US equities were weaker Wednesday, the S&P down 0.5%, while US10Y yields were down 1bp to 1.61%. Oil rebounded 5.9% on near-term supply concerns after a container ship found itself sideways on the Suez Canal.
As risk assets remain challenged by the recent Covid-19 surge and catching stock markets at the wrong time, some estimates predict there will be as much as $88.5 bn of month-end rebalancing out of equities and into US fixed income. These factors continue to weigh on risk.
But when the short-term wobbles, investors naturally start to fret about those lingering longer-term concerns; they’re also hurting sentiment with renewed worries about US tax policy and a realisation that any lingering hope of a reset in US-China trade relations is unwarranted.
The latter is quite a worrying proposition as the two economic behemoths draw battlegrounds and set the stage for a real dust-up as the superpowers shift from vying for supply chain domination to battling it out for global internet technology supremacy. Buckle in for this one as it could make the Trump era Trade War legacy look like little more than an Axis and Allies board game.
With so much economical and growth optimism priced into Q2, the recent global growth scare has likely validated that the value rotation looks likely to peak and exhaust. Hence, any watering down of growth expectations suggest those optimistic stock market valuations could feel a near term pinch, especially if the economic data remains less supportive or turns sour.
Europe is light on cyclical-growth stocks. If value doesn't perform, it isn't easy to see Europe outperform over the medium term. Historically, in periods of outperformance of cyclical when value lags growth, Europe has struggled to keep pace with other regions due to this relative lack of cyclical-growth stocks.
Exposure to short-end rates continues to be a massive forward-looking overhang; small firms would take a significant earnings hit once the Fed starts raising rates, possibly as early as 2022. But until we get a better idea of month-end mobility data on both sides of the pone, the risk backdrop could remain challenged by the economic knock-on effect from the Covid-19 scare – even though some, if not all, of the headwinds are transitory (i.e. reopenings are delayed, not derailed), and the broader constructive narrative remains intact. Some areas of the market, like travel and leisure, were priced for a near-perfect recovery and are very susceptible to a reopening delay.
For example, pressure on airlines is becoming acute, with British Airways needing to offer their lucrative 'crown jewel' landing slots at London's airports as collateral to secure funding. Other airlines have already headed this way, but it’s the first time BA and owner IAG have needed to offer such valuable collateral.
An unlikely course of events has come to the rescue of the oil market in the form of a wayward vessel.
Oil rallied on the news of a giant ship blocking the Suez Canal, disrupting a primary supply chain conduit. While positive European economic data assuaged some of the newfound growth implications, EU backyards and factories remain super busy despite being in soft or rolling lockdowns for most of the year.
But one of the possibly vital contributing factors to the bounce-back might be Germany's Merkel announcing she would cancel the stricter Easter lockdown restrictions after the decision received widespread criticism. To the extent that European lockdowns may have triggered the recent pullback in oil markets’ reopening optimism, this could, on the margin, help to calm some of the negative sentiment around the demand impact. The front spreads are back to backwardation, and the Dec21/Dec22 have rallied by $0.90/$0.95 for Brent and WTI, respectively.
As it became apparent the Suez Canal will not reopen as quickly as initially envisaged, prices continued to rally despite a negative oil stockpile report; however, gasoline demand has increased, which tends to be a reliable soothsayer.
For crude, this means more oil on the water – either queuing for the canal or diverting around Africa. The extra voyage time is akin to "filling a pipeline" and should support the very jittery market that has seen a rush for the door over the past five sessions.
While it's a bit early to guess what cards OPEC is holding up their sleeves, the weakness in oil this week seems to have validated the cautious view expressed by Saudi Arabia at the last meeting, and it increases the probability of yet another rollover of current production levels.
The USD has extended its rally overnight, with FX traders fixated on equities to signal broader risk sentiment. The news flow around the US economy has not changed and the Fed’s upbeat message on growth without sounding any alarm bells on inflation provided a solid backdrop for the US dollar beyond its safe-haven appeal. You don't have to look too far to support that view – even the robust March PMI data from the Eurozone failed to deliver any lift higher in EUR as Covid-19 concerns persist.
The resilient US dollar is likely the biggest obstacle for the ringgit and USD/Asia right now as even higher oil prices are failing to boost traditional OIL currency betas overnight, with the Canadian dollar only improving marginally despite a 5.7% underlying price recovery. While higher oil prices could stem the ringgit’s bleeding, it might not be enough to trigger a bullish revival.
The re-imposition of lockdowns in Europe and resurgence of Covid-19 in hotspots around the world does little to improve the prospect on regional travel and leisure sectors, as even what small glimmer of hope there was around summer travel would be questionable given the new spread and concerns over the new variant.
Risk in markets
Most risk in the market falls into two places: volatility and short-dated US treasuries.
The direction of the dollar is the lowest conviction trade out there. Most buy into the twin deficits triggering dollar weakness argument, but it hasn't worked. The US economic strength argument should work, but history says no. However, my view is that while the dollar strengthens, whichever version of events is proving correct, EURUSD can't stay here. By association, a more robust/weaker dollar has implications for all other assets. Vol is too low across the board. The very moment the market decides on USD’s next significant direction or what the Fed’s real intentions are, there'll need to be wholesale repricing across all markets.
Three and five-year treasuries – and especially rates – are in a dangerous position. They’ve been well behaved and buying into the Fed’s story of lower/longer mantra, but the Fed is forever economic and inflation contingent. Strong payrolls, strong retail sales, vigorous activity and the Fed will be able to activate "on track" for sustained progress. Despite the quick move lower in yields of late, the market is at risk of regional Fed presidents breaking ranks on the policy call.
If this version of events plays out and data improves, the front end reprices higher again, the dollar gains big, equity volatility goes through the roof and EM suffers a tsunami of risk aversion.
Gold shrugged off USD strength overnight and finally reversed some losses thank to lower US yields; bullion could see further upside traction if US bond yields stay sluggish, especially in this risk-averse environment with US-Sino tension starting to bubble again.
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USD regains ground on April inflation figures to outperform low-yielding currencies; EUR/USD meets strong resistance; Gold looks increasingly attractive