US equities were weaker Tuesday, the S&P down half a percent heading into the close, having finished at a fresh record high on Monday. US10Y yields fell 4bps to 0.87%, while oil was down 0.5%.
A sense of caution has returned to equity and FX markets. Risk appetite rose in the wake of the Moderna Covid-19 vaccine announcement, but there has been little follow-through in stocks or FX in the post-Moderna announcement world.
While the vaccine throughput into currency markets is more pronounced through the EMFX channel, that lack of movement in G-10 FX isn’t overly surprising What is incredible, however, is that stock markets chose to ignore a vaccine's potential – despite unambiguous guidance on timelines. The Pfizer and Moderna candidates' efficacy was far better than expected, with the latter not needing Antarctic type temperatures for storage.
Dollar down, equities down, US Treasuries bull flatten; the reflationary impulse from the Moderna vaccine news lacks follow-through as the risk of more mobility restrictions is rising, and new Covid-19 infections accelerate in the US seems to be the obvious reason. Still, given we’re heading into year-end, investors are also keen to mitigate risk to protect gains rather than rotate from their structural bets.
Let’s face it: with Covid cases in the US soaring and putting huge strains on the medical system, it’s resurrecting ghosts of Christmas past where more than a few skeletons remain in the closet. So, investors could be right to be a little risk-averse and wanting to defend profits where it might be easier to channel bullish thoughts into 2021, rather than in the Covid depressing climate of today.
The next catalyst to propel the vaccine narrative has to be efficacy results from AstraZeneca (its vaccine doesn’t have the same infrastructure challenges as Pfizer's). However, these are not expected until late December/early January. Markets are therefore likely to find themselves in a bit of range, pending the reopen trade in 2021.
Still, the vaccine news has understandably led to more positive sentiment. And, when viewed from a "down the road" perspective, it’s hard to argue that we won’t be in store for a positive economic reassessment and improved macro environment, which will prove risk positive and provide a favorable backdrop for risk assets.
After all, the Fed made it clear, once again, that there will be more rather than less stimulus in the coming months. Nevertheless, in the next few weeks, we might get a few bumps along the road. After all, quite a few positive catalysts have now materialized and, as we’ve seen so often in this roller coaster ride, what goes up ultimately comes down.
Essentially, we have an incredibly nice narrative set against a horrible Covid-infused sentiment backdrop. If your time horizon is beyond 2020, it's an incredibly bullish story, but if you’re a short-term trader (1-2-month horizon), it's hard to be bullish with the Covid storm clouds lingering overhead.
It was a lackluster day for US equities on Tuesday, with the rotation showing signs of exhaustion. It’s not about factors today – i.e. not about Reopening vs. At Home – instead, there’s more single-stock dispersion within subsectors; growth is outperforming defensives, though volumes are normalizing.
There’s plenty of fairly large intraday movement on the single-stock side, in particular in pharma after Amazon launched an online pharmacy. Indexes do not tell the whole story as this market is warming up below the surface, albeit selectively.
The efficacy of both the Pfizer and Moderna vaccines was better than expected, but the market chose to lean on trades that suggested the world would not ever recover. That’s clearly wrong in my view. Is it right to stay wholly invested in the expensive growth and momentum stocks in the current size and scale? The rotation has not yet happened and the roaring 2020's trade may still occur, even if it gets deferred to 2021.
The general view is the rotation into value will continue – it’s just going to remain choppy. Bond yields are likely the biggest component to keep an eye on, especially when moving out of growth. Flows within US industrials/materials yesterday continued to have a cyclical tilt and we’ll need to keep an eye on how quickly some of these names become consensus plays; there’s only a short list of names investors are selectively moving into right now.
The silence was not golden for the oil market overnight as any bullish dreams of waking up to a + WTI $42 in Asia this morning were dashed after the OPEC+ JMMC meeting ended without an explicit recommendation to delay planned output hikes in January.
While OPEC+ can extend the current cuts at its next full meeting on November 30, it may well be viewed as a disappointment that we didn’t hear something more explicit already, especially in the context of a market that, on the margin, is still hopeful that additional cuts in 2021 will be at least put on the table.
Oil had that sinking feeling again after the API reported an unexpectedly larger inventory build than anticipated. With the market focusing on the ultimate inventory fixer – the OPEC+ month-end meeting – the post-API sell-off was muted even when considering the slight disappointment from zero forward guidance from the JMMC.
Oil markets have leaked a bit lower in line with general risk sentiment. However, markets are no worse for wear as yesterday's bounce on Moderna's vaccine is still providing a favorable tailwind along the curve. Still, topside ambitions remain relatively muted above WTI $ 42 because expectations had been built into the vaccine cake following the Pfizer announcement last week. Also, winter 2020/21 is still likely to be a tough period for northern hemisphere economies, as evidenced by soaring US coronavirus case counts and new virus containment measures in Washington, California and Pennsylvania.
Oil fell today, trading both sides of unchanged for the first part of the day. Investors were hoping the OPEC+ JMMC would provide a firm course of action for the next quarter. But, as no decision was made, the market tumbled.
