The Week Ahead
As we move towards the end of February there are several focal points for market participation. In particular, developments on the Covid pandemic will be critical – including UK Prime Minister Johnson's roadmap out of the lockdown – as well as a summit of EU leaders later in the week.
On top of this, investors will be focusing on US stimulus, with the potential for a floor vote in the House of Representatives at the end of the week, as well as remarks from Fed Chair Powell and ECB President Lagarde. Finally, earnings season will continue, with 64 S&P 500 companies reporting.
After a week of heated rates debate, it's becoming apparent that reflation will likely be the central theme of 2021. Many investors started to price higher inflation along with more robust growth rates, particularly in the US, on the back of an ultra-accommodative monetary and fiscal backdrop. And just because there were a few misses on weekly US jobs data report – a direct consequence of mobility restrictions resulting in a servicing sector malaise – it doesn't mean we aren’t on the road to inflationary fireworks.
But it does seem we continue to see-saw between higher rates being the harbinger of doom to the markets being able to handle higher yields. The thorny point is trying to pick a number out of a hat that will cause maximum market discomfort as the stock markets don't like rapidly rising real yields. I stress "rapidly" here as I think the market can handle even higher rates (+1.5 %) if the economic condition remains supportive and the rise is gradual. The long-term balancing act suggests any risk market can stay at lofty levels, provided the macro conditions remain well supported.
Not out of the woods, but optimistic and despite resilient manufacturing, restriction-related services weakness kept the composite PMI in contractionary territory. The flash Eurozone Composite PMI rose by 0.3 points to 48.1 in February, suggesting ongoing economic activity contraction. The sharp divergence between strong manufacturing and weak services have been a worrying and consistent feature during the Covid-crisis, and even post-crisis in China.
Pull-back in crude prices, with WTI back below $60/bbl as some inevitable exhaustion and profit-taking hit as the Texas cold snap, looks to be receding. And highlighting one of the significant risks around the supply-side outlook, the Biden administration is exploring diplomatic re-engagement with Iran. Both factors contributed to a cooling of oil prices, despite a bullish 7.26mb US crude inventory drop reported yesterday by the EIA.
There’s still a significant gap between the US and Iranian positions: Iranian officials are still insisting on removing all US sanctions as a prerequisite for talks. The US wants Iran to return to compliance with the nuclear deal before making additional concessions. But this recent news is still a sign of progress that will limit upside in oil and may drive another wedge as markets weigh the impact of an additional 1-1.5mb/d of Iranian supply.
Forex has devolved into a 24-48-hour trade, and I don't think there’s an easy path with global breakevens driven by a surge in the inflation risk premium component all moving to the same beat. The increase reflects a dissipation of perceived downside risk to the inflation outlook amid a broad-based improvement in global economic prospects, massive fiscal stimulus and widespread monetary easing.
With commodity prices looking like they could top out, I think it’s time to reduce some commodity currency linkers. Higher US interest rates could very well throw a damp squib on the reflation trade, which could result in less top side speculation for commodities and that the frothy top may get blown off’ the AUD, CAD and NOK could follow suit.
NOK price action turned mostly underwhelming last week; I think the risk of a correction is rising right across the commodity spectrum, with the oil anchor looking a bit fragile ahead of the OPEC meeting.
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US equities continue to welcome any high-risk event being put in the rear-view mirror – especially when rates markets look prime to consolidate lower