One of the most debated yet quantitatively important unknowns is how much price normalization we’ll see in goods affected by the pandemic. Indeed, this is what’s creating an extraordinary level of inflation uncertainty. And with 10-year yields remaining above 1.6%, investors are ostensibly buckling in for higher inflation.
At the moment, the bond market is more up in arms about inflation than stocks thanks to the Fed’s commitment to hold short-dated rates in check through 2023; however, any blink on that commitment could send the stock lower. If we’re being realistic, we know that even the slightest hint of any rate rise expectations moving forward would see equities move significantly lower. So, will central bank messaging then become more market dependent rather than data-dependent in their views.? Perhaps we might find a hint of that view via the FOMC messaging.
According to the latest BAML fund manager survey, just over 40% of investors think US 10y yields can get back to 2% before causing a drop of 10% or more in equity markets. The other shift in the survey was that since February 2020, Covid-19 is not the number one tail risk for markets for the first time. That honour goes to higher than expected inflation, with a bond market tantrum at number two. So, inflation tops the market’s new 'Wall of Worry’.
It was another quiet session on Tuesday, the S&P ending down 0.2%. US10Y yields were back up 2bps to 1.62% as stocks stepped back from all-time highs in whippy trading ahead of the coming FOMC meeting where the board is up against a market call that believes even if Fed Chair Jerome Powell doesn’t pivot to less dovish at the March meeting, he’ll shift his tone soon after.
Such are the types of presumption and challenges that suggest any relief Powell provides against higher bond yields will be short-lived. Similarly, he’ll have a hard time delivering a believable signal that hurts the USD on a sustained basis.
The Fed will be loath to send any hawkish signal. Still, the board faces a tricky balancing act as incorporating the US stimulus into their forecast will lower unemployment and push inflation over 2% in 2023, hence the tail risk is that the median dot shows a hike in 2023.
In December, five FOMC participants expected liftoff by 2023. But Powell said that he was not "even thinking about" removing accommodation and has tried to project a dovish tone. And while I suspect he doesn’t want a median hike at this round table, not everyone will be like-minded. And with the Fed likely increasing its inflation forecast, there’s a chance two or three more participants will show a hike in 2023.
UST and, by extension, long-duration stocks fear two things: a shift in the dots to suggest an earlier than expected rate hike and the Fed's lack of pushback on higher yields continuing. As a reminder: in December 2020 the dots showed twelve FOMC members thought rates will still be as they are at the end of 2023, one member thought rates take-off would be before the end of 2022, three thought there'd be one hike in 2023, one that there would have been two hikes and one that there would have been four.
While it takes four of the twelve to move the median for 2023, it perhaps only takes one or two to shift position to move the markets. Such are the challenges Powell faces not to rock the boat and walk investors through recalibrated policy goalposts that are neither too dovish nor hawkish.
US February retail sales were not significant. The control group came in at -3.5%, lower than forecasts for -0.6% and after +6.0%. Take the miss with a pinch of salt, though: after the bumper number in January (which was revised higher), there was inevitably going to be a comedown. The winter storms during the month will have messed up the numbers and expectations.
Interestingly, the market emphasizes higher US export/import price indices than the weaker US retail sales. As a result, the knee-jerk reaction to the numbers was both yields and dollar up, in line with the current heavy focus on inflation risks and the Fed being behind the curve. However, this also means that if Fed Chair Powell manages to out-dove markets tomorrow, the impact could be sizeable.
The market was wrong-footed but still pleasantly surprised after US oil stockpiles unexpectedly fell last week as a narrower weekly draw in gasoline stocks signalled that refiner activity was normalizing following the big freeze in Texas smothering production the previous month.
However, word on the street is that China is buying close to 1mb/d of sanctioned Iranian crude at discounted prices, displacing oil from its usual suppliers and complicating OPEC+ efforts to tighten supply and accelerate the draw-down global inventories.
Oil is also under pressure from headlines that global Covid-19 infections ticked up last week and concerns over side effects within one of the primary subscribed vaccines. However, neither of these stories represents a material risk to the recovery trajectory currently being predicted.
But after the run oil has had so far this year, with Brent still comfortably above $68/b after a minor correction, it’s unsurprising to see profit-taking on upticks in response to even marginally negative headlines.
Still, with a much-improved economic outlook as demand visibly increases and catches up with sentiment, it will encourage OPEC and other oil producing-nations to ease production curbs. And these extra barrels (depending on the velocity coming back to the market) will likely prove to be the oil price’s main headwind as the year unfolds.
The consensus for Wednesday's FOMC decision expects more optimistic forecasts and dots, but a dovish Chair Powell. And looking at the rally in stocks over the past week, Fed communication's credibility is strong right now, which, if it holds, could slow down the move higher in yields and US dollar appetite. But the market is cautious that this view will hold the test of time – some think it won't even survive 30 minutes post-FOMC.
However, a hands-off FOMC message on yields leaves EURUSD extremely vulnerable, especially with EGB yields biased lower in the region in the near term.
The EURO has been dealt the weak hand in the Forex world. The suspension of the AstraZeneca jab will delay the EU’s vaccination target and the flawed rollout across the region will continue to weigh on the growth and outlook of the economy. On the other hand, the US is on track to meet its vaccination target, and the Fed seems unable to stop the charge in US rates and the dollar.
The political risks in Europe are also starting to prevail, with the recent CDU defeats adding to uncertainty in the region ahead of the German elections later this year.
The Malaysian Ringgit
The MYR remains deterred by the strong US dollar and higher UST yields, and with the real possibility of US economic outperformance and higher yields becoming more pronounced in Q2. For the time being, the Asia FX market – including the USDMYR – has shifted into buying the US dollar dip mode while keeping an eye on US yields. Still, it’s probably a good idea not to lose sight of Asia’s growth acceleration via the global trade revival.
Investor sentiment towards gold is less damaging and positioning is cleaner. Physical is still strong, with Korea joining the gold bar buying bonanza. However, India has pared down slightly this week, heading into local elections at the end of the month, while boots on the ground suggest that China is showing decent interest to import physical gold, indicating a solid chance of new import quotas granted in the coming weeks.
Assuming 'steady dovish state' after the FOMC absent of any post hawkish FOMC fireworks, $1,761 spot could focus. Friday is GLD option expiry and the USD165 strike (USD1761 spot) has 530k oz in open interest, providing a target for speculators to throw darts.
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Investors are still digesting the latest statements from the US central bank, which surprised markets with a far more hawkish stance than expected