US equities were weaker Friday, the S&P down 0.2%, while US10Y yields rose a further 4bps to 1.34%. Those moves were capping off the overriding trend in markets last week: growing concerns about inflation risks pushing nominal bond yields higher and weighing on the equity rally.
The Biden administration continues to stay on message, stressing the need for Congress to pass a significant fiscal package and downplaying recent more robust economic data as its full-throttle package exceeding 1.9 trillion heads for a House vote this week in a fast and furious attempt to get the US back to full employment next year.
The unprecedented and highly stimulatory policy is an attempt to exceed one million jobs a month from April to September. Still, it underscores the narrower timeline from easing to tightening compared to post-GFC. This suggests taper tantrum fears are understandable, even if severe inflation is still a 2022 issue.
But timing is everything. The next leg of the reflation will have to be carried more and more by a continued recovery in economic growth, as fiscal and monetary stimulus gets increasingly packed into the price. And all the while, this will bring the Fed closer to acknowledging that policy normalization is coming.
On to China, the PBOC restated its position overnight as "neither too tight nor too loose". However, the problem for markets is the conflation of near-term liquidity management by the PBOC with a change in monetary policy direction. Unfortunately, although the CNY-related noise should fade, you'll need to get accustomed to the on again off again implied policy normalization lulls and crescendos, creating a level of policy uncertainty that’s never great for risk.
The real question here is that in the absence of inflation on the ground, is the market willing to look through higher yields because it sees a better and much improving economic outlook at the end of the reopening tunnel? Or will the market decide that the Fed might taper in late 2021? Hence the narrative will change dramatically, and the idea that the denominator for all discounting all assets =0 might shift a bit.
What began as a power issue for a handful of US states quickly turned into a global supply shock for the oil markets. Still, the restart of shut-in US production and news that the Biden administration is exploring diplomatic re-engagement with Iran have contributed to a cooling of oil prices, despite the bullish inventory data.
But "the day after" sees oil prices nudging higher amid ongoing evidence of recovery in global demand, mostly good news on the Covid-19 trends and anticipation of a nearly 2 trillion US stimulus designed to get people working again quickly.
The sharp rise in global oil prices before the OPEC+ March meeting means the calculus for the OPEC+ alliance becomes more complicated. But with Saudi Arabia seemingly comfortable with Brent above $60, they’re unlikely to upset the apple cart.
With production constrained, inventories are drawing and vaccines promising a return towards normalcy; at the end of the day, expectations continue to run high for oil markets.
Global breakevens drove by a surge in the inflation risk premium component, all moving to the same beat. The increase reflects a dissipation of perceived downside risk to the inflation outlook amid a broad-based improvement in global economic prospects and massive fiscal stimulus.
Australian Dollar: AUD yields push higher
Implied yields continue to move higher, supported by tight funding (trades around flat yield to -3 bp) but also supported by excess USD in the system, which is also the case for most G11 currencies, driving implied yield higher there too, hence the US dollar weaker in the common theme from last week.
Malaysia's ringgit continues to trade in a tight range, supported by $60+ Brent crude prices but getting held in check by rising US yields. How disruptive US yields become via the currency market, and particularly Asia FX, really comes down to the speed of the rise and how quickly traders reprice the short end of the US curve. Any signs of a faster Fed Fund's rate hikes will be the ultimate wrecking ball for Asia FX sentiment.
But look for the MYR to trade to the beat of broader US dollar markets, which should be favourable to today's ringgit.
Implied Inflation vs Fed Funds
An irregularity is building between inflation expectation and Fed Funds rates. It's not about lower for longer, rather about the terminal peak. The Fed says that, all being well, it still thinks long-term neutral is 2.5%. The front end of the curve has repriced of late, from 1.5% to 2.5%, and that’s the driver of real rates at the moment. In January, it was a very different story; that was a risk premium associated with taper fear which is why breakevens didn’t have too much of a problem – today is different.
But so long as US front-end rates and rate vols remain unresponsive, despite other assets repricing post positive normalization/societal reopening/fiscal stimulus developments, the dollar bulls could remain relegated to the pen over the short term.
Gold is trading a bit higher in delayed response to USD weakness. The yellow metal may steady, but rallies face headwinds. Besides higher USD as the most significant impediment, Bitcoin is sucking the life out of Fort Knox as speculators think Bitcoin, not gold, is the best hedge for the Fed's tinder box of a balance sheet this time around.
BTC continues to suck the life out of Fort Knox as the growing consensus continues to resonate among investors that holding cash is an awful thing. In the wake of Tesla’s profit bonanza, discussions are likely accelerating in the corporate board room as to what role BTC could play on the balance sheet from now on.
Besides the enormous Middle East consortium interest and another Bitcoin ETF trading on the Toronto exchange, if corporates start to add physical coins to the balance sheet this year, it’s the game-changing panacea.
As corporate treasuries accumulate Bitcoin, they could face a reckoning at some point as regulators might eventually wonder whether a 100-vol asset belongs on corporate balance sheets. Who knows, maybe it does?
This week, as we move towards the end of February, features several focal points for market participation. In particular, developments on the Covid pandemic will be critical, including UK Prime Minister Johnson's roadmap out of the lockdown, as well as a summit of EU leaders later in the week.
On top of this, investors will be focusing on US stimulus, with the potential for a floor vote in the House of Representatives at the end of the week, as well as remarks from Fed Chair Powell and ECB President Lagarde. Finally, earnings season will continue, with 64 S&P 500 companies reporting.
After a week of heated rates debate, it's becoming apparent that reflation will likely be the central theme of 2021. Many investors started to price higher inflation, along with more robust growth rates, particularly in the US, on the back of an ultra-accommodative monetary and fiscal backdrop. And just because of a few misses on weekly US jobs data report, a direct consequence of mobility restrictions resulting in a servicing sector malaise, it doesn't mean we’re not on the road to inflationary fireworks.
But it seems we continue to see-saw between higher rates being the harbinger of doom to the markets can handle higher yields. The thorny point is trying to pick a number out of a hat that will cause maximum market discomfort as the stock markets don't like rapidly rising real yields. I stress "rapidly" here as I think the market can handle even higher rates (+1.5%) if the economic condition remains supportive and the rise is gradual. The long-term balancing act suggests any risk market can stay at lofty levels, provided the macro conditions remain well supported.
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US stimulus passes the Senate; Data beats could relieve yield fears, Oil higher on Iran-backed Houthi attack on Saudi Arabia.