‘Difficult and vicious’ are the talks between Ukraine and Russia according to the Ukrainian President Zelensky, but there is room for compromise as he also recognized that being part of the EU or NATO is perhaps a faraway dream for Ukraine. Yet, he had already said that, to prevent an invasion when the tensions were escalating a couple of weeks earlier. Therefore the diplomatic efforts are only a slim hope for a resolution.
But the market sentiment is better today. We saw a strong rebound in three major US indices on Tuesday. The S&P 500 gained more than 2%, while Nasdaq jumped close to 3%, as Apple bounced higher from the $150 dip of the day before on news that one of its iPhone suppliers in Shenzhen had to halt production due to the Covid lockdown.
Don’t mistaken: Bad news is bad news
The overall positive mood is put partially on the back of a terrifying Empire State Manufacturing index which dived to -11.80 in March whereas analysts were expecting an improvement from 3 to 7 level. The bad news could’ve acted as ‘good news’ for the market as the weak data may have revived the Fed doves. But the US producer prices hitting 10% in February certainly rules out that explanation as inflation is what matters the most for the Fed policy at the moment.
Therefore, the rebound could be just a short-term positive correction in a comfortably bearish medium term trend.
The dot plot
The Fed starts its newest tightening cycle today, and investors stand ready for a steep tightening to tame the 40-year high infaltion. The ‘dot plot’ will give more clarity on what the US policymakers think about the potential implications of the Ukrainian war on the future of the Fed policy. But there is a chance that we discover a more hawkish FOMC due to the rising inflation that is triggered by the skyrocketing energy and commodity prices, than a dovish outlook because of a slower growth due to the geopolitical tensions. The US 10-year yield is now at the levels it was before the pandemic started.
The US dollar? Tighter Fed policy is, in theory, a booster for the valuation of the greenback and should lead to a further appreciation in the US dollar across the board, but the historical data confirms that the dollar weakened on average 4.1% during the four latest tightening cycles, as a tighter Fed suggests an improving global growth and a greater demand for raw materials and stronger currencies other than the US dollar.
But this time, the Fed isn’t necessarily tightening because the economy is doing well, it’s tightening because there is an urgent need to tame the skyrocketing inflation despite the threat of a slower global growth.
The news from Ukraine will certainly be the major driver of the US dollar in the coming weeks. A diplomatic solution will certainly trigger a rapid downside correction in the dollar despite a more hawkish Fed, while the lack thereof could support a further appreciation of the US dollar.
Oil
US crude dipped to $93 per barrel yesterday than rebounded back above the $98 mark this morning. The Covid lockdown in China, and the news that India bought discounted Russian crude, potentially diminishing the hit to global supplies from import bans in the US, UK, and Canada, have certainly helped, along with the failure to break above the $130 mark after the announcement of the Russian oil ban which triggered a massive cut in long positions.
I expect a solid support near $88/90 per barrel range, including the major 61.8% Fibonacci retracement on December – March rally. Above this level, the price outlook will remain positive, while a break below, will certainly hint at a deeper and more sustainable downside correction. But that’s not my base case due to a globally tight supply. UBS also says that they expect the global oil demand reaching record highs in the second half of the year, and the impact of the latest Chinese lockdown will be limited in the medium run.
Default?
Russia is due to pay $117 million in interest on its dollar-denominated bonds today, and the failure to service debt could lead to a massive $150 billion default next month. Russia has means to pay back the interest, yet they can’t pay in US dollars that they can’t access.
A default could be a blow to the banking stocks due to their exposure to the Russian debt, because the latter was investment grade just a couple of weeks ago. The good news is, though an eventual Russian default will give a shake to the financial markets, it is not a systemic threat to the global economy. Phew.
