Markets Outlook: An increasing polarity between economic outlooks

Market Analysis / 6 Min Read
23 Nov 2020

Market highlights

  • FOMC minutes highlights a packed economic calendar
  • Lockdowns, vaccines and policy support currently have the market circumscribed
  • Increasing polarity between near- and medium-term economic outlooks
  • Shift in production/demand balance has oil spreads at their lowest in months
  • An increased chance of gold establishing a new, lower range

The Week Ahead

The current week's holiday abbreviated financial schedule is packed with significant events – in particular Wednesday's arrival of the November 5th FOMC meeting minutes. The minutes take on added significance as Fed Chair Powell had shown in his post-meeting question and answer session that the board had had a lengthy conversation on their QE program, but no firm conclusions had been reached at that point. So the minutes ought to give more prominent detail on how the Fed is pondering possible changes to QE, and maybe a few signs regarding how they might want to shape the forward guidance.

The data docket may give financial policymakers a clearer need to keep rates easy. The calendar's schedule commences with November consumer confidence (98.7 gauge versus 100.3 already). The drop in preliminary University of Michigan consumer sentiment is one reason traders expect confidence to slip a bit. The ongoing surge in Covid-19 cases and increasing restrictions on activity in many states is another reason to expect a depressing reading. 

In summary, there’s an increasing polarity between the near- and medium-term outlooks for the economy. On the one hand, economic disorder from renewed virus growth will inevitably dampen the pace of economic improvement in the current quarter and into the beginning of next year; ongoing political uncertainty about the next phase of fiscal stimulus could exacerbate this situation. On the other hand, better-than-expected vaccine developments and the potential for earlier deployment could provide a much-needed boost to the global economy next year.

The three key market limits

Markets are currently circumscribed to three related themes: lockdowns, vaccines and policy support. 

A fledgling rotation from tech to value in equity markets and an ongoing rally in key industrial commodities suggest these asset classes are focused on the reflationary possibilities of a vaccine rollout.

However, the transporter to the post-vaccine hereafter depends on ongoing monetary and fiscal support in the interim, particularly in the context of worsening hospitalization rates and tightening social mobility measures in the US, that is, following Europe staggering numbers with statistical lag. But the US numbers are worse!

Future optimism is balanced by growing near-term downside risks that are driving a bull-flattening in the UST curve. Risk assets require carefully graded monetary and fiscal policy support for this period. 

While the US Congress is back in session a new budgetary stimulus deal is no closer, yet initial jobless claims continue to tick higher.

In this context, the US Treasury's request that the Fed end several lending schemes, including the Main Street Lending Program, is a negative surprise.

This emerging risk for investors is an untimely withdrawal of support for the US's real economy, just as social-mobility restrictions sabotage activity for the second time this year.

US economic underperformance justifies USD upside vs. EM FX. However, renewed bear steepening in the UST is becoming less likely for now.

Currency markets

I suspect EURUSD failed at the top of the range again (1.1900), and gold weakness will remain a significant short-term risk for USD bears. 

This EURUSD rally has mostly been a mechanical response to Asia FX strength, so with the speedy reversals in stuff like USDKRW, topside EUR pressure is off. EURUSD back to 1.1650/1700 makes sense to me, but I don’t feel super inspired by the trade as I think we’re more likely to see a random range trade chop-fest than the start of a big dollar rally.

I cut my long EURUSD this morning after getting a fortunate bounce higher overnight and will start dabbling from the long USD side and continue to do so. 

My only thematic view right now is that the vaccine story (long-term bullish) will eventually win out over virus worries (short-term bearish). Still, the EPFR, insider selling and AAII show this is dangerous to be bullish risky assets. Once sentiment resets, I’ll be more excited about the vaccine trade then start selling the dollar in earnest, especially against EM. I think the big reset hits on the reopening trade 2021. 

Oil Markets

Although we woke to some Covid-19 nasties last week, the contango has been tightening despite the front-end yo-yo. Spreads are at their narrowest in months, reflecting the shift in the production/demand balance on a combination of factors:

  • Lower production by OPEC+ countries
  • Numerous weather-related shut-ins in the Gulf of Mexico
  • Asia's increased purchases (China binged on cheap oil in the first half of the year)

Calendar spreads are down along the Brent curve, from mid to the end of 2021 are now below $0.10 contango. And, really, that’s the key to holding the front end in check.

As John Kemp (Reuters) puts it: "such contango would not cover the cost of storing and transporting crude, implying that stocks are expected to be below the five-year average and falling rapidly at that point."

Rising Covid cases and restrictions tempered the enthusiasm around good vaccine results. Still, we shouldn’t expect to see the same playbook for downside oil market risk that we saw with the second Covid wave in Europe; not only were the vaccine results excellent (which should soon lead to Emergency Use Authorizations), but rising cases are elevating expectations around Fed action at the upcoming December 16 meeting when they may conduct a QE twist that will do much of the oil market’s heavy lifting due to inactivity on the stimulus front.

But it’s all down to OPEC and no formal decision will be taken before the full OPEC+ ministerial meeting at the end of this month. Still, with the rise in coronavirus infections and new mobility restrictions, it seems all but a rubber stamp kind of likelihood that an extension will be undertaken to support sentiment, tighten the market and avoid a pullback in oil prices.

As we count down to the meeting of OPEC on November 30th, the Axi Expert Series is pleased to welcome Henning Gloystein, Director of Energy, Climate & Resources at Eurasia Group, to discuss his views and insights in what’s an important week for oil markets.

Watch now

Gold Markets

The chance of gold establishing a new, lower range has increased this week as the 5-day change in ETF gold holdings touched -1.60 mm troy oz, surpassing the previous negative extreme of 1.48 mm troy oz seen on March 20. Indeed, this supports my anecdotal premise that non-traditional gold investors will cut speculative bets on gold with the vaccine in the air. News of another vaccine is most welcome but is intuitively negative for bullion prices, and with several in the pipeline, it screams “sell gold!”

For more market insights, follow me on Twitter: @Steveinnes123 

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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