The spotlight will again be on Washington DC this week, while the FOMC meeting on Wednesday is competing for centre stage. The new Congress expects to begin crafting legislation to implement the Biden Administration's priorities for the next recovery phase. Still, it appears there will be more than a few Republican stonewalls to clear for anything other than Presidential Executive Orders for to hit the ground running.
With investors in "what could go wrong now mode", this week could provide a good sentiment gut check after US equities closed a bit lower on Friday, but didn't paint the big picture as investors turned decidedly risk-off late last week due to Covid-19 concerns and the negative economic knock-on effect from the seemingly never-ending lockdowns. At the same time, investors took their foot off the gas into earnings season, so the key might be how quickly it will take them to go pedal to the medal again.
Vaccine breakthroughs make it likely that life will become more functional again at some point in 2021, resulting in higher GDP growth and more robust corporate earnings. But increasing global Covid-19 infections, new variants of the virus, tightening social distancing restrictions and delays in vaccine rollouts in some places all increase the near-term growth risks.
This tension was magnified tenfold through the China Lunar New Year lens where the resurgence of Covid in China provided a most unwelcome surprise. The speed and effectiveness of the vaccine rollouts and the rising case numbers create a high degree of unwanted uncertainty around the outlook.
In the past, weaker growth meant looser policy, but now that we’re likely at the end of the US policy runway the market doesn't have the luxury of policymakers to inflate those balloons further to float on. Ultimately at this stage of the recovery cycle, and to provide quicker and better economic health, it's all down to the vaccine distribution.
As for the FOMC meeting, intuitively, Fed forward guidance promises to keep rates low and ignore reflationary impulses or more robust data. If markets believe this guidance, they will refrain from pushing interest rates in response to positive data surprises. The key here will be if the market continues to trust the guidance and not push US yields higher.
Generally, at this point in the year investor attention would switch to what's going on at the World Economic Forum in Davos. However, the main event will now take place in Singapore in late May because of the pandemic. Nevertheless, an online event called The Davos Agenda will feature several influential global leaders and central bankers, among them Chinese President Xi Jinping, German Chancellor Merkel and French President Macron. Several central bankers will also make an appearance, including from the Bank of Japan.
The Lunar New Year headline heebie-jeebies did a number on oil prices into week’s end. Yet, after hitting an intraday low $54.48 bbl Brent crude managed to close above $55, despite the clear demand impacts of lockdowns in Europe and additional measures in China.
The enormous question mark remains around demand and supply.
The street uniformly downgraded 1Q21 market in the world ex-China due to clear demand impacts of lockdowns in Europe to start the year. But last week it was back to the downward demand revision drawing board. More worryingly, since Asia has been the backbone of physical crude oil demand, this time it was to down-ballot China consumption as lockdowns spread in the country just weeks ahead of the Lunar New Year travel surge.
The second risk is around supply, given that the price rally might encourage a wave of new supply from US drillers, and OPEC members themselves, saturating the market.
Still, the one mbd of additional Saudi curbs over February and March should alleviate the currently projected level of attrition in global demand recovery without much impact on the path of OECD inventory draws.
An executive order from US President Biden that restricts new drilling on federal land for the next 60 days surprised the oil sector and raised concerns about its administration stance. Still, in a case of what is terrible for companies exposed to US drilling activity is good for the oil price, it perhaps helps explain why oil prices didn’t react as negatively after the US Open on Friday, which was then complemented by refinery utilization which was up +50bps to 82.5% of operable capacity (consensus was +40bps) – its highest level since Mar-20.
However, a focus on a more efficient rollout of vaccines also helped buttress the Lunar New Year anvil effect.
In the US, the number of Covid patients in ICUs has started to drop over the last week. Simultaneously, the vaccination campaign has picked up momentum and is already close to the new administration's target of one million shots while only running at 50 % capacity, so there’s much room to grow.
The ECB last week walked back EUR-negative policy divergence which offered support for the Euro into week’s end. While there's good cause to be wary of EURUSUD over the short term, a still-fragile political situation notwithstanding, the single currency’s moderately pro-cyclical beta and its positive correlation with equity and commodity prices should limit downside.
The Euro outperformed on Friday as the 'risk-off' move negatively affected all of those short EUR crosses, more than the Euro itself, while the single currency’s performance is a bit surprising in the face of BTPs hitting new wides against Bunds as Italian PM Conte contemplates going to an early election. But key on Friday was the street scrubbing divergence risk off the near-term chalkboards.
Sterling traders paid the price on Friday for Thursday's exuberance when bullish Pound bets were smacked by visions of another hit to the service sector as Boris Johnson signalled the lockdown could last into summer. Oddly, the PM delivered these comments despite successful vaccinations and a slowing-down in cases' growth rate. So, on a fact or fiction trade, traders will always run with the facts, hence Cable came back bid and was unwavering at 1.3635 support.
While the path is likely to remain bumpy, given the all the vaccine optimism, investors will be pressured to hold the course on cyclical assets and cyclical EM currencies in particular.
Gold investors will continue to monitor fiscal stimulus progress. The dialogue appears to be shifting to a lower top-end number, which is not suitable for gold from the" bigger is better" perspective. And last week’s market reaction to favourable US economic data with bond yields lower suggests the FOMC may not be highly impactful unless the board surprises the markets by hinting at a taper withdraw date. The bond traders will then start to throw darts at that target and drive yield higher, negatively for gold. Regardless, at some point in Q1 or early Q2, I expect the market to price in more term premium negatively for gold, pointing to an ultimate top-end capper around $1,950-60.
It's not entirely clear what triggered the large sell-off in metals on Friday as it was a pretty big outsized move relative to the reaction in rates markets. Perhaps thoughts of the expected physical Lunar New Year buying bonanza wilting and with much of the US stimulus event, be it 1.5 or 1.9 trn, priced into the golden cake, leaving investors headline and backchannel prone to the discussion around central banks shifting focus to the upsides.
It will undoubtedly be a long process to monetary policy normalization. Still, central banks have already started to change direction to upside scenarios that broader vaccinations this year might bring, to the horror of virtually every gold investor. In this regard, the vaccine will be a central bank policy game-changer – and likely one for gold prices which I firmly believe have seen their policy-inspired heyday and it will be up to inflation from here on out to do the bulk of the heavy lifting.
The decline in precious metals did not appear so severe when looked at against the broader move lower in a range of asset classes. From equities to commodities, including petroleum to agricultural goods, all fell back for much of the day. Gold and the other precious metals pared losses at the end of the day, as did other commodities, including oil.
This coming week we will see what progress is made on the US USD1.9trn fiscal stimulus package. Presumably the smoother the packet passes, the more favourable for gold. On the central bank front, the highlight is the FOMC decision. The FOMC meeting should be gold supportive, but it’s not new news. Robust GDP data could weigh on gold if yields react higher, but aid silver and the PGMs. On balance, in this context, gold may trade in an $1,825-1,875 ahead of the Fed with only a very modest up.
For more market insights, follow me on Twitter: @Steveinnes123
The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.
With equity markets rising to fresh record highs in the United States and Europe, risk appetite is rising again