Bond meltdown

Overview:  Federal Reserve Governor Brainard's suggestion of a rapid unwind of the Fed's balance sheet stoked a bond market sell-off that is continuing today, rippling through the capital markets.  The US 10-year yield is rising for the fourth consecutive session.  The six-basis point gain today puts the yield near 2.62%, which represents a little more than a 25 bp increase since the jobs data on April 1.  European benchmark yields are 3-6 bp higher.  Japan's 10-year yield is poking above 0.23% to again challenge the BOJ's Yield Curve Control.  Equity markets are taking it on the chin.  The major markets in the Asia Pacific region fell, led by a 2%+ sell-off in Hong Kong. China's markets re-opened after a two-day holiday, and although the Shanghai and Shenzhen markets posted minor gains, the CSI 300 slipped by 0.3%.  Europe's Stoxx 600 is off around 1.1% and US futures are about 0.75% weaker.  The dollar is mixed.  The Swiss franc, Norwegian krone, and Japanese yen are weaker.  The Swedish krona, sterling, and euro are posting small gains.  Among the emerging market complex, the South African rand leads the few currencies higher.  Poland, which is expected to lift rates 50-75 bp today has not prevented the zloty from softening.  The Hungarian forint and Indian rupee lead the decliners today.  Gold is edging higher within its consolidative range, after the $1915 area held.  May WTI is firm near $104, but within yesterday's range (~$99.90-$105.60).  US natgas is extending yesterday's 5.6% gain by another 2% today. It is up roughly 40% since mid-March.  Europe's benchmark is snapping a three-day 13% decline with a 2.75% gain today.  Iron ore is off around 1.3%, while copper is slipping lower for the first time this week.  May wheat is paring the two-day 6% rise.  

Asia Pacific

China's mainland markets re-opened after the two-day holiday.  The news was poor.  The Caixin service and composite PMI were weaker than expected.  The services PMI slumped to 42.0 from 50.2. The composite dropped to 43.9 from 50.1.  In some ways, the news confirms what the market already knew in broad strokes.  The world's second-largest economy is struggling mightily as the zero-Covid policy is disrupting activity.  The lockdown in Shanghai, for example, has been extended.  The economic disappointment will underscore expectations for additional policy support.  

New Zealand is placing a 35% tariff on imports from Russia while extending its export prohibitions.  Australia reports February trade figures tomorrow.  Weaker exports and stronger imports are projected to translate into a smaller surplus.  The new pact between the US, UK, and Australia (AUKUS) is not just about the nuclear-powered submarines.  It was announced that they are also working on developing hypersonic weapons.  Meanwhile, a Quad (Australia, Japan, India, and the US) meeting slated for next month may be delayed until after the Australian election.  This also means that US President Biden's first trip to Japan will also be rescheduled.  

Rising US yields have helped lift the greenback to JPY124.  The dollar's multiyear high set in late March was almost JPY125.10.  The market looks set to challenge it again and a marginal new high is possible.  Recent comments by the Minister of Finance and the BOJ Governor show continued sharp depreciation of the yen is not desirable.  A month ago, the dollar was near JPY115.  The Australian dollar surged yesterday as the central bank appeared to signal the likelihood of an earlier hike, but it is trading quietly today.  The Aussie is in around a 15-tick range on either side of $0.7575.  Although it reached $0.7660 yesterday, the $0.7600 area may offer a cap today.  China's mainland market re-opened today, and the dollar initially jumped to a five-session high near CNY6.3765.  It spent the local session drifting lower and is now near CNY6.3600, back within the April 1 range.  The PBOC set the dollar's reference rate at CNY6.3799.  The median projection (Bloomberg survey) was CNY6.3791. 

