Darkest before the dawn?
Vaccines are coming. There’s a weird narrative conflict right now as Covid-19 is getting much worse, and quickly, while the vaccine timeline and efficacy stories suddenly look better. For stock market concerns, I would think that the negative from the current wave of Covid – no matter how bad this wave is – will eventually be overpowered by the positive of vaccine optimism because the recent surge is temporary. In contrast, the end of Covid-19 will be perpetual. If you discount all the positive vaccine knock-on effects to now – which is easy to do given the near-zero policy offered up by the Federal Reserve Board – the vaccine matters much more than the current surge of Covid-19 malady.
I understand vaccine approval and delivery are wildly complicated, but the market could eventually see the light of day as it’s always darkest before the dawn.
We cleared two significant risk events this past week: we got a (somewhat) clear US election result and a vaccine. However, challenges remain as a vaccine won’t come soon enough to inoculate the world from the current spike in Covid-19 cases. The Georgia Senate run-off in January keeps the Democratic sweep scenario on the table. As a result, the broad risk-on mentality has endured. At this point, the comprehensive buying support from systematic players has subsided and is now skewed to sell. At the same time, hedge funds might continue to de-risk, given the sharp rotations in the market.
The longevity of the rotation remains the most debated topic. Most folks I’ve talked to seem to think we’ve probably have seen the worst for Growth/Software over the near term as the group is bouncing right off the November lows today. At the very least, price action Monday/Tuesday was a warning and a reminder of how crowded trades still are and how powerful an unwind of the Long Momentum/Growth trade can be when there is a catalyst.
US equities were stronger Wednesday, the S&P up ½% heading into the close. Tech stocks did slightly better as the NASDAQ closed up 1.7%, lifting the broader market indices. However, the bond sell-off has extended for a third day, with US10Y yields now up to 0.98%. 2s10s, now at 79bps, is at its steepest since October 2017.
More positive vaccine news might be on the way soon. At an FT summit, US infectious disease expert Anthony Fauci expects Moderna to begin assessing its Phase 3 trials "within a week" and indicated he "would be surprised if we didn't see a similar degree of efficacy" to the Pfizer/BioNTech results.
With more vaccines on the way – and if the efficacy rate holds up – this could reduce some of the Pfizer candidate's logistical distribution challenges and increase the chances that in H2 2021, the pandemic will be history in large parts of the world and yet there will continue to be a massive monetary stimulus and very accommodative fiscal policy as well. So, once we’ve made it through what is still bound to be a winter of despair for health care concerns, it could trigger the mother of all economic rebounds, boosted by unprecedented policy support.
The official DOE numbers are delayed until tomorrow by the Veteran's Day holiday. If the large draws in all product stocks are confirmed, the market should benefit from that support, but it feels that the vaccine binge is losing steam and prices are vulnerable to setbacks.
At the same time, Christmas came early to producers where selling was evident as higher prices invited December hedging. But for those investors chasing the prompt market higher on the vaccine impulse, when they should be getting bulled up on the back end of the curve, they might end up with the proverbial lump of coal in their holiday stocking as it’s the pandemic that matters over the vaccine when it comes to prompt delivery for oil markets.
The medical advances are likely to help the economy and oil market normalize through 2021. Still, the winter of gloom continues to look challenging, hence OPEC+ supply-side action to counter demand softness will be critical in the near-term. And for the gnarly proof in the pudding effect, OPEC's monthly report was released overnight where they stated, "The oil demand recovery will be severely hampered, and sluggishness in transportation and industrial fuel demand is now assumed to last until mid-2021".
This provides traders with a stark reminder just how negatively impactful the second wave of mobility restrictions are on oil demand.
The short US dollar story is in a mutability stage as "MMT on a Blue Wave" and "real rates are collapsing" themes are withering for now. And given the legendary volume of euros purchased on the way up to the high 1.18s by macro funds and now here we’re way down here, there’s likely less appetite to double down. And while I don’t think there’s a raging USD bull story – or even a grand short-term FX narrative in the vaccine news – I suspect G-10 types will prefer to hedge long USD on the back of the rise in yields and further falls in gold. USDJPY is incredibly cheap vs. its typical measures of fair value (S&P 500 and US bond yields).
But here’s how I’m playing this one out:
The USD is steady even as US Covid-19 cases rose 135k yesterday while EURUSD dips back below 1.18 as Covid-19 case counts snowball across Europe as the winter of despair sets in, suggesting further monetary and fiscal measure will be on the way.
The lira surged overnight after Turkish President Erdogan was broadly hawkish when he spoke on Wednesday, saying the central bank should have full leeway. It does feel like the market intends to buy EM and risk more broadly, especially chasing any of the laggards like TRY while putting to the side all the structural fears that haven’t gone away.
The ringgit continued to fall as bond yields rise and foreign investors turn cold on Malaysian assets due the highly contested nature of the negotiations for the passage of the current fiscal budget amid opposition demands.
But compounding the matter is two-fold.
Oil prices have turned lower overnight, but perhaps a more worrying aspect for end-of-year fortunes is a buyers’ strike unfolding in the global bond market as US yields look set to move higher. As a result, it caused the US dollar to strengthen, which is also perceived as unfavorable for the ringgit.
Higher nominal yields without the inflation offset to drive real rates lower, causing demand for the US dollar, is flat out bad for gold prices.
At some point, the mother of all reflationary rebounds the likes of which the world has never seen, boosted by unprecedented policy support, will happen. The problem for gold is that we still have to deal with the deflationary winter of despair while waiting for a vaccine to get rolled out.
Gold is no longer a safe-haven hedge as its inverse correlation to stocks is much less convincing, so gold is looking for a new narrative; new bullish reasons include broad-based USD weakness or higher inflation (actual or breakevens). However, switching from disinflation to reflation as a gold driver will not happen overnight, suggesting that gold prices are biased lower in the near term. I still like gold, but I like it a lot better closer to $1,800.
Still, if the vaccine plus the stimulus creates a reflationary impulse like the world has never seen – and that's a mighty big if – then the Fed will have no choice but to lift rates earlier than expected, which would be the ultimate stroke of doom for gold investors.
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Today’s key charts focus on oil, where the recent rally has stalled amidst talk of a lift in sanctions and speculation of a production boost.