Asian Tech Sell Off

MACRO FRAME

The pause in military exchanges between the US and Iran could lead to more action on the diplomatic front, though the geopolitical risk premium in energy continues to support a hawkish macro backdrop.

STOCK INDEX FUTURES

Equity index futures were mixed overnight with the Dow leading gains, the S&P flat, and the Nasdaq lower following a semiconductor route on Asian exchanges overnight. Samsung Electronics fell about 13%, SK Hynix about 15%, pulling the KOSPI down roughly 11%. Meanwhile, Kioxia in Japan down nearly 18%, and MediaTek in Taiwan down about 10%. Sentiment over AI infrastructure has shifted dramatically, and Sunday’s report that Nvidia may provide around $250 billion of financial support for an OpenAI datacenter project raised questions about how much AI chip leaders are effectively financing their own customers, and how sustainable that is. Meanwhile, competition from China has raised fears that that Chinese memory makers could ramp capacity faster, intensifying global competition and raising oversupply/price‑pressure risk. The growing popularity of low‑cost Chinese open‑source models, such as Kimi K3, is prompting investors to ask whether future AI workloads will be less compute‑ and memory‑intensive than previously assumed, implying lower demand for cutting‑edge AI chips and HBM.

Amazon, Meta, Apple, and Microsoft report earnings later this week, investors center around their investments into AI infrastructure and whether or not they are yielding returns. The reports  will also offer signals on demand for chips and other AI infrastructure. Should any of the above see a drop in their free cash flow levels, worries that these companies stock and bond issuance are likely to significantly weigh on the broad indexes.

CURRENCIES

US DOLLAR: The USD index was little changed overnight at 101.57. Despite the recent pause in fighting and drop in oil prices, money markets have not repriced Fed policy expectations. Markets are fully priced for a rate hike in September and see a 32% chance of a hike at tomorrow’s meeting. However, given Warsh’s preference for little-to-none forward guidance and current inflationary risks, a 25bp hike should not be discounted. The sustained move above the 100 level since mid-June continues to reflect market expectations that the Fed will hike rates this year, leaving price direction vulnerable to the divergence in expectations between Fed and ECB rate expectations.

Watch point: While markets are not expecting any change in policy from the Fed, a hawkish outcome should not be discounted. Meanwhile, underlying fundamentals remain supportive of the dollar.

EURO: The euro is little changed at $1.1365 as traders largely await tomorrow’s FOMC decision. Just like the Fed, money markets in Europe have not significantly repriced ECB policy expectations given that the broader geopolitical and inflation risk backdrop remain hawkish. The ECB considers the current inflation shock to be medium-sized, which requires some policy action but not aggressive moves. It expects price growth to return to 2% in the next year. Slovak Central Bank Chief Kazimir said a rate hike at the September meeting is likely needed. Money markets are pricing a near 67% chance of a hike in September and remain fully priced in for a move higher in October. ECB President Lagarde has also made clear that renewed energy shocks make the case for a September hike more likely. Lagarde warned that the “full effects of the energy shock have yet to play out” and that earlier hopes of a benign scenario were unlikely.

Watch point: With the pause in fighting supportive in the near-term, broader price direction will be subject to Fed-ECB policy expectations.

BRITISH POUND: Sterling is little changed at $1.3298. Softer labor-market data has raised expectations that the Bank of England will hold rates steady on Thursday, although unease over spending plans under new Prime Minister Burnham have weighed on the pound this month alongside broad-dollar strength. The pound remains caught between rate hike expectations and questions surrounding the strength of the economy. Still, traders remain fully priced for a hike come November.

JAPANESE YEN: The yen is little changed at 163.86 yen per dollar. This week’s Bank of Japan meeting is likely to see no change in policy, leaving the focus on how strong or weak forward guidance from the bank is. Policymakers will likely stay ambiguous about further moves, though a lack of a commitment to raising rates is expected to leave a bearish pressure on the currency. The timing of the next move could be pushed forward to September or October if the BoJ raises the risk of an inflation overshoot. Verbal efforts to support the yen have had little effect on the currency, and official intervention is unlikely to offer a durable rebound unless the Bank of Japan commits to raising rates quickly. Therefore, BoJ rate hike expectations will continue to be the dominant driver in yen direction, outside of the geopolitical bid. Prime Minister Takaichi’s government has retained language in its economic blueprint urging the BoJ to align with government policy, fueling worries that Tokyo might pressure the bank to slow further hikes.

Watch point: With the yen sustaining a break above the 160 level, intervention from the government appears to be the greatest near-term risk against further depreciation.

AUSTRALIAN DOLLAR: The Aussie is 0.30% lower to $0.6969. Central bank Governor Michele Bullock said underlying inflation remained too high and a further slowdown in domestic demand may be required to tame prices, though emphasized that the rate outlook remains uncertain as it was not yet clear whether the three rate hikes already delivered would be sufficient. Those comments led traders to pare back expectations of an August rate hike from 30% odds to 20%. Elsewhere, a sharp selloff in Asian equities and broad-based dollar strength added pressure to the currency. Outside of US-Iran developments, quarterly inflation data on Wednesday will be in focus. The trimmed mean measure of core inflation is expected to rise 0.9% in Q2, lifting the annual rate to 3.7%. That would remain above the RBA’s 2%-3% target band, but below the central bank’s forecast of 3.8%. Traders are no longer fully priced for a rate hike by year-end.

Watch point: While a durable end to the war would alleviate downside risks to growth and moderate inflation pressures, ongoing pass-through into broader prices is likely to be in focus in upcoming data.

TREASURY FUTURES

Yields inched lower across the curve in a steepening move. While tomorrow’s Fed decision is not expected to bring any change in policy, the risk of a move higher in the Fed Funds rate or a hawkish vote should not be discounted. Ahead of the Fed meeting, oil prices will likely be in the driver seat regarding yield direction. Additionally, we expect this to be true during periods of no/pause in fighting between the US and Iran. It would appear that the escalation leading to deescalation theory proved correct in regard to US-Iran fighting. Still, the lack of certainty and flow of oil through the Strait continues to support upside risks in inflation and the higher-for-longer bond yields. Traders are now fully priced for a rate hike at the September meeting. A stable labor market has also supported the view that policymakers are expected to focus on taming inflation. A Reuters poll showed that economists are expecting the Fed to keep rates on hold for the remainder of the year, while a majority of those who answered a separate question about the chance of a rate hike this year now described the likelihood as “high”, a reversal from last month when most saw it as “low.”

Watch point: Mainly, the prospect that inflation will remain sticky reinforces a hawkish backdrop for the Fed over the medium-term.

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