It should be an exciting week ahead as markets will continue to digest the reopening boom and yields cycle through the lens of a series of crucial and timely PMI releases. There will also be a healthy heaping of Fedspeak this week, including two appearances by Fed Chair Jerome Powell, which will be sure to keep investors on their toes.
With the surge in yields post-FOMC – and seemingly no end in sight to the current levels of rates volatility which has been very disruptive to pockets of risk markets – there’s likely to be no rest for the weary and there’ll be no escaping the rough and tumble inflationary "Lather, Rinse and Repeat" debate cycle where the level of daily dissonance remains highly unsettling to investors. Believe it or not, "inflation" in Google Trends is at its highest level since 2004.
But, in the main, not much has changed as bond yields should continue to rise, supporting the dollar, equities will make the most of the economic recovery, but mega-cap tech will be troubled by yields – so the beat goes on.
VXTLT, a measure of volatility for treasuries, is now higher than the VIX and has been the major exporter of risk across most assets as the swift moves in yields last week showed the Fed's complacency around upcoming inflation might have unintended consequences.
Markets quickly moved from a risk-on dovish Fed narrative to concerns about vaccines, renewed European lockdowns, tense US-China trade talks, equity rotation out of tech, and falling oil prices.
The dramatic drop in oil prices on Thursday has stabilised, but the after-effects remain in other markets. US treasury yields are calmer, possibly due to lower oil prices which have alleviated some inflation concerns.
Still, as long as stocks remain resilient and the data is good, nothing stops the market from continuing the repricing in fixed income; it will happen because growth and inflation expectations turn up after all.
The oil market is searching for answers, with some linking the oil price collapse to slow European recovery due to lockdowns and slow vaccine rollouts, which was never a convincing argument.
The timing of last week’s drop in Brent, and plus WTI lower, suggests that April WTI contract rolls played some part (22 Mar expiry). Indeed, this was despite numerous adjustments to USO fund methodology last year to reduce market impact. The sell-off has calmed down, but Thursday's slump did some severe damage to the oil curve as confidence in carry trades' safety remains in focus. It could take time to restore confidence which has seen a significant chunk of oil reflation speculators shifting to other assets like gold.
While there are demand issues, that’s not likely because of the spot lockdowns in Europe. In reality, we’re still a long way from a full demand recovery and it’s the record levels of withdrawn production capacity that’s the main prop for the oil market. So, having crested $70/bbl on sentiment alone, prices were always vulnerable to a pull-back.
Still, the fundamental drivers are not weak enough to pivot the market bearish, or for traders to veer into selling the rally mode. And while the increase in Iranian exports to China is a complication to OPEC, the recent US inventory builds primarily being in the rear-view mirror and renewed European lockdowns likely do not signify a big step down from already-low December refinery runs. The upshot is that I don't suspect oil prices will shift too far lower.
USDTRY is up 14.2% on the day (8.23) after rallying as much as 17.3% at the day's highs on stops, as Turkish lira "carry traders" in Tokyo were dealt a reality check this morning as the lira collapsed, sending the best currency carry trade this year up in smoke after Turkish President Recep Tayyip Erdogan fired the central bank governor after a more considerable than expected increase in interest rates. After handing out his third central banker pink slip in less than two years, evidently there’s no such thing as "go big or go home" in the President's eyes when it comes to interest rate nor central bank autonomy.
Turkey faces a classic EM trade-off between squeezing the domestic economy in an attempt to narrow the current account deficit versus a looser-than-needed monetary policy that drives TRY weakness. Still, the Central Bank of Turkey (CBRT) policy uncertainly amplifies macro risk to an unwelcome level for "carry trade" investors. So, it could take a little while before the dust settles after this morning’s stop loss run on the lira.
The Malaysian Ringgit
The ringgit will remain tethered to the inescapable clutch of the US yield and inflation curve momentum. The problem is we don't likely get to decide on that debate for another several months. In the meantime, dollar bulls will continue to favour 10Y US treasuries moving to 2.25%; hence, the MYR could remain defensive for a while.
The other issue is speculation on the oil market has come off the boil as the market thinks that sentiment has run too far ahead of demand reality, so it may take some convincing economic data to kick the oil market back in favour. Hence, I’ve turned more neutral on the ringgit as both the commodity and rates channels present some near-term challenges.
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With equity markets rising to fresh record highs in the United States and Europe, risk appetite is rising again