Risk appetite wanes as Russia intensifies bombardment of Ukraine
Talking Points: Developments in Ukraine steal spotlight from economic data releases in EMEA
South Africa: Yesterday's local data releases reflected a rebound in economic activity. ABSA's manufacturing PMI rose to 58.6, which is not far off its highest levels on record. This suggests that SA's economic reopening has led to a significant improvement in purchasing manager activity, with even the employment component rebounding back above the 50-expansion mark at a reading of 50.6. The NAAMSA vehicle sales data came in significantly stronger than consensus, indicating that an economic rebound is underway through the lens of vehicle sales. Due to the significance of vehicles in economic activity, their relatively high cost, while often being purchased with bank credit, vehicle sales are considered a leading indicator of economic activity. Higher sales suggest that consumers and businesses are experiencing improving levels of economic certainty. But to what degree this plays out in generally higher growth rates is questionable as global markets price in a deterioration in geopolitical stability in Europe. Structural factors domestically are also ultimately bearish on growth, notwithstanding the prospect of fiscal and economic reform.
Investors are also digesting the third instalment of acting Chief Justice Zondo's state capture report that was published last night. In the report, Zondo outlined how former President Jacob Zuma, Mineral Resources & Energy Minister Gwede Mantashe, and former Gauteng Premier Nomvula Mokonyane were implicated in state capture. The chief justice instructed law-enforcement agencies to conduct further investigations into Zuma, Mantashe, and Mokonyane with a view of prosecuting them on corruption charges over dealings with now-defunct security company Bosasa.
Turkey: Turkey's manufacturing PMI fell marginally from 50.5 in January to 50.4 in February. This marks the second consecutive month that the PMI reading dropped, reflecting the impact of natural gas and electricity outages which contributed to a slowdown in output. The IHS Markit survey also showed that total new orders softened for the fifth month running as price increases and market uncertainty deterred customers. However, the employment index continued to rise as firms expanded their staffing levels amid efforts to improve capacity and keep on top of workloads. Notwithstanding the recent drop, the PMI gauge remains buoyed above the 50-mark, suggesting that the manufacturing sector remains relatively healthy and will continue supporting economic growth in the near term.
Russia: Whether it be by design or desperation, the bombing in Ukraine has intensified and the damage now being imposed on Ukraine is nothing short of catastrophic. The response has been and remains a passive-aggressive one. The Western world refuses to engage militarily with Russia but has stepped up sanctions very aggressively and has isolated Russia almost entirely, save for cutting off any trade on oil and energy products. Companies like Boeing, Apple, petro companies, banks, film studios and many others have all cut ties. The EU will be banning seven Russian banks from SWIFT, and while they might shift across to the Chinese Clearing House Interbank Payments System (CIPS) the disruption will still be enormous and will impact heavily on consumption.
The consequences not just for Russia but the rest of the world will be significant. Oil prices have surged higher, commodity prices have risen, and central banks will be left to make some very tough choices in the face of rising and stubbornly high inflation. Equity markets are correcting and the risk is that the world starts to price in a long and protracted war in Ukraine that consumes resources and keeps markets priced heavily for risk.
Hungary: Data released yesterday showed that business conditions in Hungary's manufacturing sector continue to improve, which could support economic growth in the near term. The headline PMI reading rose from 50.7 in January to 53.2 in February, reflecting the further easing of lockdown restrictions and recovering economic growth. Information from the Hungarian Association of Logistics, Purchasing and Inventory Management revealed that an increase in the overall PMI gauge resulted from the rise in new orders, output, employment index and purchasing activity.
Today, investors will be assessing the final Q4 GDP data. Market expectations are for GDP growth to rebound in the final three months of the year supported by the government stimulus measures, increased vaccination effort, recovering domestic and global demand and tightening labour market. Stronger economic growth will justify the tightening of monetary policy. While growth is expected to remain strong this year, the ongoing geopolitical risks alongside soaring inflation and the uncertain path of the epidemic pose downside risks to the growth outlook.
