Federal Reserve Chair Jerome Powell has drummed home his recent message of cautious optimism on the economic outlook that supports still-ample policy support: "We feel like we're at a place where the economy's about to start growing much more quickly and job creation coming in much more quickly."
The interview with CBS was conducted last Wednesday and televised earlier today. Powell views the "principal risk to our economy right now really is that the disease would spread again." This risk, in Powell's view, supports the idea of powerful policy support. In an increasingly argued case for continued policy support, he notes the "disparate" or uneven recovery nature.
At least at the core of the FOMC, the hurdle for more hawkish communication is pretty high, particularly for the April 27-28 meeting. Beyond then, holding onto downside risks will prove more difficult as incoming data improves.
After stocks surged into the NY close on Friday, profit-taking seems to be the early gates trade ahead as long duration stocks look set to drift into the highly anticipated earnings season and keen US CPI print.
With earnings season set to kick off this week, investors prepared by snapping up stocks at a fast and furious pace, anticipating that this year's hottest trades will receive another boost from earnings season And coming off a busy week for stocks, earnings growth is required to push markets further.
While expectations are high, given the vaccine runway we’re likely not at the end of the upgrade cycle yet. Substantial operating leverage, a forceful rebound in consumer splurge and fiscal stimulus provide the recovery's key pillars.
As the market shifts back into "don't fight the Fed” mode, a chorus of Fed speak and Tuesday's CPI report will be the main focus for most bond market participants. In a continuing and common theme over the past several months, energy prices will boost headline CPI. But investors will be much more focused on what’s going on at the component level.
Yields losing their topside for a moment last week allowed investors to grow more comfortable with the absolute level and, at least until this stage, they were happy with the Fed mantra that 'growth is driving yields". "Don't fight the Fed" has become the sharp one-liner again that if investors chose to ignore, they might be doing so at their peril. The Fed's forceful verbal intervention seems to be finding an echo in markets these days; after all, what the central bank wants is typically what it gets, sooner or later.
Interest rates will remain the most important topic for some time and will continue to guide the equity market bus – even more around this earnings season.
Investors will be looking for clarity on the margin outlook, particularly around input cost pressures as squeezed inventories and logistically constrained supply chains add to the bottom line. The big question for bond markets is whether firms have the pricing power to raise prices at the consumer level. If they don’t – in part because the labour market is still in the early stages of recovery – a pick-up in CPI inflation could prove little more than transitory as supply chains improve. That, in turn, would slow the rise in yields.
The index (SPX) has rallied 9% YTD and now trades at many Wall Street mid-year 2021 targets of 4100, so it's going to take a great earnings season and tepid inflation data to keep the ship sailing in the right direction.
Beyond input cost, the other primary focus is the potential negative EPS impact if the Biden administration's new tax reform proposal is adopted. According to the market’s consensus base case, the S&P 500, 2022 EPS growth would diminish from 12% to 5%.
An unsettling calm has come of oil markets recently as Brent remains anchored around $63 with traders adopting a wait-and-see range trade mentality. All things being equal, we’ve entered the waiting game, with the prices holding ahead of signals that demand inflects higher over the US summer driving season, and Covid-19 related factors start easing worldwide.
While Covid case numbers in the Euro area have started to decline, they were helped by lockdowns and positive sentiment spurred on as vaccinations should accelerate sharply over the next three months and provide an excellent boost to opinion as the Old Continent returning to standard will be suitable for gasoline demand.
In Asia, however, "New Waves" bring risks onshore, compounded by the slow vaccine rollout. The vaccine rollout remains slow in Asia, but what’s more concerning is a renewed divergence in virus caseloads, with second waves taking hold in India, the Philippines and now Thailand. And counties to sully the global travel outlook.
Traders need to ask themselves who's next. Indeed, the street is particularly worried given the spread of new variants and high fatality rates, and the latter could force more stringent lockdowns.
Anecdotally, I spent last week working and doing some family business in Hua Hin (a popular local holiday spot); however, as soon as the news hit on Friday that Bangkok and other areas around Thailand are experiencing another wave, the 400 room hotel immediately had 200 cancellations as the fear of the virus tops everything.
$63 could be the springboard into summer driving season but with OPEC+ and US (DUC) expected to add more barrels into this demand as US Energy Secretary Granholm reportedly raised the importance of energy affordability in a call with Prince Abdulaziz early this month. Affordability could be a driving force in OPEC+ new game plan and keeping the border $60-70 range trade in play.
The USD seems to have turned a corner last week with quarter-end demand and rebalancing in stocks out of the way. But after the big move last Monday, the markets have been back and forth. Still, the dollar has been anchored to the weaker end of the recent range after Fed officials indicated they had little concern about inflation. It's still too early to consider tapering monetary support, helping push down Treasury yields to the US dollar’s detriment.
As rates volatility drops, correlation fall by the wayside, and FX outside of some micro lurches becomes relatively range trade tame.
Fed Chair Powell once again managed to surprise markets on the dovish side, commenting on last week's 1m jobs report that "we want to see a string of months like that so we can really begin to show progress towards our goals."
We get our first CPI "string" this week; while we can speculate how many months a 'string' is, it certainly means that a couple of reports like that won’t be enough to change the Fed's communication. In a way, the only thing that could make a difference over the next few months would be higher inflation expectations, possibly on the back of higher-than-expected inflation readings (hence the importance of the CPI this week). Though for any change in Fed tonality, the hurdle is very high as doggedly defending their communication credibility requires sticking to the narrative. Which, in my view – so long as this plays out – means that tapering before year-end will be challenging and supports US yields consolidating around 1.6-1.8% or so and the dollar range-bound or slightly weaker.
The higher China inflation prints last week tempered a recovery in Asia FX sentiment. Asia FX deals with new waves and reshoring virus concerns bound to upset the recovery applecart and muddy the anticipated travel boom in popular Asia destination like Thailand and the Philippines, where second waves are taking hold.
The Malaysian Ringgit
The ringgit remains stuck in a channel between higher US yields and finicky oil prices. But a new negative twist has emerged in the form of higher inflation in China due to high commodity prices that could see the PBoC quell China’s credit impulse. Indeed, this is potentially negative for commodity exporters like Malaysia into China if the transitory inflation effects from higher oil prices don't ebb.
To start the week, local FX traders could remain in the wait-and-see mode, similar to their G-10 colleagues, ahead of a key US CPI, which should provide our the first read on the US inflation dial and if it’s anywhere nearing a point of consternation for risk assets.
Like most other rate-sensitive and long duration asset, gold could drift into wait-and-see mode ahead of the keenly anticipated US CPI release. Any transitory look through or miss lower in the data could be good for gold price.
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With equity markets rising to fresh record highs in the United States and Europe, risk appetite is rising again