The Week Ahead
US payroll data points to an inflexion in the labour market. The stronger-than-expected print demonstrates once again that the US economy is poised to accelerate as the risk from Covid-19 recedes. And even if the bond and currency markets aren't buying what the Feds are selling, it doesn't matter too much – at least in the Fed’s eyes – provided "Curvemageddon" doesn't hit inside of 2022.
The Fed has provided dovish leadership in what’s a tricky year for central banks globally. A refusal to react swiftly to bond market wobbles is not a change in approach. As long as the Fed's underlying dovish determination is undoubted through 2022, the global risk market’s sentiment could remain strong, including equities.
Indeed, this is as supportive an environment for the US as it gets, buttressed by double policy supports, fiscal and monetary, which should remain pedal to the metal. And all that needs to happen is for the rates markets to start buying into what the Feds are selling.
Perhaps Chair Powell could have been clearer on Thursday, but the basic 'Fed message', taking all of Fed speakers together, is that rates are staying where they are for a long while. Inflation will have to realise and sustain a little above 2% before Fed funds are an agenda item at a FOMC meeting.
When robust US data comes along, the treasury market should steepen as it adds inflation expectations. Investors need to get hold of that – the data is excellent, the Fed is leaving rates on hold for a very long time in market terms, consumers are getting mailed stimulus cheques, and the president is spending money. And with every American set to be vaccinated by the end of the year that should be the cause of celebration and something the markets will eventually revel in once the raging interest rates fire burn out.
Chair Powell might have been a bit tongue-tied and overprepared on Thursday, but let's not forget that treasury yields aren't rising because the Fed has somehow messed up; instead, they’re increasing for one very encouraging reason: the entire USA will be inoculated from Covid-19 by the end of 2021.
The Fed will likely remain steadfast in anchoring front-end rates close to zero as inflation rises. The yield curve's steepness reflects the Fed's new framework and a coming cyclical recovery rather than a driver of Fed policy itself (in the Fed’s eyes). That, in turn, suggests the hurdle for higher yields in forcing intervention will probably have to be driven either by liquidity concerns in the UST market or a tightening in financial conditions unjustified by macroeconomic fundamentals.
Improving activity data should make investors more comfortable with higher real yields that could lift reflationary assets once more, including commodity prices and more value-dominated equity indices. The sooner the US employment data picks up, it will provide a huge lift to value.
It was one of those weeks where one has to look below the surface to appreciate what happened. The general tilt to the tape on the week favours value and defensives, with energy (up 2.8%) set to be the only sector in the green heading into the week’s end. Indeed, energy has outperformed tech for the fifth consecutive week. One thing to note, whenever the velocity of the index moves picked up, active investors moved to the sidelines, stepping back in once momentum shifted. Folks have again become momentum players, which is just exacerbating the intraday swings.
Finally, the post-Covid-19 economic boom will be driven by services; the USA is the most services-heavy economy globally and will provide the icing on the cake. The cherries on top will unquestionably be the 1.9T of stimulus passed in the next week or two and then a massive US infrastructure package from Mayor "Go Notre Dame" Pete Buttigieg.
Despite the stronger dollar, oil rallied about 4% following the OPEC+ announcement that production will not increase. Several analysts have raised their price forecasts, with Goldman Sachs seeing Brent at USD75 a barrel in Q2 and USD80 in Q3. Of course, it found an echo in virtually every copywriter analyst report, as well as an echo in market sentiment.
WTI and Brent were up on the week by 7.8% and 5.1%, respectively, with oil now back to 2019 levels. So, which of the two grades has performed better since the announcement? The arb has widened USD0.45 to -USD3.42. WTI has added 7.75% from Wednesday's close, while Brent has added 8.19%. Meanwhile, the US oil rig count is up by one unit to 310 wells, the highest since last May.
Other central banks are closely following the Fed's words and actions too. So far, fears of their currencies appreciating against the dollar have not materialised.
US yields continued to dominate market attention, as there were a plethora of Fed speakers reluctant to push back on the recent US treasury selloff. And despite treasuries, US stocks should be flying. In fact, under the surface, they are – and shrugging the rates market off pretty quickly.
With rising rates, a quickly recovering economy and a surging equity market, what’s not to like about the US? Why would you want to own any other currency right now as we could be back at the old US of A being the only game in town.
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With equity markets rising to fresh record highs in the United States and Europe, risk appetite is rising again