Despite the political rancour that has vexed market sentiment in recent days, US stocks edged higher Wednesday as investors are willing to look past the political uglies to sunny days ahead as expectations build for additional, and perhaps larger, fiscal stimulus efforts as pandemic priorities remain the first order of business for the Biden administration.
All the while central bankers stay the easy money course, resurfacing the runway for lift-off which experienced a few policy pivot potholes this week.
More dovish Fed commentary, this time from FOMC member Brainard, suggests the economy is far away for our (FOMC) economic goal. Meanwhile, on the other side of the pond and providing an offset to the political rancour building in Europe, there was a dovish tone as well from the ECB's Lagarde: "Any tightening at the moment would be very unwarranted", and pre-emptive tightening could lead to "very serious risks", suggesting the market should not get too far ahead of itself.
Speaking of the outside chance that "Congress passes a much bigger stimulus package" than folks anticipate, it's worth at least mentioning that Bernie Sanders is poised to become chair of the Senate Budget Committee. In an interview with the Times, Sanders made it clear that he doesn't intend to dither to tackle the current crisis. "Underline the word aggressive," he said. "Start there." All of which suggests "Bernie means Bigger" when it comes to stimulus.
On the “when rising rates become a problem” front, bonds rallied for the second consecutive day. A strong Treasury auction result suggested the selloff may have run its course – the back-to-back strength coming out of this week’s 10 and 30-year auctions represented a turning point for the market, at least for the near term, but more importantly primary dealers took down only 14.2%, compared to a 21.0% average – no pressure at all for primaries to mop up unwanted supply.
Yield suppressant bond auctions like these – especially when stocks markets are trading in rarefied air – offer up a convincing oxygenated lifeline to assist the ongoing higher altitude attempts a lot more comfortably.
Of course, more stimulus means more borrowing. While the street has been in a bit of a taper tizzy, simultaneously attempting to factor a Democratic Senate stimulus deluge inflationary effect into their forecasts, it's telling that both Tuesday's 10-year auction and Wednesday's 30-year sale went well, even as markets are acutely aware of the prospects for much higher spending it suggests investors are willing to draw a tentative line in the sand, expecting the FOMC to do the bulk of the heavy lifting if any excess supply mop-up duty is needed.
Stock market dips continue to be bought on the promise of brighter days ahead and what’s now a dual policy put of both a monetary and fiscal backstop, making it ridiculously difficult for short selling strategies to execute and hence for equities to a selloff in earnest. After all, there’s nothing like good old policy stimulus balloons lifting markets to vaccine nirvana (aka: herd immunity).
The oil market’s sizzling rally likely took a hiatus as the stronger dollar and omnipresent gasoline supply overhang offset the evaporating US crude inventories, capping both primary benchmarks under key psychological and technical inflexion points.
Even before the not-so-rosy gasoline read on the DOE report this gnawing temporal disconnect was weighing on market sentiment, with spot miraculously trading better now than they were before the pandemic.
But this is the intentional result of OPEC+ supply discipline, which is the keystone anchor to fundamental deficits which are drawing on US inventories, compounded by Saudi Arabia already limiting supply to Asian refiners ahead of production cuts planned in February, signalling their commitment to the production cut.
This price boosting effect could be further amplified by Saudi Arabia's unilateral cut of a further -1 mmb/d in February and March, especially via a pivot lower on the Covid curve, speedier vaccine distributions – even a larger than expected US stimulus impulse could do the trick.
With oil prices running ahead of many forecasts, it's going to very interesting to see how "The Street" interprets the effects of the recent rise in crude prices through the lens of shale; one would have to imagine there will be considerable head-scratching as to whether WTI near $54 will prompt increased investment in US oil or whether a conservative financial strategy prevails.
Oil is still pricing in a great deal of optimism, linked to the roll-out of Covid-19 vaccines, and any negative developments would prompt a sharp negative reaction. Still, demand will gradually improve as more folks get vaccinated, and the supply side is under control thanks to OPEC+ and Saudi Arabia's continued efforts. Risks remain, but there appears to be a clearer path to oil upside with downside risks diminished.
The USD has stabilised after weakness that was prompted by some unsurprising pushback on tapering by Fed speakers. And while the Fed is unlikely to taper before H2, or even 2022, the "Taper Talk Genie" is out of the bottle and the magical spirit will linger over price action for months to come as well as prominently feature in the Fed debate this year, as inflation should make a strong comeback, at least temporarily. Bond rallies will therefore eventually be selling opportunities, in my view.
In the meantime, there will be more than enough US data disappoints to keep the dollar bull’s nose ringed to the pen. At the same time, Fed Chair Powell will probably also sound very cautious tomorrow and dismiss any reducing stimulus notion.
Despite US yields falling after well-received US bond auctions, some EURO weakness continues to linger in the market. Moves earlier in the week were a broad USD short trade getting stopped out, but that appears to have run its course. It looks like more general EUR weakness is setting in amid dovish comments from ECB President Lagarde; the ECB seems to be more attentive to the FX impact on inflation and very carefully monitoring exchange rates. The possibility of a longer German lockdown and concern about the vaccine rollout speed in the Eurozone are all clouding the Euro's bullish viewfinder.
Intuitively, a much bigger yield differential between a currency pair will create a stronger FX force than if the differential is barely perceptible. During the last period of stronger FX-rates correlations, the US-EZ 10y yield differential was persistently over 150bp and at its widest was close to 300bp in late 2018. The current spread between the US and EZ 10y is on the cusp of when differentials count" zone.
My assumption here is the same type of logic applies to the CGB vs UST argument and is negatively impacting the yuan of late. The yuan benefitted in 2020 from a confluence of accelerating Chinese credit growth and declining US real rates. However, the exact opposite is already playing out in 2021 so far.
With short dollar trades tempering over the great US dollar debasement story of 2021, it's not such an easy glide path for gold to start the year. So, I suspect gold remains tied to the hip of the US dollar fortunes this quarter. The market then morphs into "sell the rally mode" as the US economy recovers tangentially to the vaccine distributions. Of course, positive factors like the resumption of a USD downtrend, or if the FED pulls a policy rabbit out of the hat and eases into the economic recovery, would be a risk to my not so cheery gold view. Still, I'm afraid to say gold's glory days might be over.
What I'm looking at today
The February 4 meeting of the Bank of England has been on my mind and could be interesting as, I would guess that, despite some recent pushback on negative rates, there will be increasing speculation on chances of a BoE rate cut that would punish the long GBP trade.
But coming on to my radar this week are the red flag warning signs that political risk in Europe is starting to percolate as Germany faces the transition away from Angela Merkel, Italy is yet again an epicentre of a political firestorm, and even France's President Emmanuel Macron will be more and more of a lame duck as the year progresses. With all the focus on US politics and Covid-19, I don't think this has currently reached the market viewfinder.
The Christian Democratic Union has helmed Germany for all but seven of the years since reunification. Still, it’s in a state of turmoil as long-time leader Merkel plans to step down in September after 15 years running the country and 20 years running the party. The CDU is searching for a new direction, which is always an arduous political process. There will be more uncertainty to come, with implications for Germany, Europe and global financial markets. The first step comes this weekend with the culmination of the party leadership race.
Axi in the media
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US stocks appear to have reached a mini cyclical fatigue point, but the pace of vaccinations remains the key driver for risk markets