MARKET WRAPS

Watch For:

No major data scheduled; Pfizer results

Opening Call:

Stock futures pointed to muted gains for major indexes, while the worst bond rout in decades continued, as investors geared up for the Federal Reserve's policy decision and a batch of earnings.

All eyes are on the Fed's next steps as the central bank tries to tap the brakes on the fastest pace of inflation in decades. Rising rates have combined with coronavirus shutdowns in China and the war in Ukraine to send jitters through stock markets this year.

"It appears that the war in Ukraine hasn't derailed the Fed in the slightest," said Gregory Perdon, co-chief investment officer at Arbuthnot Latham. Financial conditions have already tightened significantly, Mr. Perdon added, pointing to a strengthening dollar, the increase in Treasury yields and rising mortgage rates.

Earnings season continues apace. Broadly positive corporate reports have failed to steady the market in recent weeks. Earnings growth is in line with historical norms at about 11% annually, according to Deutsche Bank analysts, while margins have remained near record levels in spite of rising input prices.

Overseas stock markets broadly rose. The Stoxx Europe 600 gained 0.7%, led by shares of banks and oil-and-gas companies on a busy day for earnings in the region. Mainland Chinese markets were closed for a public holiday. Hong Kong's Hang Seng edged up 0.1%.

Economic Insight:

The chaos caused to supply chains, triggered by China's zero Covid-19 policy, is likely to weigh on U.S. manufacturing sector growth, said Pantheon Macroeconomics' chief economist Ian Shepherdson. There is no end in sight to the increasingly severe disruptions, and even though that domestic demand is strong, U.S. goods producers will likely be hit by the difficult context in China, he said.

Manufacturing accounts for about 11% of U.S. GDP, so the slowdown wouldn't necessarily translate to a huge risk for the economy, Shepherdson says. "None of this will prevent a 50-basis-point hike on Wednesday, or likely in June, but we are on the alert for markets to start scaling back their expectations for mid-summer onwards."

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U.S. wages are growing at the quickest pace since the 1980s, but the current rise isn't likely to fuel a wage-price spiral that would push inflation even higher, BlackRock said.

Higher wages don't necessarily mean higher inflation in the current situation as companies are paying less in labor costs per unit of output than before the pandemic as workers are more productive. "Wages have room to rise as they catch up with productivity and price gains, rather than drive more inflation pressure," BlackRock analysts said.

Forex:

With the Fed expected to raise interest rates on Wednesday and the U.S. economy looking "robust" the dollar looks set to remain strong, said Commerzbank.

Despite questions over the dollar's high valuations after the DXY Dollar Index recently hit a two-decade high, the currency "remains the better alternative," said analyst You-Na Park-Heger.

"In view of the Fed meeting tomorrow and the increasingly concrete discussion about an EU oil embargo against Russia, the dollar is therefore likely to remain in demand."

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A firm break for the euro below the $1.05 level against the dollar looks very likely this week as the single currency suffers from underperforming European equities and fears of a prolonged Russia-Ukraine conflict, said ING. This also comes as the dollar performs well ahead of a likely interest-rate rise by the Fed on Wednesday.

"A week with the FOMC meeting and not much action on the eurozone calendar/ECB speaker side could definitely see a decisive technical break lower [for the euro]," said ING.

Read: Powell Wants to Get Closer to Neutral. But What's That?

Bonds:

The yield on the 10-year Treasury hovered close to 3% Tuesday, as traders braced for the outcome of this week's Fed meeting.

As it stands, interest-rate derivatives show that investors expect the Fed to increase its benchmark federal-funds rate from its current level between 0.25% and 0.5% to just above 3% next year.

Meantime, the 10-year German Bund yield briefly breached 1% for the first time in almost 7 years, tracking its Treasury and gilt peers.

"The big market moves show the market is slowly starting to price that the Fed will be able to keep inflation and inflation expectations in control through a higher real yield," said Deutsche Bank's strategists. They still see upside potential for Treasury yields from the current level.

Energy:

Crude futures edged lower in Europe as expectations of an EU oil ban countered weak U.S. economic data.

EU proposals to ban purchases of Russian oil by the end of the year are expected to be circulated among member states Tuesday, the Wall Street Journal reported.

"Oil remains supported as the EU appeared to progress on a Russian crude import ban. But further gains will be limited," said SPI Asset Management.

Traders are awaiting a meeting of ministers from OPEC members and their allies including Russia on Thursday, and also monitoring shutdowns in China that are curbing fuel demand.

Commodities:

Prices for gold and base metals were lower in European trade, on mounting economic worries over Covid-19 lockdowns in China and tightening by the Fed.

Dampening economic sentiment is still continuing to hit metal markets, with investors looking to the dollar and U.S. Treasury bonds as safe havens.

Other News:

Even though nickel-price volatility has eased in recent weeks, the disconnect between Chinese and London nickel prices remains wide, said Macquarie analysts.

Chinese prices of nickel pig iron and nickel sulphate are trading at "major and unprecedented discounts" to the benchmark London Metal Exchange contract. The analysts said Chinese prices have been depressed by a jump in supply from Indonesia.

"The expected nickel surplus in 2022 is likely to be entirely in class 2 material, with the size of the deficit in class 1 [battery grade material] reduced [but] not entirely eliminated."

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The economic recovery from the pandemic and the war in Ukraine has driven an unprecedented demand for fossil fuels, but this has not come at the expense of investment in green energy, said Macquarie CEO Shemara Wikramanayake at the Macquarie Australia Conference.

Wikramanayake said high energy prices were pushing business and consumers to bring forward investment into energy efficient areas like electrification.

"The weight of available capital means there is still scope for significant investment opportunities this year despite the specter of rising interest rates."

She said Macquarie was working with resources clients about how to meet the burgeoning demand for essential inputs for electrification, like copper, lithium, nickel and rare earths.


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