reuters/Ipsos. PredictIt.Org continue to show that the Republican Party is easily favored to capture the House of Representative and Senate in the mid-term elections in November.   

There are two European elections in April that garner widespread interest. First, Hungary goes to the poll on April 3. Prime Minister Orban and the Fidesz Party seek a fourth term. Although the opposition parties have united behind a single candidate, and Orban is more supportive of Russia than the general public, Fidesz is running ahead in the polls. A week later, on April 10, France holds its presidential election. It is doubtful that any candidate will secure an outright majority. This will result in a run-off on April 24, where Macron is expected to face and defeat Le Pen again.  

April 2022 monthly

Bannockburn's World Currency Index, a GDP-weighted basket of the top dozen economies, edged higher in March after falling in January and February. However, within the components, there was wide divergence. The Japanese yen was the weakest currency, falling by a little more than 5% and reaching levels not seen since 2015.  At one point, it was down more than 7%. On the other side, the Russian rouble seemed to appreciate by around a third, though the trading remains distorted by the sanctions and capital controls. The Brazilian real appreciated by nearly 6% to bring the year-to-date advance to more than 17.5%. The Chinese yuan accounts for almost 22% of the index, and it eased by about 0.3%. The euro is slightly more than 19% of the index, and it was flat in March. Among the major currencies, the Australian and Canadian dollars rose (~2.1% and 1.4%, respectively), helped by the strong backing up of their rate, commodity exposure, and the greater appetite for risk reflected in rising equity prices.  The MSCI All-Country World Index rose last month rose almost 4% after falling by around 7.5% in January-February.  

Dollar:   The preliminary indications suggest that although the US economy struggled at the start of the year, it is proving fairly resilient in the face of the jump in energy and food prices and the surge in interest rates. There has been a significant shift in interest rate expectations, despite the criticism heaped at the Federal Reserve.  The minutes from the March FOMC meeting, due April 6, are expected to have more color on the timing and pace of the balance sheet unwind.  Many expect the balance sheet to begin shrinking as of next month. At its peak,  US 2-year yield rose nearly 100 bp last month, the largest increase since  May 1984. The 10-year jumped over 60 bp. While the 2-10-year yield curve did not remain inverted (yet), other parts of the coupon curve did as many feared the Fed would not be able to achieve the proverbial soft-landing or lower inflation without driving the economy into a recession. The Fed funds futures market has fully discounted more than 200 bp in rate increases this year, implying at least two meetings with 50 bp hikes. The market sees about a 75% chance of the first 50 bp hike at the next meeting that concludes on May 4. The swaps market puts the terminal Fed funds rate between 2.75%-3.0%.  

Euro:  There are two knocks on the euro. First is the war in Ukraine. From February 10, when the US warned that Russia was set to attack Ukraine, until a week after the war started, the euro fell by about 6% against the dollar. Europe is vulnerable to the disruption caused by the war and the subsequent sanctions. Stagflationary forces seem particularly strong  Second, the ECB will lag behind the Federal Reserve in adjusting policy. This is illustrated by the roughly 50 bp jump in the US premium over Germany on two-year money (to around 245 bp). The ECB's new forward guidance suggests that asset purchases could stop in Q3, widely seen as a precondition for increasing policy rates. The hawks are pushing for an earlier end. This may be the focus of the April 14 ECB meeting. The swaps market is pricing about 50 bp in rate increases before the end of the year. The first round of the French presidential contest is on April 10. Macron is the easy favorite to be re-elected in the second round (April 24).  

(March 31 indicative closing prices, previous in parentheses)

Spot: $1.1065 ($1.1270)

Median Bloomberg One-month Forecast $1.1045 ($1.1300)

One-month forward $1.1075 ($1.1280)   One-month implied vol 7.8% (7.0%)    

Japanese Yen:  The 10-year Japanese government bond yield rose about six basis points last month, which prompted the central bank to defend its Yield-Curve Control policy cap. The dollar briefly traded above JPY125 as this took place in part because it underscored the policy divergence with the US. Between the Covid restrictions and the earthquake in March,  the Japanese economy may have contracted in Q1. The government's budget for FY22 includes more measures to address Covid, an increase in social security, and military expenditures. Nevertheless, a supplemental budget is in the works. It is expected to be around JPY10 trillion (~$87 bln), and the main issue now seems to be whether it is financed out of budget reserve funds or new borrowing. While the economy is likely to begin recovering in Q2, inflation is set to jump starting with the April print as last year's drop in mobile phone charges falls out of the 12-month comparison. This will lift core inflation measures. In addition, rising food, energy, and metals prices pose a negative-terms of trade shock to the world's third-largest economy and boosts headline inflation. We suspect the exchange rate will enter a new trading range.  Our initial guesstimate is that it is between JPY119.50 and JPY124.50.  

Spot: JPY121.65 (JPY115.55)      

Median Bloomberg One-month Forecast JPY120.40 (JPY115.00)    

One-month forward JPY121.60 (JPY115.50)   One-month implied vol 9.2% (6.3%)

British Pound:   Sterling was the second weakest major currency against the dollar after the Japanese yen, falling by about 2.65%. It has lost around a nickel this year, of which four cents took place in March. While the BOE delivered a 25 bp hike, the one dissent favored no change, and in the face of the high degree of uncertainty, it softened its forward guidance. It suggested that further tightening "might be" necessary. In February, it was additional hikes would be likely. The market has fully discounted a hike at the next MPC meeting on May 5. It has about a 20% chance of a 50 bp hike instead of 25 bp. Of course, it is subject to change based on incoming data and official guidance. However, the market judges that the BOE will not keep up with the Federal Reserve, and the US 2-year premium over the UK more than doubled in March to nearly 100 bp, which was around where it was when the pandemic struck. British consumers are experiencing a severe cost-of-living squeeze amid higher food and energy prices and a national health service tax increase (as of April 1). Without extensive fixed-rate mortgages, such as are available in the US, UK households are also more sensitive to higher interest rates. A break of $1.30 could spur a move to $1.2850.  That seems more likely than a move above $1.3400.  

