US equities were stronger Monday, the S&P up 0.4% heading into the close and on track for a fresh record high. US10yr yields were unchanged at 1.17%, though 30 year yields lifted through 2% for this first time in a year (albeit briefly).
Indeed, the reflation trade remained fashionably in vogue to start the week, further buoyed by an upbeat set of earnings from the holiday season and vaccine optimism which provides the ultimate recovery safety net that will allow people to participate on all those pre-Covid activities, like the simple pleasures of going to a movie or having a meal out at the local eatery again. But, importantly, these activities will provide a massive boost to economic sectors most beaten down by the virus.
With much of the stimulus fondant (market pricing in 1.7 trn) already wrapped around the Fed’s policy cherry-topped recovery cake, in the wake of yet another exceptional top bill podium performance by Treasury Secretary Yellen over the weekend, the latest stock market buying bonanza could be as much a reflection of investor confidence in the Biden administration to not only steer the economic recovery on an even keel but handle the pandemic.
There’s plenty of good news for US President Joe Biden in a new poll from the Associated Press regarding getting the stimulus package through Congress. About three-quarters of Americans say they have at least some confidence in Biden's ability to handle the pandemic. Three quarters also say they have a great deal or some confidence in Biden's ability to manage the White House effectively. That is a decent, bipartisan base on which to build popular support, despite divisions that remain in Congress and the country.
It’s incredible how quickly markets went from fear to focusing back on the positives. There’s a lot of talk about inflation and broad upward movement in asset prices globally. 10-year inflation break-evens have hit their most expansive levels since 2014, helping re-fuel the reflation theme and providing the bid to energy, materials and financials.
But if there’s a cautionary tale of the tape, volumes are much lighter to start the week, suggesting some prefer to sit out this latest fear of missing out move higher as vaccine concerns continue to linger in the background.
After yesterday's news that South Africa had halted its rollout of the AstraZeneca vaccine, another speedbump might be emerging in Israel. So, while the vaccine is working, it may not be working as effectively as some rollout plans had expected. While virus incidence and hospitalizations in older Israeli adults have been falling, severe cases of Covid-19 in the under 60 categories have increased. These latest findings suggest mobility restrictions in densely populated areas of the world currently struggling with the old variants may need to be extended.
As equity volatility drops back towards fair value, look for attention to switch back to rising US bond yields. Inflation expectations can act as a positive impulse for equities but are nearing levels where they become headwinds. At the index level, the Hang Seng, Nasdaq and Emerging Markets have the highest beta to US rates, while Europe is least sensitive.
Brent surged though $60/bbl like a hot knife through butter, continuing the positive momentum from last week. Progress on US stimulus and optimism around the rollout and effect of vaccines across the remainder of 2021 and a slightly weaker US helps the view, albeit there was mixed news on the impact of the current vaccines formulated on the emerging South African variant.
Indeed, it was another solid day of gains for oil on Monday. Much of the focus has fallen in Chinese demand, which has been rock steady buyers of North Sea cargoes lately in the Platts window. Simultaneously, the OECD inventory declines by design due to OPEC supply curtailment regiment helping the rebalancing act.
But perhaps a cut above all else is that focus has now shifted to North America as US demand via hometown USA is now the largest buyer of domestic US crude oil for January. Indeed, this is the crucial signpost the bulls have been relishing as once consumption in the world’s number one oil consumer turns the corner it should make the ride much smoother for oil price ascent.
The US oil rig count rose again last week by +4 to 299, but remains well below the level required to cause a stir (around 400). But unlike the absence of tier-one events on the macro front, this week is a data-rich week for oil markets with the EIA STEO, OPEC's Oil Market Report, and the IEA OMR due for publication, all reviewing and updating on current market conditions and the short/medium-term outlook.
And while I'm not a big fan of technical signals like overbought and oversold, positioning can remain at elevated levels provided the fundamentals hold up. But since oil is surging on a combination of supply constraints and rising demand (both current and anticipated) a word of caution is due as both the WTI and the Brent markets are well in thick of overbought territory.
So, while I remain a bit cautious at current levels, the medium and longer-term outlook for demand is healthy, and one can understand a willingness to look through some of the near-term uncertainty that remains for oil.
In the wake of last Friday’s NFP, the US dollar continues to trade softer as the report's mixed details reinforce the Fed's holding pattern. And concerning their communications, the recent run of economic data has likely done little to move the needle in terms of Fed officials' views on the timeline for when they can begin the process of removing monetary stimulus.
However, with inflationary storm clouds building on the summer horizon, courtesy of an anticipated stimulus deluge, you would have to expect the market to test the Fed's AIT resolve, if not begin bringing Fed rate hike expectations forward, perhaps limiting the scale and the duration of the US dollar’s expected sell-off via the synchronized global growth view.
But I must ask: in G-3 currencies, did someone forget to pass the memo to the big boy FX desks?
The reflation trade is alive and well if you look at rates (bear steepening), commodities (oil and copper at the highs), stonks, bitcoin or inflation expectations (with break-evens back to 2014 levels). But gold and the USD have not received the memo. Sure, gold is trading near 1830 but it’s hardly on fire and the same could be said for the EURUSD.
Mind you I'm still looking for company on my EURUSD lower trade as the market's euphoria on former ECB President Draghi getting handed the mandate to form a government in Italy has pushed BTP spreads to multi-year lows, but it hasn't seemed to support the Euro. But going against this view, a good chunk of the market stills view the FX narrative as a positioning story, with traders caught emotionally long gold too far over their skis at $2,000, while the street was left marked to market at very awkward levels in the USD trade at the turn of the year as US rates shot higher and put upward pressure on the greenback.
In Asia, expect the pre-Lunar New Year liquidity drain to start impacting trading decisions. But local currency traders still need to stay sharp and focus on China money supply and TSF, which will stand as an important signpost for mainland growth momentum beyond the Lunar New Year.
China's new bank loans are expected to surge to a record high in January on a seasonal boost. A Reuters poll showed that while some marginal tightening of monetary policy may constrain credit growth, the central bank focuses on preventing risks. Anything other could be an ominous sign.
Typically, Chinese banks tend to front-load loans at the beginning of the year to get higher-quality customers and win market share.
The surge in Brent oil prices back above USD60bbl may shine a light on commodity currencies, but the more significant driver may be risk appetite.
A combination of supply constraints and rising demand (both current and anticipated) has helped to extend the rally in oil prices from the depths of April 2020. Since that odd descent into negative territory for oil prices, the best performing currency in G10 has been the NOK. However, it’s unclear how much of this has been a function of oil or risk appetite, given both are interwoven with global growth expectations. The AUD, NZD and SEK come in 2nd, 3rd and 4th respectively, suggesting RORO rather than oil might have been dominant. The CAD, a more loyal oil play, trails even behind GBP.
The Malaysian Ringgit
While the ringgit typically enjoys all the same benefits of petro currency peers when oil prices surge higher, the ringgit is more decisive this week but not precisely ringing in chart-topper type actions, likely still getting held back by higher US yields where EM sensitivity is more pronounced than other risk assets – even more so with currencies whose countries are struggling to recover while still in the throes of mobility restrictions.
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Sometimes you have to throw conventional wisdom out the door and just let the good times roll