The Overnight Report: Inflation Fears Rise

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This story features TPG TELECOM LIMITED, and other companies.
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Higher oil prices and questions over the duration of the Middle East war weighed on markets with Nasdaq falling the most, despite cyber security stocks rallying on cyber attacks concerns.

Bond yields tracked higher as inflation worries ticked up, supporting the US dollar.

After Thursday's sell off on the Australian market, ASX200 futures are signaling a weak start for the final day of the trading week.

Good Morning,

Rising oil prices, above US$100bbl, weighed on the Australian market on Thursday with the ASX200 falling -114 points or -1.3% to 8,629.

The tech sector fell -3.5%, as the worst performer, while energy gained 2.1% and outperformed.

Oil, Inflation and a Shift in Market Thinking, Chris Weston, Pepperstone extract

Taking an overview of broad financial markets on a holistic basis, it feels like something has shifted in market thinking this session.

Perhaps Donald Trump expressing a tolerance for higher oil prices is one factor. 

Iran stepping up its involvement, not just through its influence on the Strait of Hormuz but also through its broader impact on financial markets, is another. 

However, it feels as though the market has taken its timeline for the duration of the closure of the Strait of Hormuz, and the conflict more broadly, and pushed it further out, suggesting this could have a more damaging effect on inflation and potentially consumption patterns.

At some stage possibly even corporate earnings.

The energy markets are naturally front and centre. Brent crude futures trade at US$101.45, up 10.3% on the day, with its high-low range on the day at US$6.60, which is tighter than we have recently seen, but price is still settling in the 94th percentile of the day’s range. 

Volumes have pulled back a little, with 652,000 futures contracts having traded in Brent crude futures and 522,000 in WTI crude futures. This is still a tidy premium to the 30-day average, but lower than what we have seen on most days this week.

It is the volatility channels that continue to stand out. Brent futures one-week at-the-money implied volatility has risen 10 vols on the day to 144, with WTI one-week at-the-money implied volatility at 115%, and the OVX sitting around 120%. 

This tells us there is still considerable hedging activity in the options markets, as has been the case in FX markets, with a notable rise in AUD implied vols. At these volatility levels, we can expect significant price swings off headlines at any stage.

The inflation markets are what really stand out though. 

US 1-year inflation swaps are pushing towards 3%, up 10 basis points on the day, with the 2-year inflation swap up 6 basis points. 

This has led to a sharp sell-off in the front end of the US Treasury curve, and Treasuries have not acted as a safe haven in this environment as inflation expectations move higher. 

Two-year Treasuries now trade at 3.73%, up 8 basis points on the day, pushing levels that suggest the funding markets may start needing attention from the Federal Reserve.

It is still early days, but the moves at the front end of the Treasury curve warrant monitoring, and US banks will certainly be watching this closely.

In equities, it has not been a pretty day. Within the S&P500 it has been a very defensive session. Utilities and staples have held up reasonably well, with energy the best performer as oil prices rise. Beyond that, only 22% of stocks are in the green, with healthcare, consumer discretionary, industrials, and other cyclical areas of the market under pressure.

We see the S&P futures trading at 6679 and eyeing a move back to retest the 200-day moving average, which contained the selling on Monday. A break of that level would put us at risk of revisiting Monday’s lows of 6584.

If we were to see a break of that level on a closing basis, conditions in equities could become more concerning. The need to hedge and rotate into ultra-safe havens and defensive plays would likely increase, and the risk of a more pronounced drawdown would rise.

The dollar has had a strong day, while interestingly, despite higher energy prices, the yen has outperformed against most currencies except the US dollar, suggesting it has retained some safe-haven qualities.

In contrast, the Australian dollar and the Swedish krona have sold off sharply. The DXY has pushed toward the top end of its range at 99.73 and looks poised to test the 100 level.

If front-end US Treasuries continue selling off and 2-yr yields move higher, with inflation expectations rising and implied Fed rate cuts being priced out of the USD OIS curve, the US dollar will naturally benefit. 

The combination of higher US nominal and real yields, alongside dollar strength, seems to be weighing on gold today, which has not acted as a safe haven in any capacity. In fact, one could argue Bitcoin has held up better on the day, although calling Bitcoin a safety asset is probably a bridge too far.

Looking toward Asia, Japan is likely to receive considerable attention. With crude closing near its highs, markets are increasingly pricing in a longer duration for the conflict and the continued impact of a potential closure of the Strait of Hormuz.

