Markets Outlook: Vaccinations to drive market direction

Market highlights

• US vaccinations to drive equities at the index level – and provide key signpost for oil markets which continue pricing in optimism
• Keeping an eye and ear on Fed speak for signals around QE tapering
• Gold takes a shot at the $1,900 level – and the results haven’t been pretty for investors

The Week Ahead

As we look forward to what 2021 has in store, the scheduled week ahead is a quiet one on the markets calendar. The pandemic will remain a keen focus for investors as attention turns towards the vaccination programmes in various countries and how quickly distribution occurs.

The second derivative of US vaccinations will drive equities at the index level and provide a key signpost for oil markets. As people get vaccinated, they’re likely to return to those activities most impacted by Covid-19, such as dining out, travelling and other personal service-related areas. Therefore, the number of people vaccinated is likely to also be a leading indicator of shifts in consumption.

But it would be wise to keep an eye on the Fed speak in the coming week for any signals around QE taper, with Powell speaking Jan 14. Voter changes for 2021 are dovish on the margin; Evans replacing Mester, in particular, is a notable shift. 

There were notably hawkish comments from Atlanta Fed President Bostic, saying the FOMC might pull back on QE 'sooner than people expect'. Of course, he isn't a leading force at the Fed, but if inflation goes higher this year, expect him to get more company across the board.

The US reflation trade is gaining some traction, with US fixed income selling off harder than the rest of the world; the Bund versus Treasuries spread is at its lowest level in nearly a year, and EURUSD is accordingly feeling the heat. Market positioning (short USD) doesn't help calm the nerves, as we could be on the verge of death of the year's consensus trade by a thousand cuts. And markets are flat out not positioned for the USDJPY to bounce higher. 

With the USD bounce again today as treasury yields continue to march higher, USDJPY is approaching the crucial technical level of 104.30-35. Indeed, this is the bottom line of the daily Ichimoku cloud and a downtrend going back to February/March 2020. There’s been very little flow so far this year in JPY and the market is not positioned for a bounce in USDJPY – especially with the consensus trade being short USD.

But suppose the market decides that the Fed might taper in late 2021, and Fed Clarida doesn’t push back on that feeling. In that case the narrative will change dramatically and the idea that the denominator for discounting all assets to 0 might shift a bit. 

In that situation, the EURUSD will veer steeply lower to the 1.2000, the first huge psychological level. And with the People's Bank of China hinting at slowing yuan appreciation, those retail and macro shops backing the US dollar lower trade of the year are feeling a bit confused as they’re getting steamrolled subtly by G-10 FX reversion players. 

Oil is still pricing in a great deal of optimism linked to the roll-out of Covid-19 vaccines, and any negative developments would prompt a sharp negative reaction. While demand is gradually improving – and the supply side is under control thanks to OPEC+ and Saudi Arabia's continued efforts – risks remain, but there appears to be a clearer path to oil upside with downside risks diminished.

As expected, paper gold at the banks ramped up margins and took a shot at the $1,900 level on Friday; the results have not been pretty for gold investors. Indeed, futures activity in gold has been quite extreme; 6,675 lots traded in the February Comex gold contract in one second (08:00:21 GMT), with one million ounces loaded and stopped, which sent the gold price down $27.30 to $1,875.10. Thus far, the futures volume on Comex has been 60k lots, which is usually the average for the whole day; 1/6 of that was executed in one second.

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