In its monthly forecast yesterday, the EIA expects oil output from shale to decline by about 139kbd in December to about 7.51mbd, the lowest since June. Most of the drop is seen in the Permian basin of Texas and New Mexico, which helps the supply trimming bullish narrative for oil.
The WTI front spread has tightened slightly today as Dec20 approached expiry. The Jan1/Feb1 has widened by a fraction; the same spread in Brent has widened to -$0.22 from -$0.17 last night. The one-year spreads too have widened, but only marginally. Crack spreads have done better by comparison; the gasoline crack has tightened $0.15 compared to the previous night's close but remains around the lows seen since mid-September. Heating oil cracks are doing better, all able to stay above $10 a barrel.
It’s an options expiry today, but with the machines running the settlement show these days, there’s a blink of expiry risk as everyone seems quite pared off.
The Malaysian ringgit looks to be heading for its fifth consecutive winning day, riding the regional bullish sentiment wave from the RCEP trade deal and helped along by a favorable tailwind as oil prices rise with OPEC+ considering postponing its plan to taper production. And earlier in the week China delivered a twin boost of better-than-expected industrial data and a fresh injection of financial liquidity, which boosted local FX sentiment.
In FX, the US dollar downside is increasingly attractive vs. EM FX. Within EM FX, currencies of economies that have suffered severe contractions in GDP this year due to Covid and/or the loss of tourism income are recovering admirably on the latest vaccine impulse. And, on that note, the ringgit fits the bill on both accounts. And that’s not to mention the much-anticipated release of AstraZeneca vaccine candidate’s efficacy and roll out, followed by the Chinese vaccine candidates (Sinopharm, Sinovac, CanSino) which appear the most important for Asia and should provide another booster shot in 2021 as almost all countries in the region – excluding the Philippines, Malaysia and Taiwan – have a deal with Astra-Zeneca.
On a similar trend, after China delivered a twin boost of better-than-expected industrial data and a fresh injection of financial liquidity, the yuan has a picked up a massive head of steam this week, defying G-10 range trading proclivities.
Again, the RMB complex is wearing the yellow jersey in the short dollar trade peloton and is within an earshot of the critical 6.50 level, trading just below 6.55 overnight. Most economic activity in China recovered further in October. Assuming that Covid-19 remains under control, the V-shaped growth recovery on the mainland should continue in Q4, thanks to improving consumption, although the new lockdowns in Europe may act as a headwind for China's exports. Still, the impact from the signing of the RCEP trade accord might help cover some of those external trade blemishes.
Given China's growth outperformance, a widening C/A surplus, a large potential global appetite for Chinese assets on the vaccine bounce, and greater policy comfort with a stronger RMB, the street sees much more value in selling USD/CNH. I suspect we could hit a 6.40 target in Q1 2021 as FX markets will typically fully price in a reflationary event (vaccine) 8-12 weeks before delivery. Also, Moderna's news suggests that other vaccine candidates could elicit a similar degree of efficacy. Clarity can only increase the rollout of vaccine programs, which is crucial for companies assessing their 2021 hiring and investment plans.
The combination 10Y CGB yield at the highest level this year and the lack of traction in higher US yields may tell us more about the possibility of central bank action. The current CGB favorable differential is increasingly attractive for long term investors.
What does a vaccine mean for G10 FX?
My answer is not 100% obvious, but my lean is that it would benefit growth/commodities (CAD, NZD and AUD) and eventually hurt funders (JPY and CHF) via the 2021 rates channel. The net impact on the USD would be heterogenous around idiosyncratic growth stories. Given the lift to global growth, the USD's net effect should be negative via the dollar smile, but performance would be highly assorted across pairs. It should also take the blot out the "Asia (Long Yuan) is the only game in town" trade.
Narrowing FX Ranges
Despite the positive Moderna vaccine news out this week, the market reaction was even more subdued than after the Pfizer vaccine news on Monday last week. Trading ranges in FX are narrowing, with EURUSD stuck between 1.18 and 1.19 and the street looking to fade the extremes.
GBP-USD is edging higher on trade talk optimism. While there’s little new news (barring an optimistic article in The Sun newspaper), investors appear to be still assuming that UK/EU Brexit negotiations will prove prolific.
EUR-USD is modestly firmer, despite Hungarian and Polish threats to veto the budget. Yesterday both countries voted against the EUR1.1tn budget, which requires all 27 member countries' approval. Still, the market is keen to hold long EURUSD positions this week. The Euro bulls are more attentive to the vaccine news and lower relative Covid-19 case counts vs. the US.
Gold markets remain pretty stagnant, but the buy on dip mentality still prevails with Chair Powell and Vice Chari Clarida sticking to script this week. Both acknowledge the surge in coronavirus cases is a big concern for an economic recovery that still has a "long way to go," and the economy will continue to need support from fiscal and monetary policy.
I don’t have much of a salient view on gold these days as other assets are lighting up more distinctively for the eventual 2021 reflation lift-off that has fewer concerns about the fears of rising yields and are less affected. But how long will the central banks be willing to honor their current yield backstops in the face of a reflation torrent?
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There’s a palatable disquiet brewing in market circles as questions get raised over the AstraZeneca -Oxford vaccine data.