Poland: Poland and Lithuania brought forward the launch of their gas link in the wake of Russia's invasion of Ukraine, which raised worries about the gas supply in the EU. The GIPL pipeline will become operational on May 1 and will connect the gas networks of Lithuania, Latvia, Estonia, and Finland, to the Polish gas grid. According to Bloomberg, Lithuanian Energy Minister Dainius Kreivys said that "the integration of Baltic and Finish markets into common European gas markets is a guarantee of energy security and independence for the entire region." The pipeline's capacity to flow gas from Poland to Lithuania will be 230k cubic meters per hour from May until the end of September. From Lithuania to Poland, gas will flow at 217k cubic meters per hour. Whether or not the gas connection will be sufficient to offset the flow of gas from Russia will remain to be seen.
Czech Republic: The Czech Republic's economy expanded by 0.9% q/q in Q4, matching the preliminary reading after expanding by 1.6% q/q in Q3. The growth was primarily supported by increasing external demand and expenditure on fixed capital formation. On a y/y basis, the economy expanded by 3.6% in Q4, matching the preliminary figure but exceeding Q3's 3.5% growth. The Czech National Bank (CNB) reported that the annual GDP figure was 0.1 percentage point higher than expected, based on its latest forecast, with the difference being caused mainly by gross capital formation.
Accordingly, the Czech economy grew by 3.3% in 2021, despite difficulties in the automotive industry in H2 of the year and Covid-19 restrictions, after contracting by a record 5.8% y/y in 2020. However, the economy will likely face growth headwinds due to the uncertainty regarding the consequences of the war in Ukraine. The direct impact on Czech economic growth from the country's trade links with Russia and Ukraine will be limited. Still, inflationary impacts can be expected, mainly through higher prices of oil, natural gas and other energy and commodity items.
Forex: Commodity currencies trade with some degree of resilience in face of Ukraine risks
South Africa: ZAR trade continues to reflect broader financial market uncertainty, with volatility the order of the day as investors weigh ongoing developments in Ukraine against potential second and third-round effects. On the one hand, Russia's invasion has turned increasingly brutal, with this triggering further risk aversion that has driven a strong rotation into safe havens. On the other hand, surging commodity prices have bolstered many an EM country's terms of trade, in turn supporting their respective currencies. The ZAR, for one, has remained somewhat resilient, mainly due to the rise in metals prices. This will limit the damage surging oil prices exert on households and businesses, although it remains to be seen whether this resilience can be sustained. A cautious approach remains the best approach, and the USD-ZAR will likely retain a slight bid tone (tilted towards ZAR weakness) if matters in Ukraine continue to escalate.
Turkey: The USD-TRY traded in a consolidative fashion during the first trading session of the new month, with the pair pivoting around the 14.000 handle. FX interventions by the CBRT have underpinned the steady performance seen in the USD-TRY. Despite this, the risk for the pair remains skewed to the upside as risk appetite remains vulnerable to geopolitical tensions and rising oil prices, with Turkey's weak fundamentals a key factor to watch.
Russia: After depreciating past the 110/$ level during Moscow trade yesterday, the RUB has recovered slightly overnight. More generally, the currency continues to trade with a high degree of volatility, with markets reacting on headlines as the West implements punitive measures to punish Moscow for Russia's invasion of Ukraine. The Russian government has implemented its own measures to ease the pain, however, such as ordering export companies to sell their forex revenues on the market, or banning the export of cash in the foreign currency system exceeding $10,000 in value. As this back and forth continues, the RUB will remain extremely volatile, with the bears still very much in control for now.
Hungary: Consistent with the performance in the CEE currencies, the HUF remained under pressure a the geopolitical risks weighed. Intraday, the local currency depreciated by 2.10% to reach a multi-record high before sellers joined the trend to trim the losses to 1.45%. The HUF pared the decline after the NBH announced that it could intervene in the FX market to boost the local currency. Deputy Governor Barnabas Virag also struck a hawkish tone, pledging to remain committed to monetary tightening to rein in spiralling inflation and ensure stability as the market fallout from the war in Ukraine intensifies.
