China’s Covid Sends Commodities Lower and helps the Dollar Extend Gains

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Marc Chandler
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Overview: Fears that the Chinese lockdowns to fight Covid, which have extended for four weeks in Shanghai, are not working, and may be extended to Beijing has whacked equity markets, arrested the increase in bond yields, and lifted the dollar. Commodity prices are broadly lower amid concerns over demand. China’s CSI 300 fell 5% today and Hong Kong’s Hang Seng was off more than 3.5%.  Most of the major markets in Asia Pacific were off more than 1%. Europe’s Stoxx 600 is off around 1.9% after falling 1.4% last week. US futures are about 0.7%-0.8% lower. The S&P 500 fell last week for the third consecutive week, the longest losing streak in 18 months. The US 10-year Treasury yield is almost seven basis points lower at 2.83%. European benchmark yields are 4-6 bp lower. The BOJ bought JPY727 bln of 10-year bonds at the pre-committed fixed rate operation, more than in the previous three operations last week combined. The yield slipped half of a basis point. The dollar rides high. It has appreciated against all the major currencies but the yen. The Australian dollar, Scandis, and sterling have been hit the hardest and are around 0.9-1.2% lower in the European morning.  Emerging market currencies are heavy as well. Hungary, Mexico, and China have seen their currencies decline by around 1% to lead the complex. Gold fell to new lows for the month around $1912 before stabilizing. June WTI is 4.3% lower near $97.70 after falling around 4% last week. US natgas is extending last week’s 10.5% sell-off, while the European benchmark is up 2.5% after a flat showing last week. Iron prices are off 8.7%, after tumbling closer to 12% at one juncture today.  It fell a little less than 5% last week. Copper is off around 2.1% after declining about 3% last week. July wheat is up about 0.5% as it tries to snap a four-day slide.

Asia Pacific

China’s Covid has emerged as a powerful economic force in its own right. It is threatening demand for commodities and threatening to extend supply chain disruptions. Shanghai reported a record number of fatalities, and the infection is spreading to Beijing. The Chaoyang district will submit to three days of testing this week for people who live and/or work in the area. Reports suggest 14 smaller communities have been sealed and another 14 have imposed limitations on movement. China’s demand for gasoline, diesel, and jet fuel has reportedly fell by 20% year-over-year, which may translate to 1.2 mln barrels of oil a day.

The US has threatened unspecified action if Beijing’s new security pact with the Solomon Islands result in a permanent Chinese military presence. While the US has defended Ukraine’s right to make its own foreign policy decisions, it seems to want to limit Solomon Island’s choices. Prime Minister Sogavare has articulated his own 3 No’s Policy. He says that the secret treaty has no provision for a Chinese military base, no long-term presences, and no ability to project power from the islands. The Solomon Islands are about 2k kilometers of Australia’s coast.

The dispute over the Solomon Islands has emerged as a campaign issue in the May 21 Australian elections. Prime Minister Morrison, who seeks a fourth term, has defended his foreign policy, and tried shifting the focus back to domestic issues with a promise to cap tax revenue at 23.9% of GDP and A$100 bln of tax relief over the next four years if re-elected. Government revenues were 22.9% of GDP in FY21. Labor leader Albanese has been diagnosed with Covid at the end of last week. This disrupted his campaign in the tight contest.  Morrsion had contracted the disease in early March.

The dollar initially approached JPY129 but falling US yields saw it come off and traded below JPY128, where a $425 mln option expires today. The greenback remains in the range set last Wednesday (~JPY127.45-JPY129.40). Indeed, it is trading within the pre-weekend range (~JPY127.74-JPY129.10). The takeaway is two-fold. First the exchange rate is still closely tracking the US 10-year yield. Second, after surging in March and most of April, the exchange rate is consolidating. The Australian dollar is falling sharply for the third consecutive session. It fell 1% last Thursday and 1.75% before the weekend and is off another 1% today. It is lower for the 11th session in the past 14. It fell to a two-month low near $0.7150 in late Asian turnover before stabilizing. The $0.7200 area now offers resistance. The sell-off of the Chinese yuan continued. The greenback gapped higher and never looked back.  Recall that the dollar settled around CNY6.3715 on April 15. A week later, last Friday, it settled above CNY6.50 and today, pushed over CNY6.56. It is the greenback’s 5th consecutive gain and today’s advance of a little more than 0.9% is the largest advance since March 2020. The dollar is trading at its best level in nearly a year and a half. The PBOC set the dollar’s reference rate at CNY6.4909, slightly lower than market projections (CNY6.4911 in the Bloomberg survey). The next key chart area is CNY6.60.

