Stocks remain extremely sensitive to the US rate outlook

MARKETS 

US equities saw a bounce in another low-volume session as markets entered full holiday mode. Indeed the S&P 500 is up over 1% ahead of the Thanksgiving holiday on Thursday. The clear read-through here is that stocks remain extremely sensitive to the US rate outlook as US 10yr yields are down 7bps to 3.76%.

Numerous central bank officials commented overnight with mixed signals but leaning less hawkish. The Feds Daly and Mester commented in separate remarks that inflation is still too high, but the bank can afford to slow the pace of rate hikes. Given the proximity of these comments ahead of the FOMc minutes, it would be safe to assume that rate downshifts were broadly discussed at the last FOMC meeting. Hence the less hawkish commentary is one of the main catalysts driving equity market outperformance overnight.

Price action beneath the surface proved less defensive on Tuesday, as Energy rebounded (tracking crude higher) and Tech found some support led by Semiconductors and lower yields. Positive news on the corporate earnings front helped support sentiment, with AAPL, BBY and NVDA rising after raising profit forecasts.

Investors now find themselves torn between trading the downturn in inflation vs. the negative impact on growth that’s yet to come, yet both roads lead to a Fed pivot.

While the consensus is that we are still in a bear market squeeze, equity positioning flows and buybacks indicate plenty of room for it to run further.

For Macro investors, the incremental seller most of the year, there is little incentive to press shorts into yearend and jeopardize a good year, especially after painful drawdowns post-CPI. That paints a picture where buyers and sellers live higher, setting up a collision path into the 4100 level.

OIL

Crude oil rallied following yesterday’s whipsaw after OPEC+ reiterated plans to stick to targets to cut production rather than increase output to compensate for any shortfall from Russian supplies.

But Russia’s response uncertainly to any formal price cap is also putting a bid under oil. Traders closely monitor Russia’s exports and will look for how much they might trim the nation’s foreign sales in retaliation, which could be a bullish fillip for oil prices.

The more polarizing issue is China. China’s covid policy easing announced last week should pave the way to future and more significant policy change. That said, you can not rule out more intermittent lockdowns in the near term, but in a more targeted way. For oil markets, the China reopening play will be laced with fits and starts as two steps forward; one step back becomes the norm.

Since oil is priced in US dollars, a lower dollar will facilitate higher oil prices.

FOREX

World cup woes and pre-Thanksgiving liquidity drain continued to weigh on markets as flows were reasonably subdued. The USD fell against nearly all major currencies during Tuesday’s New York session on a string of less hawkish Fed speak and the slight miss on Richmond Fed index data siding with the pivot camp.

Improving risk sentiment and the fall in US 10 years rounded out the bearish US dollar scrim overnight.

The writing is on the wall for the US dollar now; even if more rate hikes get priced in for 2023, they will be more than offset by more significant rate cuts in 2024. On its own, sitting longer in a deeply inverted US yield curve, that dynamic should be USD-negative.