Asia investors are poised for a sluggish start after a weaker close on Wall Street on Friday. The big miss on US retail spending in December set a dour timbre on Friday and the much softer than expected data tone adds gravity to the 1.9 trillion stimulus package President-elect Biden pushed forward last Thursday. The package is significantly larger than markets factored into their forecasts, but the final package will ultimately be pared down significantly, adding a touch of uncertainty to the view.
FX markets are seeing muted action, which is likely a cause and effect of the US long weekend; there’s no trading of cash Treasures due to the Martin Luther King Jr holiday; on Friday, the S&P declined; bonds rallied, pushing the yield on 10-year notes down to around 1.08, but the dollar was up, which is unusual.
But there are many culprits for Friday's risk-off move that might form the basis of discussions this week and possibly lead to an extended "risk-off" skew. The market might continue to grapple with higher US yields, discussions around Fed tapering and the Democrats’ tax and tech sector regulation agenda. At a minimum they could linger in the background, tempering risk appetite.
We open the week to a noisy route step beat of US national guards ring-fencing Capitol Hill; it's hardly a festive backdrop to set the stage for a risk rebound into earnings season, especially with the latest unsavoury macro developments hanging like a dark cloud over markets.
Earnings season will begin to ramp up with 43 S&P 500 companies reporting, at a time when US stocks remain close to all-time high levels as the fiscal and monetary mix remains exceptionally supportive and dips at this stage are getting consumed. The Fed will continue to be highly accommodating, even if they taper in QE in 2021 as they’re unlikely to hike Fed Funds until 2022 or beyond. Still, the big questions remain as to what factors will take us higher over the short term in the face the viral variants forcing politicians to lock down parts of the economy.
Related to that, Johnson & Johnson announced encouraging results for its vaccine candidate, and while risk positive it feels like investors are in deep need of some economic "proof is in the pudding" at this stage of the reopening rally.
Risk appetite can remain at high levels for extended periods as long as the macro environment remains supportive. What’s typically been a glorious season for US shoppers flopped after December retail sales data were even weaker than most bears feared; in the past, "bad news was good" as it implied potentially larger fiscal stimulus – now the starting details around fiscal are known, that no longer applies.
I was hoping to wish everyone an early Gong Xi Fa Cai. However, it looks like a grim Lunar New Year ahead. And with Covid-19 tearing through parts of Asia like a wrecking ball, it can't be good news for the relation trade, especially with Asia doing the bulk of the real-time heavy lifting.
China’s economic recovery continues to fire on all cylinders and today's GDP print is expected to show the fastest expansion in two years, due to the full stop and restart effect. With the pandemic largely under control in China, factories and export-oriented companies have been able to resume normal operations earlier than most other countries, allowing China to meet global demand better. The ongoing lockdowns in Europe and the US are likely to continue to spur demand Chinese goods in the coming months.
Is it Mother Nature to the rescue?
Oil prices struggled from mid-week onwards after swelling production inventories then fused with the return of Covid-19 in China, providing a not-so-rosy near-term demand signal. And adding for downside drift to the flow, the slow roll-out of vaccines globally are walking back the timeline for jet fuel demand to take off.
The US dollar is strengthening due to the confluence of continental dilemmas. The global "risk-off" tone is also attracting US dollar safe-haven demand; A stronger USD seldom, if ever, makes for a good bedfellow with higher oil prices.
And with the Biden inauguration stealing the limelight this week, traders are also concerned about a foreign policy pivot. One of the wild cards for oil this year is the upside to Iranian production (dependent on the potential lifting of US sanctions under incoming President Biden).
Last week, US energy firms added oil and natural gas rigs for an eighth week in a row as crude prices recovered to their highest in nearly a year. The oil and gas rig count, an early indicator of future output, rose 13 to 373 in the week to January 15, its highest since May, energy services firm Baker Hughes Co. said in its weekly report. And while the street doesn't expect the gradual climb in oil prices from here on out to impact the tempo of rig dramatically adds, the supply response for US producers in a more constructive macro environment is still a risk to the views.
