Pre Open: A Cycle Like No Other

US STOCK MARKETS

US stocks traded a touch higher Friday as investors positioned around and reacted to what turned out to be a remarkably benign November PCE inflation report – an event that perhaps should have elicited more Christmas cheer for all to hear than what we have actually experienced.

While inflation may be receding, given the revision higher to the October data, investors will likely remain sufficiently skeptical until we see a more sustained and pronounced deceleration. Overall, it was particularly challenging for traders to spin Friday’s data as an all-clear signal on the inflation front.

As well, the final week of key US economic releases for the year contained more lumps of coal than holiday presents in the stocking, hinting that it is dead slow ahead as all signs point to slower growth next year

Corporate America is preparing for that downturn, as we saw from results and guidance revealed by key bellwethers like NKE, FDX, and MU last week. NKE brought inventories down in North America and China. FDX raised its cost savings plan by $1bn to $3.7bn

Still, this cycle is like no other, and the old playbooks do not necessarily apply as pandemic savings and pent-up demand have helped consumer spending be surprisingly resilient deep into this year. However, rarely has aggressive tightening like we are witnessing failed to achieve its goals.

If I am not mistaken, the Fed has been telling us they are going to tighten financial conditions until a recession or something ‘breaks.’ So, this is not a great place to own speculative assets, especially the long-duration variety telling me in times like this, cash itself is the best at the money put.

FOREX MARKETS

Bond yields are still scrambling to adjust to the ECB and FED after they made it amply clear that they are not done yet, even amid evidentiary and growing slowdown fears.

For currency markets, considerable debate is around what comes next. But given a very sticky core inflation narrative, many are starting to believe the main story is that there will be no scope for Fed cuts in the year ahead and that central banks will maintain these relatively high rates until underlying inflation is truly cracked—and that process will take time. So, I do not think it will be much of a stretch to believe central banks surprise heavily to the high side again, and we are all still talking about rate hikes even into the second half of 2023.

The BoJ widened the tolerable band for 10-year yields to ±0.5%, from ±0.25% this week, a move likely driven by various market plumbing factors.

USDJPY has been primarily rates play through 2022. And since the US rates will have a higher degree of freedom than JGBs in 2023, it is still a rates trade.

If you think front-end rates markets are over-pricing recession odds and under-pricing the Fed cycle, US rates should drive USD/JPY back higher over the coming months.

However, I would be very reluctant to play the long USD/JPY trade in the near term because the market is likely to raise the odds of a more material BoJ shift, which is a real possibility, given there has also been a shift in BoJ communication recently.

OIL MARKETS

Oil rallied to a three-week high and settled at a second straight weekly gain after Russia said it might cut output by as much as 700,000 barrels daily in response to sanctions on exports.

Fear of Russian production cuts sent oil prices flaring into the weekend. The news is catching physical traders in a precarious position needing to hedge the upside risk with US inventories low.

Markets are also getting support for the Biden administration purportedly on the bid to fill the depleted SPR, while China is toggling the speed limits higher on the zero-Covid “off ramps.”

Due to the Polar Vortex snaring much of North America, oil, and gas output from North Dakota to Texas suffered freeze-ins, cutting supplies.

GOLD MARKETS

Gold remains supported by seasonal trends and central bank buying, and as people start to recalibrate the 2023 portfolio with investment confidence tapering off, gold is getting bought as a keen diversifier