Commodity volatility weighs on economic outlook

• The war in Eastern Europe continues to be the dominant theme affecting economic policymaking and financial markets. Russia has now openly threatened to disrupt flows of natural gas to Europe in response to sanctions that have been placed on the country. Such a move would cause a massive spike in inflation that would largely need to be absorbed by consumers who face little alternative to using power: gas prices across Europe have shifted substantially higher already even ahead of any disruption. But wheat prices too continue to hit their upper trading limits almost immediately as traders scramble for available supplies. A shortfall of basic food commodities will add to inflation pain globally with longer-term socioeconomic effects.
• Japan’s current account deficit widened to JPY 1.19trn in January, up from JPY 371bn a month earlier. A major drop in exports was the catalyst for the weaker terms of trade in Japan’s economy, likely as a result of disruptions to activity caused by the Omicron variant of Covid-19. With energy and commodity prices generally surging the outlook for Japan’s balance of payments will likely worsen, putting more pressure on the yen which is already being held down by the Bank of Japan’s perpetual accommodative stance.
• Factory orders in Germany expanded in February, up 1.8% m/m, and their third consecutive gain. Factory orders are reportedly being supported by external demand though the risks there are skewed to the downside given the conflict in Eastern Europe will preclude Russia as an export market for German manufacturers.

Today’s Economic Data and Events

• 11:00 GE Industrial production m/m Jan: forecast 0.5%
• 17:30 US Trade balance Jan: forecast USD -87.3bn
• 19:00 US Wholesale inventories m/m Jan

Fixed Income

• US Treasuries pushed lower overnight even as investors pulled out even more from risk positions such as equities. Yields on the 2yr UST added 7bps to 1.5503% while the 10yr rose 4bps to 1.7734%. The spread between the two has fallen to just 22bps at the close overnight, essentially its narrowest since the start of the Covid-19 pandemic in 2020. Bonds across Europe were also lower overnight with gilts showing some of the weakest performance: 10yr gilt yields rose almost 10bps to 1.302%.
• Emerging market bonds close lower across the board with emerging Europe facing a dire economic outlook as they are acutely exposed to flows of Russian energy commodities: Hungarian 10yr yields rose 44bps to 5.864% while the equivalent 10yr yield in Romania added 42bps to 6.521%.

FX

• The rush toward the security of the US dollar continued at pace at the start of the trading week with the broad DXY index adding 0.65% to 99.293. Currency weakness was widespread with EURUSD actually managing to show some relative “outperformance” by falling just 0.68% to 108.54. That compares with a drop of 0.95% in GBPUSD to 1.3104 while USDJPY rose 0.44% to 115.32.
• Commodity currencies aren’t benefitting much from higher commodities as markets generally shed risk. USDCAD rose for a third day in a row, settling at 1.2820, up 0.7%. Meanwhile AUDUSD fell 0.7% to 0.7317 and NZDUSD dropped 0.51% to 0.6825.

Equities

• The turmoil in Eastern Europe and resultant commodity price surge weighed heavily on global equity markets to start the week. The selling pressure began in Asia, where the Shanghai Composite dropped -1.1% and the Nikkei -2.9%. The sell-off continued in Indian markets where the Nifty and the Sensex lost -2.4% and -2.7% respectively, reflecting the country’s vulnerability to higher oil prices.
• In Europe, Germany’s DAX dropped -2.0% to end the day in bear market territory, while France’s CAC lost -1.3% and the UK’s FTSE 100 a comparatively more muted -0.4%, as banks and oil companies offset the steeper losses in travel firms and consumer companies.
• In the US, the NASDAQ was the biggest loser of the three major indices, losing a further -3.6% yesterday to end down -18.0% ytd. The Dow Jones dropped -2.4% and the S&P 500 -3.0%, down -9.7% and -11.9% ytd.

Commodities

• Energy prices wrenched higher again overnight. After an initial pop to as much as USD 139/b, Brent futures faded that knee jerk reaction to fears that the US would impose sanctions on Russian crude oil exports but still managed a gain of 4.3% to USD 123.21/b. WTI followed with a gain of 3% to USD 119.40/b. Gas prices remain highly volatile with LNG and NBP prices adding more than 30% each and threatening to rise even further as Russia considers whether to cut supplies of natural gas to Europe.
• Wheat prices also remain high, hitting record levels as security of supply is in question as a result of the war in Eastern Europe. Nickel prices showed the most acute pain in metals markets, rising 66% overnight to more than USD 48,000/tonne.

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