US equities rose again Wednesday, the S&P up 0.9% heading into the close as a calmer session in bonds continued to lead the way. While rates are only down a touch, it's the fact that they have stopped charging ferociously higher which seems to have been enough to calm frayed nerves. The Dow soared more than 450 points after new inflation data left "The Street" struggling to find it in a place you would most expect: the data itself. And the muffled increase eased fears of another vicious rapid rise in rates.
The past two weeks have been extremely volatile for equities which have gotten challenged multiple times, driven by the initial spike in yields that led to a subsequent positioning unwind in long-duration growth. Indeed, US yields have acted like an anvil around inventors’ necks lately.
While certain parts of the market (profitless tech / high growth SaaS / SPACs / renewables) have performed very poorly (and could continue to lag), the re-opening/value trade has continued to do well, complimented by dip-buying even in the mega-cap tech space.
So, for all the talk about a bubble in equities or an increase in yields prompting a wave of selling in risk assets, the actual performance has been quite damning for risk asset bears.
The US ten-year auction went off well, providing the more visible Alka Seltzer moment for the risk market as lower yields allow investors to breath easier. But the recent calming in yields may also have to do with the commodities reflation taking a breather (copper down 7.6% from the recent peak, iron ore down 12.4%) and some of the pressure off the nearer term inflation risk premium that’s been fueling steeper central bank paths and has encouraged better bond market uptakes.
As the market moves past fiscal stimulus as a driver (the infrastructure bill looks like it could be substantially watered down if Senator Manchin has his way), and as central banks try their best to stick to the script, look for economic data to increasingly take the driver seat. If the last US payroll release is any indication, markets will likely not yet have seen the last of the rates reflation and can't help but think that we’re in for a very bumpy ride.
Looking at the bond yield forecast for 2021 from the likes of Goldman Sachs, UBS and Deutsche Bank – which is predicting 10-year US yields topping between 1.85-2.25% and even taking the more conservative route – it's hard not to think we’ll continue to iterate through this churning process where rates go higher. It’s scary when it happens too fast. Still, when the pace slows or yields back down, investors realize higher rates are fundamentally good economic news and a natural by-product of a rebound and start loading up on stocks again. I suspect we’ll ride the rates roller coaster for some time to come.
US crude inventories have built for the last two weeks due to the current imbalance in the US energy system, with many refining units still offline.
Commercial oil stocks continued to build, bearishly adding 13.8 mn barrels last week, having added 21.5 mn barrels the week before, according to the US Energy Information Administration. Meanwhile, gasoline stocks fell 11.9 mn barrels to provide the bullish offset and eventually send oil prices higher on the strong demand for end products, hence an economic recovery. And given the powerful signals from the US re-opening narrative, it still suggests that the path of least resistance for oil prices is higher.
And with the figures all crunched and combined, US commercial crude and product stocks are built by 1.3mb on the week, with the large build in crude once again offset by a large product draw, leaving total oil stocks relatively flat.
But if refining outages persist, there is a risk of entering the driving season with seasonally low gasoline inventories, which will continue to put upward pressure on oil – even more so as lockdowns get lifted.
But the latest market moves suggest we’re nowhere out of the woods just yet. Investors' main concern is the rebalancing of the market and the outlook for prices in the coming months remains tied to OPEC+ cohesion. It's entirely possible that global demand could be 5-6mbd higher in the second half of the year than in 1Q, but that has to be seen in the context of roughly 8mbd of OPEC+ supply curbs still in place under the agreement. Within that conversation, Russian Deputy Prime Minister Alexander Novak says Russia will increase output from April (Reuters reported).
Indeed, this hints that there are real risks of the agreement fraying in the coming months as the group looks to bring back more supply – several member countries have histories of poor compliance with allocations and of pushing for higher supply sooner than the likes of Saudi Arabia, with Russia leading the charge. And as traders pivot to the April OPEC+ meeting, this debate will get louder and potentially more cantankerous, proving to be the ultimate rally capper in the weeks ahead.
The US dollar is trading weaker as yield pressure abates and risk sentiment improves on the back of muted US inflation data. But we remain very much in a broader range trade mentality as the FX market remains much more cautios on US yields, likely still viewing this week’s cross-asset price action as representing more a reprieve than a reversal, with the US entering a solid macro phase in Q2. Simultaneously, the Fed takes a hands-off approach to the steeper UST curve that will likely follow.
It seems that everyone was expecting the same outcome in terms of weaker-than-expected US CPI. A better bond auction with inflation risk premium tempering on the back of the fall in commodities as FX reaction was relatively muted to these risk hot spots.
But I think what’s more poignant for FX markets are comments from the RBA illustrating the battle central banks may face reaffirming their dovish patience. AUD-USD moved lower on this affirmation of a dovish stance but has since reversed that move. The difficulty remains that the growth outlook is improving in Australia and elsewhere. So, the guidance for unchanged policy on a multi-year horizon is proving hard to sell to markets.
FX trading desks are hearing last week’s echo: "We’re not buying what the central banks are selling."
Gold continues to rebound on lower USD and the easing in US yields. At the same time, there is room for more gains if yields fall convincingly below UST 10y 1.50%. But with the US entering a solid macro phase in Q2, while the Fed takes a hands-off approach to the steeper UST curve that will likely follow, there’s the suggestion that this week’s move in gold could be little more than a reprieve than a reversal of fortunes.
With the equity market doing well and yields abating, there will be less urgency for the Fed to step in and push back on the current steeper yield curve narrative.
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