It was another good day for global equities which saw the S&P500 up 0.2% to notch a fresh record high, European stocks again saw similar gains and US 10-year treasury yields slipped 1bp to 1.64%. The eureka moment came on the back of China's pledged tariff cuts, which has captured the imagination of analysts and bullish investors alike. And with indications that the coronavirus outbreak is plateauing outside of China, it too provided an open invitation to strap on risk as investors appear increasingly prepared to shrug off concerns about the virus’s enduring impact on growth.
Provided the US reciprocates the Chinese tariff cut with one of its own, the trade calm will be viewed in a very trade-friendly light and well beyond the immediate fiscal benefits. The sweetener is a fantastic pacesetter for Phase Two of the trade negotiations. Still, the frontrunning commitment is also very reassuring after the legacy of delays to Phase One while also easing some coronavirus growth concerns.
Why market could pare risk today…
(…beyond the usual pre-NFP moves which typically sees traders jockeying for a position amid their regular Friday housekeeping duties)
While the outbreak appears to be stabilizing outside Hubei Province, the situation in Wuhan and Hubei may still be challenging and the disruption to China's economy will likely continue in the short term. This may give cause for pause or, at minimum, investors coming up for air as the street feels a wee bit long after aggressively front running both the reflation and Wuhan transitory trade this week.
And a possible equity market correction once the full economic impact of the virus is realized in the next series of ASEAN data releases is supporting the gold market diversification hedge.
Outlook for next week
With the thought that global central banks are more than willing to cover the market’s back, the extent to which investors look through weak China data in the coming weeks will help determine whether this week's risk rally has the legs to run.
Remember, it’s an election year and a timely rollback in a chunk of US tariffs could trigger a move in the S&P500 to 3500, all but assuring a Trump victory.
Gold suffered quite a capitulation this week, yet demand endures.
Why is gold so strong? Wednesday's strong ADP payroll result has put the USD back on top as king of the hill and the US currency looks firm. Equities have been surging, with new highs hit in the US and European markets, and bond yields have been nudging higher; all of this implies lower gold prices. And that’s not to mention weak EM physical demand, where the bulk of the world's gold bullion is purchased. Yet gold still remains firm.
Ultimately in this Risk on Risk off (RoRo) environment, gold is perceived as a fantastic asset to hold if equities correct. Investors do not, in many cases, have better alternatives with the bulk of government bond yields globally still negatively yielding. So, gold remains bought for portfolio diversification and as a quality asset, which seems to have room to outperform other safe havens regardless of whether risk sentiment deteriorates further, given its strong inverse correlation to lower short term interest rates.
In short, gold offers an excellent hedge with the market possibly returning its focus to US-China trade headlines while US election risk comes into focus.
A PEC+ technical meeting resulted in a recommendation for a 600kb/d production cut and this will need to be discussed at a ministerial meeting at a date that has yet to be agreed upon. This cut would be above the low end of the range recently mentioned in press reports, but well below the high end (1mb/d+), and price action is enough to tell you the market is disappointed.
But the bigger fly in the ointment is Russia as they remain a reluctant cutter, given their breakevens are much lower, so we're starting to see the U-turn in prices I alluded to yesterday if Russia doesn't play ball. Still, we've seen this all before and, at this time, there’s little reason for the market to suspect Russia will break from the usual pattern of flip-flopping until the last minute but ultimately agreeing to cut.
Regardless of Russia's motivations, the 600kb/d may provide little more than a band-aid on a broken leg as more oil price downgrades are expected to come down the pipe due to ruinous demand effect the virus is having on Chinese consumption. For instance, the more pronounced the virus’s effect on China, the more significant the oil demand devastation as estimates are now getting nudged higher to 3.2Mbd+ (~25% of China demand and ~3% of the global market) amid the extended period of industrial and consumption gridlock in the Chinese economy.
But with the market preparing for a (black) swan dive, it’s critical that OPEC+ compliance comes through to put a floor on oil prices.
To the extent that currency traders are willing to front-run both the global reflation and Wuhan transitory trade in the absence of quantifiable economic data will dictate the pace of play in Asia FX.
The Ringgit is trading to the top end of my weekly range. Possibly due to Malaysia's export sensitivity to a weaker China economy, and now with local traders adjusting risk tolerances for a possible BNM proactive interest rate cut, we could see a bit more weakness into the weekend. Indeed, this could be a case of short-term pain, long term gain, but look for 4.15 to hold; however, bond inflows should pick up with a rate cut in the offing.
With a litany of ASEAN central banks cutting interest in the face of weaker economic growth, ASIA China sensitive FX may not be the best place to hold currency balances with the US dollar holding firm, let alone leverage foreign exchange risk over the short term given the market risk on risk-off (RoRo) proclivities around the key bellwether USDCNH.
While the Wuhan rebound trade could be a home run this year, traders may feel more comfortable getting China's high-frequency data (widely expected to be doomy) and regional export numbers (which are going to be weak) out of the way before entering the rebound trade.
Currencies that are most sensitive to the China/Asia growth cycle and commodity demand took a hit during this growth scare; the Won and AUD stand out the most. Currencies with high real yields have performed surprising well, like the IDR as the Indonesian bond market remains extremely attractive for real money investors.
The Eur continues to languish through the RoRo cycle. There’s no haven appetite as Europe has the developed world's lowest real yields, but when risk appetite turns on, because of those low yields, the Euro becomes the world's best funder as everyone short trades the Euro to fund those EM carry trades. It's a continuous cycle of "lose-lose" for the Euro in a RoRo environment.
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In January the Fed needed to put the Taper Genie back in the bottle; now they need to convince the short end crew to back off repricing the Fed Funds strip