With the polar vortex split potentially leading to lengthier cold spells, the winter weather effect could offset some of the lockdown demand declines and could also provide a buffer if not a boost to oil demand ahead of February and March where the unexpected one mb/d cur in Saudi Production takes effect.
OPEC+ is the linchpin for higher oil prices. The gap between the call on OPEC and OPEC production should be large enough to provide a buffer if there are positive supply surprises elsewhere, particularly when factoring in the Saudi production cut planned for February and March.
Still, it remains crucial for OPEC+ to monitor the demand variables around lockdowns and stay responsive to changing conditions. Underlying demand will not approach normal levels until 2022 at the earliest, and vigilance from OPEC+ will continue to be important in supporting the oil price.
Last week's sudden shift in EUR sentiment was due to confluence of continental dilemmas that piled on the pressure; be it Italy's political meltdown or the ECB's FX deflationary concerns, it made for a for few "Nervous Nellie" moments as stop loses cascaded in the overly subscribed consensus trade of the year.
Compounding matters further is the US economy which looks set to outperform Europe as global growth "de-synchronisation" via the Biden stimulus effect takes hold. As repricing the US reopening trade takes hold and fusing with a speedier vaccine roll-out, 1.18 EURUSD looks possible.
But until 1.18 gives way, the longer-term view suggests US policy mix and the humungous budget deficit will eventually undermine the dollar, hence I think EURUSD should remain in a range of 1.18-1.28.
We spent much of last year following the trials and tribulations of Covid-19, with core yield curves flipping from either bull steepening (as the markets priced in the monetary policy response) or, of late, bear steepening (as the fiscal pressures came more into focus), but thanks to the FED policy, interest rate volatility remained significantly suppressed. Either bond curve situation proved agreeable with Asian currency appreciation, in large part because risk/equities held up well.
Since the beginning of this year, the most significant global macro pivot has been repricing US rates higher post the Georgia Senate runoffs. And while the shift in market regime does not necessarily preclude further USD/Asia dollar downside, intuitively the narrowing of yield differential between the USD and Asia FX will create a more potent FX pushback where the structural narratives, like the continuation in the repricing of the China flow fundamentals, will need to do more of the heavy lifting.
What could force the market to pivot towards buying USDASIA is a repricing of short-ended US interest rates as the market starts to price infeed cycle compression as the vaccines roll out and fiscal stimulus narratives evolve. The other risk to the view that is currently starting to play out in global equity markets is if further repricing in rates also flips the correlation between bond yields and equities.
Gold continues to lose traction on the back of the stronger USD as it both shrugs off a dip in yields and remains non-reactive to Chair Powell’s dovish forward guidance, or even the political discord on both sides the pond. However, I think it's worth keeping an eye on these developments, especially if social unrest rears its ugly head in the US.
But it’s gold's old foe, the USD, which is applying downward pressure on gold. The USD Index (DXY) closed at 90.77, the highest since December 21 (with gold closing at 1,876/oz that day). However, as US bond yields get repriced higher, it will limit gold’s rise over the short term, so the street has already morphed into a seller on rallies.
Treasury yields are far too low. A bond yield of 1.50% on the US 10y should quite easily be possible and likely pose a big gold problem.
Barring the Fed easing into the recovery, it's now unlikely gold will exceed 2020 highs. And with growth returning to trend as vaccines get rolled out, policy expectation will increase, and gold could now close out the year between $1,650 and $1,750 – assuming herd immunity is attainable.
What I'm looking at today
"Yields down, USD up" days tend to be days where risk aversion dominates and stocks sell-off. Given we’ve been in an uptrend in equities since September, in my weekend Markets Outlook note I summarily assumed "yields down, USD up" days would mark low points/buying opportunities in stocks, i.e. a speed bump. That would be wrong; as you can see from the chart below.
Lo and behold, there’s a signal using a six month back test (small sample) where I found two relatively significant stock market corrections triggered by "Yields down, USD up day", and we had two mini instances last week. So, it’s a worthy cause to keep an eye on the USD movements this week.
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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.