Spot: $1.3140 ($1.3410)   

Median Bloomberg One-month Forecast $1.3200 ($1.3500)

One-month forward $1.3135 ($1.3405)   One-month implied vol 7.6% (7.0%)

Canadian Dollar:  The US dollar set the year's high in early March near CAD1.29 before falling about 3.4% to CAD1.2430 at the end of the month. The greenback lost ground for nine consecutive sessions through March 25, matching the longest drop since 2010 and recording the low for the year.  The recovery of a small rate premium to the US, the rally in commodity prices, and the stronger risk appetite helped drive the Canadian dollar's gains. Robust economic data, including a monster jobs report ( ~337k in February and a drop in the unemployment rate to 5.5% from 6.5% and a higher participation rate), and comments by officials encouraged the market, which has almost a 60% chance of a 50 bp hike priced in for the April 13 meeting. The Bank of Canada may also begin allowing its balance sheet to run off. The political arrangement between the Liberal and the New Democrat Party ensures stability for Prime Minister Trudeau's minority government and more fiscal measures. The policy mix trajectory of tighter monetary and looser fiscal policy tends to support the currency.  

Spot: CAD1.2505 (CAD 1.2715) 

Median Bloomberg One-month Forecast CAD1.2520 (CAD1.2600)

One-month forward CAD1.2510 (CAD1.2710)    One-month implied vol 7.2% (6.7%)

Australian Dollar:  The Reserve Bank of Australia signaled that the first rate hike could be delivered later this year, but the market is not waiting. The swaps market sees a hike probable (~85%) in June and definitely in July and almost 170 of tightening by the end of the year. The April 5 meeting will allow the central bank to adjust its forward guidance. Unemployment is at 4%, a 13-year low, economic growth is solid, and while wage growth is modest (2.3% Q421 year-over-year), inflation expectations in March (Melbourne Institute) were twice as high. The rise in commodity prices, especially coal, iron ore, and liquid natural gas,  generates a positive terms-of-trade shock for Australia and a windfall for the Australian government. The pre-election (due before May 21) budget provides a six-month cut in the fuel excise tax, support for first-time home buyers, and infrastructure spending for roads and trains. The Australian dollar rose by about 3.2% in March and was the strongest of the major currencies. The gains were recorded in the second half of the month and lifted the Aussie to its best level since last October. Recall that it peaked in late February 2021 at around $0.8000. The $0.7500 area marks the midpoint of the subsequent decline. Technically, there may be potential into the $0.7550-$0.7600 area, but we suspect there is scope for downside consolidation in April.  

Spot:  $0.7480 ($0.7220)       

Median Bloomberg One-Month Forecast $0.7455 ($0.7200)    

One-month forward $0.7485 ($0.7230)    One-month implied vol 10.0% (10.0%)   

Mexican Peso:  The US dollar high for the year was recorded on March 8, near MXN21.50, and proceeded to fall 12 of the following 13 sessions. This included an 11-session slide, the longest in half of a century. By the end of the month, the dollar was probing seven-month lows near MXN19.80. Mexico's central bank raised rates by 50 bp for the third consecutive month in March. Banxico meets again on May 12, and the swaps market is divided between a 50 and 75 bp move. It has about 160 bp of tightening discounted over the next six months and around 100 bp in the following six months.   The peso is also a liquid and accessible proxy for other emerging market currencies and especially those in Latam, which outside of the Russian rouble account for five of the top seven performing emerging markets. The South African rand joins them, and what they have in common are generally high interest rates and commodity exposure. After such a strong run and the coming debate over the controversial electric bill that gives preference to the state-owned utility, the peso may consolidate. This next phase could lift the dollar back into the MXN20.10-MXN20.20 area.

Spot: MXN19.87 (MXN20.35)  

Median Bloomberg One-Month Forecast MXN20.10 (MXN20.50) 

One-month forward MXN19.98 (MXN20.46)     One-month implied vol 9.95% (11.0%)

  

Chinese Yuan:  The US dollar recorded a four-year low against the yuan on March 1 near CNY6.30 and spent the month mostly trending higher. The policy divergence reflected in the collapse of the 10-year Chinese premium over the US from over 100 bp at the end of February to almost 30 bp in late March reduces the attractiveness of Chinese bonds for some investor segments. In addition, Beijing's zero-Covid policy has led to lockdowns in several important economic cities, including Shenzhen and Shanghai and steel and auto-making regions. Chinese officials have signaled a shift from structural reforms to growth, but the market awaits concrete action. A cut in required reserves has been a tool frequently used and could be cut again without warning. However, officials may be reluctant to reduce them much more given the challenges from the property sector and economic slowdown. The benchmark medium-term loan facility rate is 2.85%. It was cut by 10 bp in January after being kept at 2.95% since April 2020. When the pandemic first struck, the one-year medium-term lending facility rate was cut by 30 bp. With less than 1% inflation, there is scope for lower rates.   It will be set in the week of April 12. A cut would likely signal a reduction in the one-year loan prime rate, which will be determined on April 19.  Q1 22 GDP will be reported the day before. Estimates are around 1% quarter-over-quarter, but the risks would seem to be on the downside.  

Spot: CNY6.3400 (CNY6.3175)

Median Bloomberg One-month Forecast CNY6.3540 (CNY6.3800) 

One-month forward CNY6.3590 (CNY6.3300)    One-month implied vol 3.2% (3.1%)

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