Risk sentiment is getting a small bounce this morning after the House passed Biden’s 1.9 trillion stimulus bill amid central bank sabre-rattling.
While investors will forever be keeping an eye on the canary in the inflation coal mine, the sun always rises on a Monday. It’s still fundamentally good news that the sell-off’s economic underpinnings – increasing mobility, inflation and US stimulus – are still intact, with global vaccinations rolling out faster than expected and the US Feb financial data looking good.
A brief intermission to the bond market onslaught Friday saw US10yr yields finishing down 12bps to 1.40 %. US equities fell again, however; the S&P 500 slipped by 0.5%. Meanwhile oil slid 3.3% as the discussions between Saudi Arabia and Russia take on a negative candour. The reversal in bond markets came amid a more alarming tone from some central bankers as they began to rattle the sabre in an attempt to fight off unwarranted market-implied tightening.
Still, it was a week where we ate a massive wedge of humble pie after the bond market served up a lesson in humility. This cyclically driven move does not change the more secular, lower-for-longer view. But it does require swagger as the left tail risks have reduced, whereby the chances of the gloomiest scenarios playing out are also much less.
The seemingly forgotten aspect is that inflation expectations indicate the Fed's lower for longer policy being accepted. Without the "street cred" of lower for longer, tightening monetary policy would wantonly begin to be priced. Sure, there‘s a shift in the odds the Fed will move rates higher in 24 months, but the market hasn’t budged in the next 12 months view. Simply put: the market is not challenging the Fed's willingness to hold rates lower for longer – at least not just yet.
It's likely too fast but not too far, so it could make sense for the Fed to push back against front-end pricing but not stepping back the absolute level of yields which are not too high given reflation, reopening prospects and US fiscal policy.
And perhaps the Fed views the move in bond yields as little more than the market’s self-correcting mechanism, given they’re left with the unenviable task of orchestrating a 2021 taper without the tantrum. And pushing back might be misinterpreted as the Fed losing faith in its own ability to guide policy. As large as last week’s moves in yields was, it’s still difficult to see the Fed change tact so quickly after the recent chorus welcoming the move higher, though more dysfunctional treasury auctions could justify some pushback response.
Thursday's sell-off in Treasury bonds put the tempo of the month-to-date move in real yields on par with recent spike episodes: the post-2016 election reflation theme return, the 2015 "Bund tantrum," and the 2013 "Taper tantrum." But we may also find some comfort that we’re in the 7th or 8th inning in two ways.
First, the market is earlier in the business cycle than in 2013, so the implications for risk broadly speaking may be more cheerful given the length of vaccine runway catalyst. Second, the market has likely priced in a Fed overshoot and even if not with about a 75% shift towards the Fed terminal rate; it’s likely we’re in the 7th of 8th inning of that repricing.
The street still expects the Fed to announce a taper of its asset purchases at the September FOMC. But several forecasts for the economy now see larger and earlier acceleration than the Fed sees. For now, the Fed message might continue to be tilted to the dovish side, especially if the sell-off in rates continues. But the Fedspeak of the past week shows how the evolution of the Fed’s communication will eventually get to that taper announcement.
Risk-Sentiment, OPEC+ Meeting Pull Oil Lower
Oil prices are recovering this morning, in line with most risk assets, on the back of the US stimulus bill passing the House and as central banks continue to sabre rattle to ward off market-implied financial tightening.
The oil market has been hobbled partly by the domino effect of "risk-off" sentiment across broader markets and by supply concerns ahead of next week's OPEC+ meeting as reports surface; Russia is pushing for a production increase while, at the same time, Saudi Arabia favours holding production steady.
It will be difficult for Saudi's cautious stance to prevail in a higher oil price situation, but they have flexibility concerning a unilateral 1mb/d cut. This was meant to apply for February and March, but the Saudis may choose to delay the return of some or all of this production to keep prices high, even if the rest of OPEC+ favours a production increase.
The OPEC+ meeting on March 4 is an increasingly essential ingredient, and producers face the tricky task of sorting through the various moving parts to form a strategy that makes everyone happy. But let's not beat around the bush: more supply needs to come onto the market to ensure OPEC+ meets incremental demand and keeps internal discipline ducks in a row.
Evidence of a tighter oil market in 2021 prompted several brokers to make upward revisions to oil price targets, which helped push Brent to a 13-month high last week. While it’s true that the market is likely to be undersupplied this year, what’s getting ignored is the fact that this deficit is entirely dependent on OPEC+ supply cuts. The artificial shortage created by the OPEC+ agreement will help to accelerate the draw-down of global inventories. Still, the upside in oil is likely to be capped by the ~9mb/d of spare capacity in OPEC+.
At the beginning of the year – and really up until just the last few days – the rates complex was priced for a perpetually and exceptionally dovish Fed. However, last week gave ample evidence of investors getting stopped out of bullish currency bets as FX traders were caught far too short dollars against the backdrop of higher US yields, especially against commodity currency linkers.
However, most forecasts and trade recommendations' basic premise hasn't changed: the global cyclical rebound should result in broad dollar weakness despite a strong US economy. And with most countries on the cusp of reopening, traders may soon start to fade the strong US dollar narrative from last week.
Precious metals fell into the close on Friday as the USD continued to rally despite lower yields, but gold is beginning to look oversold near term.
Still, the commodity broad sell-off can weigh further on the bullion complex; silver may weaken if copper falls, so it’s still not all systems go for gold at the moment.
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With equity markets rising to fresh record highs in the United States and Europe, risk appetite is rising again