With large-scale stimulus amid recovery from the Covid-19 shock, investor attention has focused on potential impacts from rising rates and inflation. Equities and inflation breakevens have shown a relatively consistent positive relationship; higher inflation is typically seen as good news for the market. But as the 10y breakeven pushes above 2.5%, concerns about slower consumer spending and higher input costs begin to weigh on markets, and the equity inflation correlation has turned from sweet to sour.
US stocks struggled and rebounded into the close, but the reflation rotation has given way to heated debates around US rates for most of the day. Stocks are at the brink of moving from the sweet zone into the danger zone as Fed rate hikes start nudging towards 2022 and the taper tantrum drum keeps beating in the distance.
For now, the Fed has been able to keep the Taper Genie in the bottle, but in a world quick to normalize due to the vaccine – and with additional fiscal stimulus providing rocket fuel to the inflationary fire – higher rates are on the verge of becoming a consensus view.
But it's still far too early to draw any conclusions despite my rates bearish bias as we live in an orthodox world where too much stimulus leads to inflation and tighter monetary policy. Plus, it’s options expiry day tomorrow, which naturally brings some gnarly dispersion.
Brent retreated on Thursday, having earlier hit a 13-month high amid disruptions in the production and refining hub of Texas and other southern US states and bullish API numbers.
The DOE data released today was for the week ending February 12, so excluded the weather disruptions there was a large draw in oil inventory coupled with a significant draw in distillates; the much smaller-than-expected build in gasoline stocks was a bit of a surprise. Oil prices are coming off the boil as the power crisis, spurred on by the massive winter storm, is starting to ebb.
The Texas polar vortex – which froze oil pipelines and wellheads and brought production in the Permian Basin to a standstill – is forecast to end Sunday as repair crews rush to brings well back online. And with far too many bullish time spread structures in place, physical traders were forced to do it out for spot delivery barrels. The market is yielding to Mother Nature’s quick and self-healing principles, which have traders paring worst-case scenario positions that are always first to be skimmed. It looks like the weather-induced rally this week has peaked, and the market will now be more inclined to shift back to regular supply and demand fundamentals.
That said, prices are unlikely to fall too much given the ongoing evidence of recovery in global demand, mostly good news on the Covid-19 trends and robust economic data allowing oil investors to turn their attention to updates on reopening timelines – especially in the US as cries for a quicker end to mobility restrictions grow more vocal.
OPEC+ meets in the first week of March and it seems likely the group as a whole will begin to ease production cuts. Oil may cool slightly on this news, but there’s nothing here that should be a cause for concern. Saudi Arabia and OPEC+ will continue to be responsive to macro conditions and manage supply through what remains a period of uncertainty on demand.
With China coming back from holidays, USDCNH is doing some catch-up to the USD/US yield move earlier this week as spot climbed above 6.46 in Asia, despite a lower than expected fix. There was a further push higher across USD/Asia at the New York open, led by USDCNH trading up to 6.47. But this could be a delayed reaction to China placing the control on rate earth mineral exports to China as, so far, there hasn’t been any talk of the PBoC influencing the window.
But this isn’t the first time China has considered using its dominance in rare earth minerals as a retaliatory measure/negotiation tactic in bilateral disputes. For the time being, I don’t think China will look to pull this string anytime soon. Hence, I remain constructive on RMB.
The ringgit is weaker and following the yuan's lead, as is the rest of dollar Asia with US real rates on the rise. But compounding matters is that oil prices may continue to decline on Texas weather pattern improvements amid early pre-positioning for the OPEC meeting in March.
The market continues to put the ‘Great’ back into Britain; GBP is bubbly once again, trading among the world's top currency performers so far in 2021. And unlike the Euro resilience, it's not merely a function of USD weakness, although the USD is on the defensive today as GBPUSD is veering back for a fresh challenge of 1.40. The pound is gaining on the Euro, adding to the momentum, with EURGBP extending its decline, pushing below support levels established in April 2020.
There were no new headlines to drive GBP enthusiasm, so presumably the themes of successful vaccine roll-out, no material dislocation from Brexit so far, and a stronger than expected Q4 20 GDP print continue to cheer spirits.
The USD is still trading soft with no fresh catalysts to give the move real conviction. But it appears the dovish FOMC minutes are perhaps setting the tone.
Gold continues to struggle under the weight of real US yields but is getting a timely reprieve from the weaker US dollar – otherwise, gold would be trading below $1,750.
The street continues to watch EURUSD movements like hawks. A move above 1.21 could provide an Alka Seltzer moment, while a shift back to the low 1.2000s could be the harbinger of doom for gold.
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Stocks recover as Fed Chair Powell says, "The job is not done"; Oil's raging bull and FX's roaring commodity currencies