Many US markets were closed for Martin Luther King Day. However, futures were still trading. But it's been a relatively sluggish start to the week, as one might imagine, and the lack of activity on the big-ticket market items like US bonds and stocks make it challenging to get a good read on investor sentiment. But overall, it’s this seemingly never-ending pandemic threat that continues to loom.
However, any hints of risk aversion dotting the market scrim have been little more than taking profit from winners; any weakness has not been much more than that. The dual policy puts from monetary and fiscal policy succour, and the vaccine rollout – as logistically challenging that looks to be – still points to gleaming days ahead.
It’s hard not to like the sound of the Biden administration's overarching focus on public health and economic responses to the Covid-19 pandemic. A crucial part will involve distributing vaccines to hundreds of millions during the administration’s first year; it’s the rollout of vaccination, not the timing of taxation that should continue to resonate with investors.
But notably, even as the coronavirus runs amok this positive policy elixir provides a resounding backstop, tempering volatility sensitive strategies while always keeping investors safely away from re-entering the pandemic doom loop.
Democrats will control Washington's policy agenda over the next two years. Hence, investors continued to bounce Biden's pro-growth policy against the significant pick in Federal spending in response to the Covid-19 pandemic. Most discussions revolve around who’ll pay for it after President-elect Biden mentioned last week that everyone would pay their fair share for the stimulus package, bringing the focus back onto taxes when the market has been pretty comfortable assuming they won't come until late 2021 or early 2022.
Still, Democrats may need to push back specific Covid-19 spending priorities that don't get sufficient Republican support, like direct support for state and local governments, to a reconciliation measure that only needs majority approval in the Senate.
Democrats will chip away parts of the 2017 Trump tax cuts. And while an extensive scale tax rewrite is coming, the market is uncertain over the timing. But it is suspected that Democrats will use the reconciliation process to make targeted tax reforms. This package's cornerstone is likely to be higher corporate tax rates and higher income tax rates for wealthier Americans.
But, at the end of the day, even with majorities in both Congress chambers, Democrats will have difficulty advancing a bold, progressive policy agenda due to a razor-thin majority, and policy uncertainty tends to create a high level of discord and lack of harmony.
In a typical case of coronavirus induced fears spreading across global markets in an almost predictable manner, oil prices are off from last week as sentiment cooled after swelling production inventories fused with the return of Covid-19 in China, providing a not-so-rosy near-term demand signal. Adding drift to the downside flow is the slow rollout of vaccines globally, which is walking back the timeline for jet fuel demand to take off.
The shift lower in oil prices is a technical correction to a large degree as it’s a Covid driven sentiment sell-off. And while oil market risk appetite can remain at high levels for extended periods, as long as the macro environment remains supportive, US data has been less encouraging lately. However, yesterday's Q4 China GDP data provided a festive reminder that China's economy continues to fire on all cylinders and brought with it dip-buying support.
Overall, the policy mixes between the current OPEC+ supply disciple coalescing with the Biden's administration's overarching focus on public health and economic responses to the Covid-19 pandemic suggest oil prices can go much higher.
Still, the current headwinds from a stronger USD and evidence that the coronavirus is continuing to spread are clouding the demand outlook. It should come as no surprise that Q1 2021 continues to reflect a complex and uncertain demand environment for oil, and the strong rally for oil into year-end 2020 and the first week of 2021 has left the price-sensitive to profit-taking. I expect oil to stabilize near the current level as progress is made on the coronavirus vaccine rollout. And as confidence builds around beating the virus as we move closer back on the path back to a typical demand environment, oil prices will soar.
With the Biden inauguration stealing the limelight this week, traders are also concerned about a foreign policy pivot; one of the wild cards for oil this year is the upside to Iranian production, dependent on the potential lifting of US sanctions under incoming President Biden.
We’ve already seen hints of the Democratic pro-green policy agenda in reports that the incoming Biden administration will cancel the Keystone XL pipeline by Executive Order, a reminder that US oil and gas investment could face new and more significant regulatory and policy headwind.
There are signs the US dollar upswing is about to pause as significant technical support/resistance levels continue to hold, especially as risk sentiment continues to stabilize, albeit with e-minis a touch lower.
The BTP market was relatively calm ahead of the government's confidence vote in the Italian Senate, and justifiably so as Italian Prime Minister Giuseppe Conte won a crucial confidence vote in the Chamber of Deputies on Monday, hanging on to power after a junior partner quit his coalition last week.
Despite the recent USD correction, EURUSD should remain supported by a robust European recovery and a large fiscal stimulus package in the US. Fed Chair Powell's assessment last week was dovish and caused a pushback in Fed taper expectations to September for December. And with gold buying into that narrative, coupled with the recent unwinding of cash and option longs and fresh downside buying, it has led to a sell-off in risk reversals. It offers a pretty good opportunity to buy discounted EUR calls, and that buy-in seems to be holding the EURUSD above the critical 1.2064 level on close.
Still, FX seems set for an extended first-quarter lull, if not the graveyard, as the EURUSD hashes out new ranges. The 10y US yields ran out of steam ahead of 1.2% and have consolidated around 10bp lower, leaving short dollar sentiment bruised but not broken.
The immediate future for FX markets has the clarity of spaghetti thrown on a wall. Still, the next USD leg lower should restart in the second quarter when the taper dust settles, oil price move higher and reflation trade soars.
Gold continues to lose traction on the back of the stronger USD as it both shrugs off a dip in yields and remains non-reactive to Chair Powell’s dovish forward guidance, or even the political discord on both sides the pond. However, I think it's worth keeping an eye on these developments, especially if social unrest rears its ugly head in the US.
But it’s gold's old foe, the USD, which is applying downward pressure on gold. The USD Index (DXY) closed at 90.77, the highest since December 21 (with gold closing at 1,876/oz that day). However, as US bond yields get repriced higher, it will limit gold’s rise over the short term, so the street has already morphed into a seller on rallies.
Treasury yields are far too low. A bond yield of 1.50% on the US 10y should quite easily be possible and likely pose a big gold problem.
Barring the Fed easing into the recovery, it's now unlikely gold will exceed 2020 highs. And with growth returning to trend as vaccines get rolled out, policy expectation will increase, and gold could now close out the year between $1,650 and $1,750 – assuming herd immunity is attainable.
What I'm looking at today
With both the upward trend in US yields and the USD pausing, gold has been able to hash out a comfortable base above $1,820 as last week’s dovish comments from Chair Powell continue to resonate.
What I'm looking at today
Frankly, way too much! Just like most other analysts/traders/investors during a political regime shift, it’s a matter of fleshing out what policy is good and bad for the investment climate.
But with such a big agenda rewrite, markets could be stuck in the revolving carousel of US political risk analyzing the Democrat victories in Georgia, Covid-19 efforts and stimulus, Democrat targeted tax reforms, infrastructure, Biden appointees, healthcare, debt/deficit issues, regulatory review, climate/green energy, immigration, China, international relations, Big Tech, financial services and other matters.
Yes, the laundry list is vast, so we could find ourselves tied in political knots for some time. But Democrats will have a hard time advancing a bold, progressive policy agenda with constant Republican pushback as it’s unlikely the GOP is going to make these next two years a policy walk in the park.
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Today’s key charts focus on oil, where the recent rally has stalled amidst talk of a lift in sanctions and speculation of a production boost.