Europe

German factory orders slumped 2.2%. It was the first decline in four months.  The median forecast (Bloomberg) anticipated a 0.3% decline.  The January series was revised to 2.3% from 1.8%, offering a small consolation.  Domestic orders fell for the second consecutive month, while foreign orders slid 3.3%.  That said, foreign orders have been alternating between gains and losses since at least last August.  A group of economic advisers to the German Chancellor cut this year's growth forecast to 1.8% from 4.6%, while warning that a recession was possible.  Tomorrow, Germany is to report February industrial production figures.  The median forecast is for a 0.2% gain after the 2.7% surge in January.  The risks are on the downside.  Note that yesterday, France reported February industrial output fell by 0.9%, three-times the decline the median forecast anticipated.  The aggregate report is due next week. 

Poland's central bank is expected to deliver its seventh consecutive rate hike today.  The reference rate stands at 3.5%.  The median forecast is for a 50 bp hike, while the average forecast leans toward a 75 bp move. Poland began the tightening cycle last October with a 40 bp move.  It was followed by 75 bp in November and then three 50 bp moves before a 75 bp hike last month.  Meanwhile, the EU has wasted no time since Hungary's Orban handily won the weekend election to begin pressing with the untested “conditionality mechanism” which can lead to the denial of EU assistance (~40 bln euros) for violating core values.  

Since posting a key downside reversal last Thursday, the euro has been unable to sustain even modest upticks.  It had been turned back from around $1.1185 and tested $1.0875 today, its lowest level since March 8.  The low was recorded in Asia, and early European dealing squeezed it to about $1.0925 before it ran out of steam.  The single currency looks poised to re-test the $1.08 area seen on March 1.  Sterling posted an outside down day yesterday, trading on both sides of Monday's range and then settling below Monday's low.  Follow-through selling pushed it briefly below $1.3050 before it too bounced in the European morning to almost $1.3110.  There may be scope for additional minor gains, but we expect it to come off in the North American morning.  

America

Many observers seem confused.  They had the Fed's Brainard as a dove.  Yet her comments yesterday were as hawkish as they have come.  Reducing inflation was paramount.  She seems to be part of the growing consensus to hike 50 bp next month.  It was her comments about the balance sheet that may have done the most damage to stocks and bonds.  She referred to a “rapid” pace.  The previous exercise saw the unwind limited to $50 bln a month and it took several months to ramp up to the limit.  Brainard appeared to confirm a more aggressive unwind that could begin as early as next month.  The 2-10-year yield curve steepened back to a positive slope, but it is not because investors think that the balance sheet adjustment will take some pressure off the need to raise interest rates.  

On the contrary, the implied yield on the December Fed funds futures contract rose to a new high and is now implying 220 bp of hikes this year.  Hawk and dove labels may be helpful for analytic purposes, but they are always contextual.  Bullard, the leading hawk now, may not have gotten what he wants, hence the dissent at the March meeting.  However, the rest of the FOMC is converging to his broad position.   Consider that in March, there were only two dots above 2.38% for the Fed funds target at year-end.  The December Fed funds futures contract implies a year-end rate of 2.54%.  Brainard did not steal all of the thunder from the FOMC minutes.  The market still wants to have a better idea of the pace of the unwind.  Anything more than around $100 bln would surprise.  The phase-in period likely begins next month and will quickly ramp-up toward the caps.  

The US dollar rebounded off CAD1.24 yesterday and settled near the session high just below CAD1.25.  A bullish hammer candlestick pattern was left in its wake.  Follow-through buying today has been minimal and the greenback tested CAD1.2510.  It looks like the move in early March near CAD1.29 has been completed.  A consolidative/corrective phase looks likely from a technical perspective.  Initial resistance is seen near CAD1.2550, we suspect a move toward CAD1.2600 is likely.  The 200-day moving average is around CAD1.2620.  The greenback's slide against the Mexican peso appeared to have ended.  The move began on March 9 after peaking the day before near MXN21.4675.  At the start of this week, it fell to MXN19.7275.  That move ended with aplomb yesterday and the greenback raced above MXN20.00 for the first time since March 29. Momentum and trend-followers are caught leaning the wrong way.  A short-squeeze could lift the dollar toward MXN20.14 and then, possibly MXN20.35-MXN20.40.