After a shaky start, investors found their feet as a quorum of US Federal Reserve officials have given risk assets room to breath after talking down the prospects of tapering and the dollar weakens. It appears all boats are afloat again.
US equities ended a wobbly session little changed overnight. US 10-year yields slipped a bit, down 2bps to 1.13% on the back of notably dovish commentary from a range of Fed officials.
The most prominent dovish voice came from typically hawkish Esther George, despite some higher inflation risk. She also noted that the outlook is for policy to remain accommodative for some time.
Her voice has helped currency markets repair some of the damages inflicted on the EURUSD on the back of the Italian political situation and the constant taper talk filtering through capital markets.
It was a tale of two tapes as US stock indexes tottered midday as tech and rate-sensitive sectors led the drop. The recent move higher in nominal rates started to weigh on expensive growth, which has a disproportionate impact on indexes given weightings.
The real question that we need to answer is whether the Fed is done with accommodation or not and I suspect Fed chief Powell will pull up a dovish chair to put the idea of a policy pivot on the backburner and give risk assets more room to breathe.
In the meantime, the market remains incredibly well supported by the two-pronged monetary and fiscal stimulus efforts and investors lean optimistic for a speed vaccine distribution and activity normalisation, which offers up brighter days and blue sky ahead.
The global economy faces numerous economic headwinds due to the omnipresent COVID-19 and its new mutations. And it is hard to imagine the taper tantrum debate will lessen any as we progress through 2021 especially when inflation picks up.
I suspect investors will constantly be revisiting the policy fidgety over the fear of one or even both policy balloons deflating at some point in 2021.
Crude oil rallied to pre-pandemic levels. Brent traded as high as US$56.75 after bouncing on a larger crude draw than expected. A weaker US dollar helped and complimented numerous price revisions by several analysts for still higher 2021 estimates on the tailwind from the surprise 1mb/d cut announced by Saudi Arabia
The remainder of this week currency action now sets up for a weaker US dollar through a droop US CPI print and via Fed Chair Powell’s dovish lens which will be oil supportive as oil is priced in dollars. This dynamic is already playing out in Asia this morning.
While the higher oil prices story continues to make sense, I suspect China’s rapid response to the outbreak in Hebei’s northern province lessened worries over a larger spread and has helped offset comments from IEA head Fatih Birol, who noted that a significant portion of US shale is profitable at current prices.
Risks remain, but there appears to be a clearer path to oil upside with downside risks diminished.
Some traders still think US shale producers’ response to the rally in oil represents the most significant near-term supply risk for oil. But most are deferring to messaging from the CEOs and other shale C-suites and many boots on the ground who suggest Capex plans remain constrained by a cautious medium-term outlook. It remains to be seen whether this view will hold if oil prices continue to move higher.
I expect there will be sizable scrutiny as to whether WTI over $50 will prompt increased investment or whether a conservative financial strategy prevails. In my neck of the woods, money flows to where investors can make profits and the higher oil price go not only will Shale producers be keen to turn up the taps but so will OPEC+.
Published by Stephen Innes, Chief Global Market Strategist at Axi