Donald Trump may continue to explore the idea of assisting vessels through the strait, and if that were to materialise, the market could see a strong relief rally.

For now, however, the dominant features are higher energy prices and extremely elevated volatility markets, which remain the most effective hedge as they price in the potential for large swings ahead amid reduced liquidity at the top of the book. 

Bonds are not acting as a traditional safe haven given the inflation dynamics, and markets are increasingly suggesting the situation could persist for longer, with potentially more pronounced implications for inflation and central bank policy.

NAB Markets Today Research extract

Oil prices rose again, with Brent back above US$100 per barrel after President Trump’s suggestion that bringing Iran to heel is more important than a rise in the price of oil.

The release of strategic oil reserves Wednesday has been unable to hold prices down, with the focus there on the limited flow rate that reserves can be deployed and which only has a modest impact on output lost from the effective closure of the Strait of Hormuz.

Approaching the US close Brent was trading US$101.3.

In recent days President Trump’s comments have wavered between Operation Epic Fury ending soon and it taking an unspecified longer period. 

Late Wednesday Trump said, “…but we’re not leaving until the job is finished.” While he said, “it’s going to be very fast,” he added, “as we end this threat to the America and the world, we do not want to leave early, do we?”

Thursday’s remarks that oil’s moves are less important, is helping drive a view the US’s part in this conflict may have a couple of weeks to go yet.

US Energy Secretary Chris Wright told Fox News the strategic oil flows of a couple of hundred million barrels would take about four months to pass through, noting the “conflict won’t go on that long.”

Wright said, “I think we’ll have the Strait (of Hormuz) open well before then… hopefully in the next few weeks, we will see ship traffic returning.”

On Thursday Wright said he thought a US Navy escort in Hormuz was, “likely by months’ end.”

Iran’s new Supreme leader Khamenei made his first official remarks. Iranian state television reported him thanking the military and warning the Strait of Hormuz should stay shut.

Khamenei said Iran believes in friendship with its neighbours, it is only targeting bases and will continue to do so. He said Iran ‘will take compensation from the enemy’.

Second tier US economic data did not have much impact. US weekly jobless claims eased to 213k from 214k, against a 215k forecast. Continuing claims continue to their softer trajectory. January housing stocks were stronger at up 7.2% to 1487k , which sees them at the high end of their range since mid-2022.

Permits, however, fell -5.4%, which was more than a -3.1% forecast and continue to look soft. The US trade deficit for January narrowed to -US$54.5bn from a revised -US$72.9bn as exports rose 5.5% m/m, and imports fell -0.7% m/m. All else equal that will help drive higher Q1 GDP forecasts, though this is the first month in the quarter and the data are volatile.

Stocks fell with the Nasdaq -1.78%, the S&P500 -1.52%, while the EuroStoxx600 lost -0.6%. Bonds sold off, with the front-end of the US Treasury market leading the way and where US 2year yields rose 9bps to 3.74%, while US 10-year yields rose 2bps to 4.25%.

The market has pared back US Fed rate cut pricing from 30bps Wednesday to 19bps, as the threat of higher inflation from the oil price rise impacts.

The ECB is now priced to hike by 42bps by year end, with the BoE by 20bps.

ANZ Bank, Australian Morning Focus, Commodities extract

Crude oil prices moved higher as the conflict in the Middle East escalated. Iran launched a new offensive, targeting ships and ports in the Persian Gulf, underscoring the widening threat to energy supply. 

Two vessels off the coast of Iraq were hit, prompting the nation’s oil terminals to suspend operations. An oil storage facility in Oman was also attacked by Iranian drones. A container ship was also hit near the United Arab Emirates. 

The attacks are also broadening beyond the Strait of Hormuz, with three commercial vessels struck within the Arabian Gulf over the past 24 hours. On state TV, Khamenei said the Strait of Hormuz should remain closed. 

UK Defense Secretary John Healey said it is becoming increasingly evident Iran is laying sea mines in the Strait. 

The market’s expectations of sustained impact on energy supplies rose after the US President Donald Trump said stopping Iran from having nuclear weapons was more important than oil prices. 

The conflict has now moved beyond a short-lived geopolitical shock and into a phase where supply losses are increasingly structural rather than transient. To date, we think markets are under-pricing the likely duration of the disruption and the risk of compounding supply losses. 

The likelihood of operational constraints leading to temporary well closures (shut-ins) over the coming weeks is rising fast. This will turn short-term disruptions into persistent production declines. 

