After a shaky start, investors found their feet after a quorum of Fed officials gave risk assets room to breath after talking down the prospects of tapering; as the dollar weakens, it appears all boats float.
US equities ended a wobbly session little changed on Tuesday, the S&P up slightly heading into the close after recovering from earlier losses. US 10yr yields slipped a bit, down 2bps to 1.13%, on the back of those dovish Fed comments.
The most prominent dovish voice came from typically hawkish Esther George, despite some higher inflation risk. She also noted that the outlook is for policy to remain accommodative for some time. Her voice has helped currency markets repair some of the damages inflicted on the EURUSD on the back of the Italian political situation and the constant taper talk filtering through capital markets.
It was a tale of two tapes as US stock indexes tottered midday with tech and rate-sensitive sectors leading the drop. The recent move higher in nominal rates started to weigh on expensive growth, which has a disproportionate impact on indexes given weightings. There was a similar theme in Europe yesterday with reflation sectors like banks and energy outperforming.
With the mild confusion on Fed policy simmering as various Fed speakers offer their personal view of the recovery trajectory and tapering timing. The real question that we need to answer is whether the Fed is done with accommodation or not, and I suspect Fed Powell will pull up a dovish chair to put the idea of a policy pivot on the backburner and give risk assets more room to breathe.
In the meantime, the market remains incredibly well supported by the two-pronged monetary and fiscal stimulus efforts and investors lean optimistically for a speedy vaccine distribution and activity normalization, which offers up brighter days and blue skies ahead. The global economy faces numerous economic headwinds due to the omnipresent Covid-19 and its new mutations. And it’s hard to imagine the taper tantrum debate will lessen as we progress through 2021, especially when inflation picks up. I suspect investors will constantly be revisiting the policy, fidgety over the fear of one or even both policy balloons deflating at some point in 2021.
Without Fed George's talking down of the possible taper tantrum, my morning market note would have read dismally different for risk assets and certainly for the Euro fortunes, with both US nominal and real yields shifting higher yesterday.
Still, in an orthodox world, more budgetary spending means higher inflation and tighter Fed policy. So, eventually, this policy tug of war will come down to market pricing.
Crude oil rallied to pre-pandemic levels today. Brent traded as high as USD56.75 after bouncing on a larger crude draw than expected. A weaker USD helped and complimented numerous price revisions by several analysts for still-higher 2021 estimates on the tailwind from the surprise 1mb/d cut announced by Saudi Arabia.
The Dec21/Dec22 WTI spread has moved higher, currently at USD2.62 back, while the same spread for Brent is unchanged. The Gasoline Crack remains comfortably above profitable territory (USD10 a barrel), trading USD12.36.
The remainder of this week’s currency action now sets up for a weaker US dollar through a weaker US CPI and via Fed Chair Powell's dovish lens which will be oil supportive as oil is priced in dollars. This dynamic is already playing out in Asia this morning.
While the higher oil prices story continues to make sense, I suspect China's rapid response to the outbreak in Hebie's northern province lessened worries over a larger spread and has helped offset comments from IEA head Fatih Birol, who noted in a TV interview that a significant portion of US shale is profitable at current prices. Risks remain, but there appears to be a clearer path to oil upside with downside risks diminished.
Some traders still think US shale producers' response to the rally in oil represents the most significant near-term supply risk for oil. But most are deferring to messaging from the CEOs and other shale C-suites, plus many boots on the ground, who suggest capex plans remain constrained by a cautious medium-term outlook. It remains to be seen whether this view will hold if oil prices continue to move higher.
I expect there will be sizable scrutiny as to whether WTI over $50 will prompt increased investment or whether a conservative financial strategy prevails. In my neck of the woods, money flows to where investors can make profits and the higher oil price goes, not only will shale producers be keen to turn up the taps, so will OPEC+.
Most currency market views were based on the 2020 rates script where breakevens and real rates moved in opposite directions. However, this wasn't the case until the FOMC pushback overnight. The current nominal rates increase was driven by both components moving up due to markets pricing higher inflation alongside higher policy rates. So, this could still be a huge risk to the view if inflation does pick and the market starts to price in a policy pivot and actually buy US dollars in earnest, instead of trimming extended dollar short.
In some cases, the US dollar pullback has allowed some of the "risk-on" FX plays to flourish also buoyed by local news. The AUD, NZD, NOK and CAD are all stronger. With the USD no longer acting as a headwind, currencies have capitalized on some gains in commodities, notably in oil prices that extended their gains materially.
The RMB may have also aided Asia FX gains. The overall narrative hasn't changed much as the mainland continues to lead the growth differential pack. However, we know the PBoC’s invisible hand is in the background and may slow appreciation. Still, it might be increasingly hard to push back on market dynamics if Fed Chair Powell opens the dovish door or a weaker US CPI print does the heavy lifting.
After initially buckling at the knees on the declared a Covid state of emergency in Malaysia, the ringgit had taken a decidedly positive turn on both the recent FOMC taper push back and gains in commodity prices, most notably for the ringgit concerning higher oil prices. The general fade play here is that lockdowns are being viewed as a speed bump. Provided vaccine efficacy remains high during the worldwide rollout, FX traders will still buy currency weakness in Asia. There is no convincing reason to turn bearish on the ringgit other than the lockdown whilst the global reflation trade still fires.
With most G-5 traders jobbing momentum plays and the USD having come a long way to start the year, the setup into a soft US CPI print (Jan. 13) and Fed Chair Powell's speech on Thursday may provide the impetus for the USD to head much lower again.
Gold is trading up this morning as the US dollar weakens after FOMC members pushed back on market taper talk, allowing risk assets to breathe more freely and support gold via lower US yields.
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US stimulus stalemate weighs on all markets; Oil perilously perched on the Covid curve; Traders sell the earnings news. Without stimulus, gold gets no bounce.