Shift in focus in APAC markets

Markets

There is a shift in focus in APAC markets from the latest developments in the Russia-Ukraine war to worsening Covid outbreaks in China. 

Shenzhen’s government announced an effective lockdown on Sunday night until March 20 and has started mass PCR testing. There are broader restrictions of varying degrees across China, including Shanghai and the northeastern industrial hub of Changchun. 

Shenzhen hosts major tech manufacturing operations for companies including Foxconn and Huawei. Reports suggest that Foxconn is suspending output at its Shenzhen HQ that will affect the production of Apple products.

The first-channel effect of Shenzhen’s lockdown in APAC markets is tech equities: the Hang Seng Index is down ~8% today, falling below the March 19, 2020 low. Second-order effects include the yet-to-be-determined impact on global supply chains and inflation, as well as growing domestic downside risks to China’s economy.

Ukraine and Russia discussions continue - European press is focusing on a military strike on the International Peacekeeping and Security Centre around 20 miles from the Poland border in Western Ukraine over the weekend.

Iran stuck a missile in Northern Iraq, hitting the US Consulate under construction. Reports suggest that it missed its intended target. Iran suspended diplomatic talks with Saudi Arabia. The missile strike does not help nuclear deal talks.

Oil

Oil prices are marginally lower, despite the attack on Northern Iraq over the weekend and the suspension of talks with Iran last week, which suggests the market is now better able to quantify the supply shock, which is far from the worst-case scenario. The first pass response was to price in the shortfall requirement to backfill 3-4 mmb/d of Russian export, but now it’s likely in the range of 1-2 million barrels after some of the dust has settled. 

Forex 

USD/JPY bounced higher on Friday, which seems like a catch-up move with US yields. But the upside move of USDJPY has exceeded the one implied by US yields, which makes the pair screening rich.

That said, Japanese real money names are usually fully hedged on their bond positions. As US  bonds continue to sell off, they will need to buy back USDJPY as they are over-hedged. Expect more of such rebalances into the Japanese fiscal year-end in March. 

But  I think the two keys for higher USDJPY are rising US yields and persistently bullish Oil and LNG markets, as currencies of oil price takers should continue to get sold until energy markets veer lower.