The release of oil from emergency inventories, coordinated by the International Energy Agency (IEA), is likely to play an important role in cushioning near-term disruptions. However, even 400mbbls will fall well short of potential disruptions. 

We estimate the market will be short by around -13 to -14mb/d amid the effective closure of the Strait of Hormuz. At maximum release rates, the IEA emergency stockpile release would cover only 14% of the shortfall. 

In this environment, price volatility is likely to remain high, but the skew is increasingly to the upside. Importantly, the longer the disruption persists, the higher the price required to restore market balances. 

Global gas prices also pushed higher as the market contemplates sustained disruptions to supplies.

Asian LNG buyers are preparing for the war to disrupt supplies for months. Companies in Thailand are looking to buy cargoes for delivery through May, while Bangladesh bought shipments for April.

Major buyers in Taiwan and South Korea are said to be considering purchases as far out as May.

Gold retreated as the Middle East conflict continues to be overshadowed by a stronger USD, rising yields and uncertainty surrounding Federal Reserve policy.

Broad equity sell-offs have also triggered liquidation of gold assets, as investors raise cash to meet margin calls.

The USD has strengthened due to its safe-haven status, particularly as rising oil prices benefit the US which is a net energy exporter.

Concerns are mounting over the Fed’s approach to rate cuts, with higher oil prices raising the possibility of renewed inflation pressures.

However, we see these pressures as temporary and do not expect the Fed to reverse its monetary policy stance, as the disinflationary trend remains intact. Lower interest rates should continue to support investment flows into gold.

Equity market volatility is also likely to persist over the near- to medium-term. As a result, gold should remain a key portfolio diversifier, providing protection against a broad range of macro and geopolitical uncertainties.

We maintain our positive price outlook for gold.

Corporate news in Australia

-TPG Telecom ((TPG)) is preparing to sell entertainment group Funlab, owner of Strike Bowling and Holey Moley

-Australia’s bond market has reopened following a pause linked to Middle East tensions, with new deals launched by NBN Co and US telecom giant Verizon

-Around $200m worth of TPG Telecom ((TPG)) shares are being offered for sale as investors monitor potential moves by major shareholder Washington H. Soul Pattinson ((SOL))

-Private equity firm KKR has joined Bain Capital in the sale process for education provider UP Education, with the business expected to fetch more than $1bn

-US private equity group MidOcean Energy has acquired Japanese utility JERA’s stakes in the Gorgon and Ichthys LNG projects

-Payments platform Pay.com.au is planning an $850m ASX IPO targeted for April

-FDC Construction, valued at more than $1bn, has begun investor meetings ahead of a planned ASX listing

-Data centre operator NextDC ((NXT)) has launched a $500m bond roadshow despite concerns about the company’s credit rating outlook

-TasFoods has entered administration after its Nichols Poultry division struggled with oversupply and heavy discounting pressures

-Coles Group ((COL)) has shut down its Swaggle online pet care business less than two years after launching the venture

-Microsoft and Meta are each spending about US$50bn on data centres as part of the global AI buildout, with cloud leasing commitments estimated to exceed US$700bn

-Janison Education Group ((JAN)) reported technology failures that disrupted exams for about 1,300 accounting candidates and affected NAPLAN testing

-Atlasssian is cutting 1600 jobs in the AI shift and enterprise growth

On the calendar today:

-EZ Jan Ind Prodn

-UK Jan GDP

-UK Jan GDP

-US 4Q GDP

-US Jan JOLTS

-US Jan PCE Inflation

-ARIADNE AUSTRALIA LIMITED ((ARA)) ex-div 0.50c (25%)

-BOAB METALS LIMITED ((BML)) earnings report

-CAR GROUP LIMITED ((CAR)) ex-div 42.50c (30%)

-DEEP YELLOW LIMITED ((DYL)) earnings report

-FLEETWOOD LIMITED ((FWD)) ex-div 9.50c (100%)

-GUZMAN Y GOMEZ LIMITED ((GYG)) ex-div 7.40c (100%)

-IPERIONX LIMITED ((IPX)) earnings report

-SUNSTONE METALS LIMITED ((STM)) earnings report

-WISETECH GLOBAL LIMITED ((WTC)) ex-div 9.63c (100%)

FNArena’s four-weekly calendar: https://fnarena.com/index.php/financial-news/calendar/

The Australian share market over the past thirty days…

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