US equities were little changed Tuesday. Most reflationary assets took a breather as investors naturally thought it was worth reducing some equity market risk after the recent volatility in rates to take a more in-depth peek into the looking glass. But the primary structural themes of more fiscal stimulus, an accommodative Federal Reserve and vaccine optimism confirms that everything should eventually come up roses.
With that said, US markets are off early session lows with the guiding light now getting carried by crude prices; as we emerge from this winter of despair the hope of spring should prove eternal, especially for oil.
Adding to the positive cross-asset vibes, on the vaccine front Europe is only a few weeks behind the US. There’s no evidence that new strains compromise protection against severe illness and positive signs that consensus is shifting to re-opening once the most vulnerable are protected.
Some pause for the reflation/re-opening trade is healthy. And, without question, it’s immeasurably tricky for investors to take that next leap of faith higher – especially at the index level with so many mixed signals enveloping the ongoing rotation trade. The reach for yield amid the most attractive policy mix in decades has generated the most improbable market pricing, with bullish expectations at an implied level not seen since before the 2008 GFC.
Rotation in itself is not surprising and is arguably healthy since a broadening out of leadership and an apparent reaction to what we‘ve been talking about and seeing in terms of breakeven expectations in the market. The only surprise was that the market moved up at the index level in the past week despite this rotation. But I think what we’re seeing is what we should have expected all along, given the weight of the rotation cycle in versus out that’s a bit of consolidation with a soft selling skew on rallies as expensive and more broadly held names sell to make room for the less costly counters to be bought. It’s certainly nothing sinister, just investors sitting tight allowing the macro backdrop to shine a bit more brightly before getting their toes wet again.
Given the absence of tier-one macroeconomic data to feed the market consumption machine it was always going to be difficult to dial up the festive mood music this week, especially coming off Friday's NFP double clunker which may have left investors wanting more economic proof in the pudding before they take the next leap of faith as we gradually return to a world where domestic information matters.
The American Petroleum Institute reported a decrease of 3.5 million barrels of crude from US inventories; that print will not dissuade oil prices from heating up further as Brent goes "up, up and away", pushing through $61 and still climbing while floated higher by vaccine and stimulus balloons. Although, I continue to view oil in overbought territory at these current levels and ripe for profit-taking.
There’s seldom one sole factor at play at any given time, whether it’s the oil curve offering up and attractive alternative in the chase for yield or oil contracts providing a favourable inflation hedge. After all, at every market street corner discussion around inflation, protection continues to resonate.
A neat feature of the oil market is that it is cyclical. It does tend to gather momentum. And it rarely, if ever. settles into a comfortable equilibrium as we saw from overnight price action.
But it might become more apparent that OPEC sees $60 as the low end of the price range that incentivizes sufficient new production capacity to the market offering attractive producer returns. Still, they may also support this level as something of an anchor by only drip-feeding spare capacity back until the US demand starts doing the heavy lifting.
I, however, see the March 4 OPEC+ meeting as a risk to the current view at which time I expect Saudi Arabia's unilateral Feb/Mar cuts to be rolled back.
Comments by Trafigura's co-head of oil trading, reported by Bloomberg on Tuesday, suggests real physical demand underpinning the market, which is the best signpost and the most pro-bullish reflection for oil prices as total order supplants any forward-looking glass view. By the same token, while inventories are dropping, OPEC+ keeps an unusually high production capacity from the market, mainly via the latest Saudi Arabia February and March production curtailment.
While this gets echoed as a game-changer by most market copywriters, I suspect oil bulls will be sitting with fingers and legs crossed that the OPEC meeting in March, which is likely to take on a higher level of importance than usual, continues to see member producers setting political difference aside and continuing to work in a coordinated effort to sustain elevated prices despite the obvious temptation to up production.
As Brent prices rise above USD 60/bbl, there’s little reason to doubt that demand fundamentals will justify a further recovery in oil prices to long term equilibrium of USD 65/bbl and likely beyond by year-end as we’re just starting to rev up the reflation trade engines. For the oil market, we could be entering the most hyperinflationary stimulation in what might be dubbed the "Year of Brent" (oil) where we’d be looking back at the current $60/bbl level with a nostalgic yearning from possibly $80/bbl in June-July if OPEC continues to keep a leash on production and the US dollar corporates by weakening off, as it's supposed to.
One week after "US exceptionalism" became the trade of the week, "USD weakness" has seemingly regained its pre-eminence. A handful of days last week saw the USD move higher alongside US equities, fostering a misguided belief that both could remain compatible bedfellows amid a global growth synchronized storyline, with the EU in vaccination catch up mode. The so-called "risk-on" imposter, the GBP, is looking stellar in this environment.
The pound has remained very well bid even against US dollar strength last week, mostly due to the Bank of England meeting, though it's not very hard to explain. The negative rates buzz was always a GBP bear’s fools dream. The MPC finally made it clear that it's effectively an administrative exercise with very little or no policy implications.
But for the pound, the critical argument has been that the UK will come out of lockdown earlier. Real money is arguably still underinvested; there is scope for more positioning catch up is colossal.
I would expect the US dollar sell-off to diminish somewhat today as one potential hurdle for USD bears is tonight US CPI. It's a well-known fact that economist forecasts are the worst at turning points because complex models need time to be tuned to handle regime. The folks submitting predictions to Blomberg and Reuters tend to exhibit anchoring bias.
I think it's safe to assume we’re on the cusp of, if not entering, a more prominent inflationary global macro regime than we’ve seen in many years. Australia, Germany and New Zealand inflation all came in higher than expected recently, and I would assume the USA will do
If US inflation comes in hot, many will argue it doesn't matter because the Fed will look through it. But at some point the Fed will blink. Still, it might be hard for dollar bears to wantonly sell the buck as, if the CPI prints hot today or tonight, logic says the earlier the Fed will blink.
The ringgit traded well overnight in line with other petrol dollar peer currencies and got a double whammy boost from the stronger yuan on robust credit demand expectations in China of January. Higher oil prices are also a boon for Malaysian fiscal position at US$60/bbl; this compares with the government's 2021 budget assumption of US$42/bbl for 2021 and US$45-55 for 2021-2. It could also provide the government with meaningful wiggle room to pump prime and fund some of the large infrastructure projects that have been a topic of ongoing discussion in Kuala Lumpur. Indeed, this should eventually see the ringgit trade much stronger this year.
The PBoC offers up a little obstacle for stronger yuan. The yuan bulls continue to set sights on 6.25 on the confluence of positive flow dynamics, the ongoing shift to liberalize the currency and lighter positioning after last week’s short dollar position clear out. Although the authorities have taken some steps to slow the pace of RMB appreciation, these measures are soft rather than aggressive intervention-styled pushback and should not affect RMB's travel direction.
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With equity markets rising to fresh record highs in the United States and Europe, risk appetite is rising again