Despite investors galloping out of the gates to face a brave new year, it was the same old lockdown fear that saw investors recoil as buyer beware set in. While the big macro recovery and rotation view may be the "ultimate trade for 2021", the "January trade" could be very different as the near-term landscape started looking a whole lot more dangerous – and very quickly.
Generally, markets have treated recent lockdowns more as speed bumps than hitting a brick wall at full speed. However, the Georgia Senate runoff complicates matters as the street doesn’t know how to trade or invest it. While it seems reasonable to assume that the status quo will see most post-elections trades pull through, a Democratic sweep is where the balance of uncertainly lies, especially if bond yields scream higher.
Indeed, it was "sound the retreat" that was heard across global trading rooms, likely triggered by several factors including the upcoming Georgia Senate runoffs and renewed lockdown concerns, compounded by the vaccine rollouts' slow pace.
The result of the Georgia election may be the most important event for the markets. To date, investors are comfortable with a Republican-controlled Senate that would offer a balance against the potentially more progressive agenda of the Democrats under President-elect Biden. If the Democratic Party candidates both win, we could see an equity market correction should investors worry that such checks and balances around tax and tech regulation will not exist.
It’s all or nothing for the Democrats who must win both seats to gain control (via a tiebreaking vice-presidential vote), while if the Republican Party wins just one of the two chairs, it will retain power. Indeed, this will have an important impact on the expansiveness or limits on the Biden presidency over the next two years.
If you asked someone in October what the Blue Wave meant, they would have answered: "Infrastructure, MMT, sell USD". Now, there seems to be much more confusion about what a Democrat-controlled Senate would mean for the world in 2021.
This is an important question, not just because the vote is today but because the odds have tightened considerably; the betting firm Ladbrokes now has the Democratic sweep as the favourite of four choices. Meanwhile, PredictIt is tracking around 46% D / 54% R.
The market seems to be confused between the pros (infrastructure, more government spending, etc) and the cons (higher taxes, more tech and cryptocurrency regulation). In October, the assumption was the sequencing of policy would put a tax on the backburner, but for some reason, people are now confused about this too. The bottom line is the market hates uncertainty.
The oil market toppled head over heels with broader markets as the sum of all fears centres around lockdown consternations. All the while, OPEC was doing its best to hold prices in check and emphasizing the need for continued cooperation and vigilance in the face of the uncertain outlook.
The most worrying aspect for oil market concerns is the case of a brave new year giving way to the same old fear as the re-imposition of worldwide lockdowns to defend against the coronavirus's mutant strain will pose the greatest near-term risk on the path back to oil demand normalcy.
If OPEC+ can avoid internal dissent signs, I think the decision on whether or not to add 500kb/d in February will have a limited impact on the oil price. Far more important will be the news flow relating to the Covid-19 vaccine rollout, stimulus measures being considered by various governments, and how quickly we can get on the path back to normal oil demand levels via the vaccine rollouts.
The Georgia's Senate runoff has precipitated risk-off behaviour in the FX markets, potentially lending the USD more safe-haven strength. The Euro is off overnight highs constrained by Covid-19 related concerns and US political developments. USDCNH fell below the closely watched 6.50 level while the dollar is finding some interim support around 6.45.
Besides the waves of downside option related activity in Asia yesterday, the change in the CFETS RMB basket weighting scheme (announced on 31 December 2020, effective yesterday) has likely contributed to the move. The USD's weight was lowered notably by 2.8ppt to 18.79%, nearly on par with the EUR's weight (+0.75ppt to 18.15%). When the 24-currency CFETS basket was introduced in January 2017, the USD's weight was much higher at 22.4%, and the EUR's weight was just 16.34%.
This adjustment is in line with China's maturing trade patterns; bilateral trade with the US has declined in recent years due to tariffs and trade tensions. Theoretically, a lower USD weight means that the CFETS RMB index may not rise as much, and can stay below the 96 level, even if the weak broad USD trend continues. Some market participants may now think this is a policy signal of greater acceptance for further downside in USDRMB.
The Ringgit stumbled a bit overnight as lockdown concerns weighed on the energy complex, which is getting complicated by a slower distribution of the vaccine than originally hoped.
At the end of the day, it matters little if Democrats or Republicans control the Senate, with either outcome leaving the dollar brittle as the twin deficits aren’t going away any time soon. That weight will eventually fracture the dollar unless US trade swings are more outwardly favourable. The Georgia election may pose a short-term speed bump, but will unlikely change the 2021 trend.
I think it’s a case of seeing the EURUSD chop around for a bit, then release higher to trade above 1.2500 by month-end.
Gold is holding on to its sensational start of the year gains, despite the US dollar attracting safe-haven demand. However, more favourably for the currency of last resort is that inflation expectations are bubbling over as the vaccine rollout is providing a sizable anticipated inflationary bounce to the economic recovery this year.
The bullish seasonality for gold in January has been one of the strongest across precious metals and the G10 space over the past five years. I expect the market to quickly try to price that over the week, with room for discussion after the seasonally move higher is reached. Additional things to look at are the Georgia Senate elections runoffs, and a potentially increased fiscal spending outlook for the US.
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With equity markets rising to fresh record highs in the United States and Europe, risk appetite is rising again