Poland: The bullish bias in the EUR-PLN remained entrenched on Tuesday as geopolitical tensions continue to escalate after Russia said it would press forward with its invasion of Ukraine until its goals are met. Intraday, the cross advanced by about 2.27% and flirted with levels above the 4.80 mark. However, this was before sellers joined the trend riding on the back of the central bank's intervention into the FX market to help support the PLN. As a result, the EUR-PLN trimmed the gains to 1.00%. The cross is trading relatively flat ahead of the local open after being subject to some whipsaw action. The central bank's interventions to manage volatility could keep the cross steady in the session ahead.
Czech Republic: The EUR-CZK bulls maintained their advance yesterday, breaking above the 200DMA to probe the 25.600 resistance, a four-month high. Before the close, the pair pulled back to close at 25.399. Since the Ukraine invasion, the pair has rallied by almost 5%. From here, the pair will eye November's 25.793 high. At this rate, authorities will need to intervene in the spot market to prevent the CZK and its regional peers from weakening considerably more.
Fixed Income: Bond markets mixed as investors weigh prospective growth slowdown against inflation risks
South Africa: SAGBs are coming under pressure as global risk appetite takes a knock. The R2030 has traded up to 9.474%, its highest since early Jan, while bear flattening could be seen if higher oil prices lead to materially higher SARB rate hike expectations. It is interesting to note that breakeven rates, which are the difference between vanilla and inflation-linked bond yields, have started to rise. The 5-year has risen to 5.34%, topping October highs and now looking at May 2019 highs. The 20-year is trading around 6.8%. These suggest that the market has been pricing in a higher risk of inflation as ZAR fragility and higher oil risks are considered.
Turkey: Turkish yields at the short end have declined notably in recent sessions, while the rest of the curve has generally been relatively flat. While investors are struggling to navigate Turkey's idiosyncratic economic issues such as an incredible central bank and red hot inflation, they are also having to trade on Russia-Ukraine headlines. The market will thus likely continue to trade with a high degree of volatility in the near term, with the balance of risks tilted to the downside.
Russia: Russian bonds have continued to trade with more volatility than many investors are able to stomach, with yields moving significantly in both directions across the curve. The market is trading on headlines, meaning volatility will likely remain the order of the day until the Russia-Ukraine war concludes. Notwithstnading the more than 450bps worth of yield increases some tenors have recorded year-to-date, the bias remains topside tilted for yields as the sting of Western sanctions intensifies.
Hungary: Interest for the T-bills auction held yesterday improved notably, with total bids arriving at HUF103.79bn compared with HUF58.9bn a week ago. Against this backdrop, the AKK was prompted to sell HUF41.5bn of discount three-month T-bills, surpassing the original offer by HUF11.5bn, generating a cover ratio of 2.50 (vs 1.96). The clearing yield also increased by 35bp over the yield at the previous auction a week earlier to clear at 4.85%. The significant increase in demand for the T-bills could be attributed to the interest rate risks as the central bank is likely to hike policy rates further to stem the high inflation and the geopolitical risks being priced in by the markets.
Poland: Polish bonds took a breather yesterday as they tracked German bund and UST yields which have continued to fall due to increased haven demand. Yields across the curve drifted lower on Tuesday, with a more pronounced drop evident at both the front and very long end of the curve. The rally in local bonds could persist amid the economic growth threats in the region due to the ongoing crisis between Ukraine and Russia and the major central banks tempering rate hike expectations.
Czech Republic: Czech bonds calmed on Tuesday with yields falling for the first time in six sessions as Russia announced it had ceased fire after its invasion upended financial markets while investors' concerns shifted to stagflation. Higher oil prices and possible downside risks to global economic growth are likely to start pricing in stagflation risks, with investors wondering whether the Fed and other central banks will tame inflation with higher borrowing costs or try to mitigate downside risks to growth by pausing tightening. If sanctions against Russia remain in place for an extended period, oil prices could stay elevated. All of this points to monetary policy and bond market uncertainty in the short term.