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Recession meltdown

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By Jeffrey Halley   

Recession fears buffeted markets overnight, with the price action across various asset classes looking like a self-sustaining negative feedback loop, triggering more stop losses as prices slumped and dragging in trend-following momentum-hunting fast money.

Europe endured a torrid day as the Norwegian oil workers’ strike proved the last straw for an energy-starved Europe. Equities plummeted and rightly so, as Europe’s energy-from-Russia Achilles’ heel was cruelly exposed.

The Euro also capitulated, EUR/USD taking out 1.0350 on its way to a 1.50% loss to 1.0260. Sterling and UK equities were also hammered by the extra headwind of political instability as three senior ministers resigned overnight with immediate effect.

There may be some respite for Europe on Wednesday, though, as the Norwegian government imposed a settlement on both sides effectively ending the strike. It is likely to be temporary.

In the US, equity markets opened much lower, but US bond yields outdid them, slumping on recession nerves overnight and sending the US 10-year down to 2.805%, leaving the 2-year 10-year yield curve teetering on inversion.

Perversely, the slump in US bond yields, which might also be due to haven inflows and not just recession fears, saved the bacon of US equity markets. US stocks reversed most of their losses, and ironically, the Nasdaq rallied to a 1.75% gain.

The still-richly-valued growth stocks of the Nasdaq are the most interest-rate sensitive on US markets, and small moves in the risk-free discount rate have outsized price impacts in these environments. Still, the Nasdaq gains looked like a mechanical rear-guard action and not a brave new dawn.

A US and Europe recession won’t do their ambitious valuations any favours, either.

The big winner overnight was the US Dollar, which rallied imperiously versus both developed and emerging currencies.

A sign of the nerves around US Dollar strength came from China on Wednesday, which set a much weaker Yuan fixing rate of 6.7346 versus the US Dollar, as it glanced around at the slump in other Asia currencies overnight.

The only winner was the Japanese Yen. USD/JPY held steady overnight at 135.90, as the US/Japan rate differential plummeted lower. However, it has immediately fallen by 0.50% to 135.15 in Asian trading. As said previously, the long USD/JPY has become a dangerous one as the primary reason for it occurring in the first place, the US/Japan rate differential narrows sharply.

Oil prices also slumped overnight on recession hype.

Ironically, one of the night’s outperformers was Bitcoin, which reversed intraday losses to close unchanged at $20,200.00. I can only surmise that the Nasdaq’s rally lifted Bitcoin as well so that’s the short-term correlation to watch now, although it has already fallen 1.80% to $19,800.00 Wednesday morning.

My line in the sane for Bitcoin remains $17,500.00, everything above that will be noise, failure should trigger another wave of margin stop outs among the geniuses conjuring 20% returns out of thin air.

Commodities also slumped overnight on recession fears, notably copper. But as a grouping, hard and agricultural commodities look to have peaked a few weeks ago, except for European natural gas, for obvious reasons.

Gold fell below $1780.00 an ounce overnight, an ominous technical development. But spare a thought for palladium. It is trading at $1909.00 an ounce Wednesday morning, it’s hard to believe it traded at $3400.00 an ounce in early March.

With another Federal Reserve hike looming at the end of the month, the noise will increase that Fed will now have to mollify the pace and size of its rate hikes. Unfortunately, inflation in the US, like elsewhere, is showing no signs of abating and the data recently has really been that bad, much like Australia.

This is more likely to be a story for Q4. If the US JOLTs Job Openings remain at 11 million or above, and the US Non-Farm Payrolls is comfortably above 250,000, there will be no sensible reason for the Fed to blink. Most of all, it is a credibility issue.

Having got transitory inflation so utterly wrong and stubbornly clung to a dogma past its sell-by date, if the FOMC blinks now, they may as well do an Elvis and leave the building. Puppies and kittens don’t need to be trained to chase their tails, we certainly don’t need it from our central banks, who aren’t even cute to boot.

On Wednesday afternoon we get German Factory Orders and Pan-Europe Retail Sales.

The releases won’t make good reading and could heap more pressure on the Euro and European equities, although I don’t discount the Norwegian oil strike settlement giving both a temporary reprieve.

Oil plummets on recession fears

Recession fears saw oil markets plummet overnight, with both Brent crude and WTI taking out their 2022 rising support lines in no uncertain terms. Brent slumped by 7.90% to $104.75, having tested $101.00 a barrel intraday. WTI slumped by 8.75% to 100.90, trading as low as $97.50 intraday.

In Asia, both contracts remain under pressure as China lockdown nerves sweep the region. Brent has fallen 0.90% to $103.85 and WTI is 0.60% lower at $100.00.

The price action overnight, with both contracts trading in near 15 dollar ranges, hints more at panic and forced liquidation, than a structural change in the tight supply/demand situation globally.

Although I acknowledge recession risks in the US, and covid zero ones in China, the world’s two largest consumers, the futures markets in both Brent crude and WTI remain in heavy backwardation. That says that in the physical market, supplies remained as constrained as ever, and despite the noise overnight, oil prices may be in danger of overshooting to the downside.

But with Russian oil supplies set to drop as the year progresses and it runs out of Western parts to maintain fields, and with the rest of OPEC hopelessly uninvested in maintaining production capacity, I fear the days of $100 oil will be with us for some time yet. That said, Brent crude and WTI are likely moving into a new $95.00 to $110.00 barrel range.

Gold capitulates

The massive strength of the US Dollar across asset classes overnight was more than gold could withstand, despite lower US yields. It wilted in the face of US Dollar strength and finished overnight 2.40% lower at $1765.00 an ounce. In Asia, it has eked out a tiny gain to $1767.40.

With gold moving inversely to the US Dollar and no other inputs driving the price, gold’s only salvation from here is entirely reliant on a sudden reversal of course by the greenback.

Having finally broken out lower from its multi-month $1780.00 to $1880.00 range, the failure of $1780.00 is an important technical development. Assuming the Dollar rally continues, the technical picture suggests a move lower to $1720.00 an ounce in the days ahead.

Gold has resistance at $1780.00, $1785.00, and $1820.00, its downward trendline. Support is at $1764.00 and then $1720.00, followed by $1675.00. Failure of the latter sets in motion a much deeper correction, potentially reaching $1500.00 an ounce.

 

Jeffrey Halley is Senior Market Analyst, Asia Pacific at OANDA

Opinions are the author’s, not necessarily that of OANDA Global Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. Losses can exceed investments.