President’s Day set the stage for a quiet US market. But we could see US investors extend the long weekend festivities into the market where conditions remain singularly focused on the reflation impulses from US policy deluges amid the rapidly improving reopening situation with Covid showing signs of slowly burning out over the past month or so; vaccines mean consensus is aligned to a surge in economic activity and strong profit recovery.
But there’s still plenty of wood to chop this week as the equity market's strength – led by ongoing steep gains since last summer in tech stocks and the current rotation into value – has caused many to ask what is already in the price. And, of course, is any of the inflation narrative real?
Retail sales will be the marquee data point in the US this week and it would be a considerable understatement to say there's concern in some corners about the US consumer. The January jobs report suggested the services sector remains mired in a recessionary wet blanket, even as ADP and PMIs send conflicting signals. So, an upbeat US retail sales could provide the all-encompassing "proof is in the pudding" investors need to take the next massive leap of faith. In contrast, a miss could offer a nasty consolation prize to stocks., suggesting investors could temporarily defer back to that "proof is in the economic pudding" view.
Also, traders will get a chance on Wednesday to parse the January Fed minutes for information that probably isn't there; that's the great thing about FOMC verbal gymnastics — everyone hears what they want to hear.
Encouragingly, progress on the vaccine rollout for the likes of Israel, UK and the US provides optimism over how quickly a reopening could happen. Building momentum behind Biden's fiscal stimulus package has also supported sentiment. Both factors suggest even great upside earnings surprises.
European equities were stronger Monday, Stoxx600 was up 1.3%, bonds sold off and German 10y yields up 4.6bps to -0.38%. Positive developments on vaccine deployment, the US stimulus package and evidence of a continued gradual recovery of the global economy have improved sentiment markedly to start the week.
Indeed, the series of upside surprises in 4Q20 economic developments, highlighted by another GDP beat, this time Japan's Q4 accounts rising 12.7%qoq annualized against the consensus at 10.1%. GDP is 98.9% of its pre-pandemic level, underpinned by a surprisingly strong capex comeback, although consumption remains weak.
But, notably, the more robust run of global economic data provides keen evidence to investors that the financial data is starting to catch up with the market’s lofty economic recovery expectations in Q2 and beyond.
With the Fed and Biden administration policies perfectly aligned, and after a week of consolidation, it certainly feels like the path of least resistance remains higher as calls grow more vocal for an increase in the pace of reopening and the positive implications that would have for some areas of the market.
Yields are back to the top end of the recent range, but we likely need confirmation of the large US fiscal package to break the range. Value stocks struggle to distance themselves from growth stocks in equity markets, despite the strength we've seen in breakevens, and generally positive vaccine rollout news.
Accelerated vaccine rollouts globally and a sharp reduction in Covid-19 infections in the US provide the backbone for the oil market’s next recovery phase. And the most likely scenario should see absolute demand liftoff starting in spring or early summer amid heightened market overshooting risks as calls grow more vocal for an increase in the pace of reopening across the US.
This week’s extreme arctic type weather in much of the US has triggered rolling blackouts and pushed prices higher across the energy and electricity complex; power prices surpassed the grid's cap of USD9,000 per megawatt-hour on Monday in Texas. In addition to the oil production "freeze in" across the Permian Basin, natural gas supply has also seen cuts to power stations and refineries in the Gulf of Mexico have been shut, pushing gasoline and heating oil prices higher.
While the omnipresent smouldering Middle East powder keg threatened to reignite after the Royal Saudi Air Force intercepted an explosive-laden drone en route to Saudi territory, heightened perceived geopolitical risk and contributed to some momentum. Keeping in mind Mother Nature nor Middle East tension price boosts amid a supply glut is likely to have the legs to support oil prices alone as both types of price bounces historically have typically faded as quickly as they come on. So, we could expect some natural downward price moves as oil markets supply naturally rebalance to the current equilibrium.
The unexpected US supply disruption provides yet another short-term price recovery bridge that has likely taken oil prices to a level where markets were eventually heading, but just a little bit quicker than expected. And with the polar vortex-type freeze anticipated to hang around most of the week – compounded by a surge in demand for oil futures from non-traditional oil patch investors as an inflation hedge – at minimum it suggests we may have entered a new upper bound range with few reasons to doubt that fundamentals will justify further recovery in oil prices to long term equilibrium of USD 65/bbl and likely beyond by year-end.
The focus will soon shift to the OPEC+ meeting taking place in early March. It will be necessary for the group to continue to present a unified front and convey the impression that it’s still enforcing supply discipline.
US oilfield activity is still below "sustaining" levels. But it is picking up quickly on higher prices and likely to continue to do, so US tight oil has been a significant swing factor in global supply/demand balances in recent years, and given its scale (at more than 11% of global supply) and relative price sensitivity, it will remain so. But this year its effect at the margin will be far less significant than the recovery in global demand, and the supply response from OPEC+ due to Capex drops.
FX has been choppy, but the risk to positive news-flow surprises suggest GBP's upside now looks asymmetric.
The UK equity market has been one of the worst-performing major global markets since the Brexit referendum in June 2016. And with the UK at the head of the G-10 class on the vaccine rollouts, Sterling is still in demand as FX traders continue to anticipate real money adjustments piling back into underinvestment UK themes that have been in the tank since Brexit.
And the bar for EUR news flow to surprise positively (vaccine, restriction lifting, rebound) is now considerably lower than that for USD (already high vaccination rate, fiscal stimulus priced), and EUR remains a medium-term conviction long.
All the focus has been on 1.39 breaching in GBPUSD, but it’s the sneaky climb in USDJPY that’s starting to capture the market attention. And it's the first time in a while the street is taking out USDJPY topside via both vanilla and leveraged structures. All this is occurring after a leaked monetary policy report suggesting that the BoJ might take measures to reduce hurdles to more negative rates by revising its three-tier current account structure.
The Malaysian ringgit holds close to two-week highs, supported by oil prices, vaccine optimism and a gradual reduction of the MCO which seems to be on the cards sooner than later. But the local note will face a keen foreign investors test as the Malaysian government will auction 2 billion 2040 MGS to settle on Feb 18, 2021, which will be a good gauge of foreign investor uptake for local debt amid economic headwinds.
I would expect the auction to be well received given global investors’ insatiable chase for yield.
Much of the gold market’s current woes are attributable to rising US yields. The absence of realized inflation on the ground hurts the view also after last week’s US CPI miss as implied or breakevens inflation can only carry the long gold narrative for so long.
Investors need to see the US dollar sledge lower vs the EUR as the keenest sing post that the dollar is on the verge of establishing a longer-term weaker trend.
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With all eyes on the FOMC where no rate change is expected, traders and investors consider what the Fed’s stance will mean for markets