Europe

Macron was easily re-elected with a roughly 58%-42% margin. Partisans, perhaps trying to bolster the turnout and some press accounts seemed to exaggerate Le Pen’s chances.  No poll showed her in the lead.  Still, the euro initially trading higher (~$1.0850) before falling to almost $1.07 before the end of the Asia Pacific session. The June parliamentary election will shape Macron’s second term and his ability to enact his program. Separately Slovenia voted not to grant Prime Minister Jansa another term. This further isolates Hungary’s Orban. Golob, the former head of the state-owned power company before dismissed by Jansa, will lead what appears to be a center-left government.

Last week, Germany’s flash PMI was mostly better than expected. Recall that helped by the surprising gain in the service PMI, the composite fell to 54.5 not the 54.1 economists expected (median, Bloomberg survey). Today, the IFO survey was also better than expected. The current assessment ticked up to 97.2 from 97.1, while the expectations component rose to 86.7 from a 84.9.  The overall business climate reading rose to 91.8 from 90.8. Separately, the government is expected to announce a supplemental budget on Wednesday that will boost this year’s net new debt to at least 140 bln euros. This is a 40 bln euro increase to fund government measures to cushion the impact of the war and the surge in energy prices. Some of the off-budget 100-bln euro defense spending initiative will may also be funded this year.

The euro traded to almost $1.0705 in late Asia Pacific turnover, its lowest level since March 2020. There is a 945 mln euro option struck at $1.07 that expires today.  The pre-weekend low near $1.0770 may now serve as resistance. There are large options at $1.08 expiring over the next two days (1.6 bln euros tomorrow and 1.2 bln euros on Wednesday). The Covid-low was set in March 2020 near $1.06. Sterling has been pounded again. It dropped nearly 1.5% before the weekend, a roughly two-cent fall that took it to around $.12825. It has lost another cent today to about $1.2730. While we noted chart support near $1.2700, the next important chart area is closer to $1.25. It finished last week below its lower Bollinger Band, and it remains well below it (~$1.2850) today. In fact, it is more than three standard deviations from the 20-day moving average (seen near $1.2755).

America

St. Louis Fed President Bullard opined last week that a 75 bp hike may be needed at some juncture. He explicitly said that it was not his base case. Yet some in the markets, and more in the media seemed to play it up. No other Fed official seemed to endorse it; Fed futures are pricing in a 51 bp for next week rather than 50 bp. The Fed’s quiet period ahead of the May 4 FOMC meeting means no more official talk.  Today’s economic calendar features the Chicago Fed’s March national activity index, which is reported with too much of a lag to provide new insight or a market reaction. The Dallas Fed’s April manufacturing survey is due as well. The early Fed surveys have not generated a consistent signal. The Empire State survey was stronger than expected while the Philadelphia Fed survey was weaker than anticipated. The Dallas survey is expected to have softened.

Canada’s calendar is light until Friday’s February GDP print. The Bank of Canada does not meet until June 1. The swaps market currently has a little more than a 25% chance that it hikes by 75 bp instead of 50 bp. However, the Canadian dollar itself seems more sensitive to the risk-off impulse spurred by falling equities than the policy mixed in Canada.

Mexico reports IGAE economic activity survey for February. It is too dated to have much impact, and in any event, is being overwhelmed by the risk-off attitude. The bi-weekly CPI report, covering the first half of April, released before the weekend, was stronger than expected. The headline rate rose to 7.72% and the core rate rose above 7% for the first time in this cycle. It is particularly disappointing because seasonal considerations, like the summer discount on electricity taxes, often point to less price pressures. The risk of a 75 bp hike at the May 12 Banxico meeting is increasing.

The US dollar jumped 0.65% against the Canadian dollar last Thursday and slightly more than 1% before the weekend. It is up another 0.2% in the European morning to around CAD1.2740, after having approached CAD1.2760 in Asia Pacific turnover.  The greenback finished last week above its upper Bollinger Band and has spent most of today’s session above it (~CAD1.2720). The market is over-extended but there is little chart resistance ahead of CAD1.28. The peso’s fall is also continuing. The US dollar traded above its 200-day moving average (~MXN20.42) for the first time since March 18. It is also above the (38.2%) retracement objective of the slide since the March 8 high (~MXN21.46), which is found around MXN20.39. The next retracement (50%) is closer to MN20.60 and the measuring objective of the potential double bottom is near MXN20.60.

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