US equities pushed higher on Friday as the reflation trade remains alive and provides the bullish impulse but is also triggering a real need for inflation hedges across the board.
Investors are beginning to revel again in the US’s fiscal and monetary bazookas that show no abating signs.
With accelerated vaccine rollouts globally and a sharp reduction in COVID-19 infections in the US, that seems to have occurred much faster than any prior waves. The most likely scenario is still for a steep economic recovery starting in spring or early summer with heightened overheating risks.
If the US Federal Reserve wants overheating there is an excellent chance those wishes will come true. Chair Jerome Powell has done a superbly effective job in communicating an entirely dovish message and successfully shepherding FOMC members around it – at least for now.
On the political side, President Biden’s incentives look fully aligned with getting the US economy and populations as healthy as possible ahead of the 2022 mid-term elections. If both fiscal and monetary policy makes maximum efforts into a post-pandemic recovery, then at the very least we will get temporary inflation along with plenty of debate whether it might become more permanent.
Expectations for larger fiscal stimulus closer to US$1.9 trillion have been moving into the price in recent weeks as Democrats have shifted focus to budget reconciliation.
However, rates making a run for the highs in yields without an exact driver likely caught a few by surprise. Although the soft result in last week’s 30-year auction result implies the recent resurgence of reflation in bond markets may not be misguided.
And now in the US, fiscal stimulus is likely to come in towards the higher end of expectations, and there is nothing Powell can say now, short of rate cut action itself, that would be considered a dovish surprise to the market.
As we suggested last week, ironically, the very taper tantrum risk the FED is trying to avoid may now be considerably elevated so now back end yields are moving higher in response that growing market views.
At some point, the surge in US yields will become a temporary problem for stocks. Still, with both monetary and fiscal policy likely going ahead full bore pedal to the metal, it’s hard to see a sustained sell-off in that environment.
And for the US dollar, even though it looks set to weaken in the post-pandemic world, the growth divergence with Europe should continue to keep EURUSD in a range in the shorter term if not trending lower.
Mini oil super cycle?
There is no accounting for good old mother nature when it comes to oil prices, which now sees the bulls frolicking in bone-chilling cold and a barrage of a winter storm raging across the Premium Basin resulting in crude streaming from those wells to slow or halt completely according to boots on the ground.
The US oil complex is counter seasonally short inventories due to OPEC production curtailment’s objective as the demand for heating oil surges, so supply and demand laws take over.
But US refineries are also throwing their hat in the ring competing with Asia’s insatiable demand for US sweet crude. US refineries started to process large amounts of oil in anticipation of a surge for gasoline at the start of the summer driving season on the expected pent-up vaccine -driven gasoline demand boost.
Finally, with the market-based inflation readings snapping back to pre-Covid-19 levels, commodities, particularly oil, provide an exacting breakeven hedge against inflation.
So, the combination of mother nature supply disruption fusing with real demand and in addition to that in cross-asset trades using oi future as a perfect inflation hedge, February has surprisingly morphed into a mini oil super cycle.
Russian Energy minister Alexander Novak was out on the wires over the weekend, saying the oil market is balanced, me this is the start of some Russian production pushback. Still, the market continues to focus on inflation break-evens and good old mother nature.
Weather trackers suggest the worst of winter’s wrath will miss the significant cities along the East Coast because the storm’s track will be too far to the west. So, with most of the North East missing the wrath of the storm, once Texas thaws and oil flows free prices would then show an inclination to rebalance lower.
Multiple themes in forex markets
Multiple themes have emerged in FX markets—US dollar weakness has become narrower, the euro is lagging, and Emerging Markets high yielders are outperforming thanks to dovish FED and investors insatiable appetite for yield.
There is lots of dispersion in the macro outlook, so trader and investors alike are preferring the high-quality commodity currency and risk betas.
The USDJPY remains bid on tip due to UST vs JST widening differentials amid BoJ verbal intervention.
Malaysian Ringgit in good stead
Surging oil prices and negative US real yields, a dovish FED for as far as the eye can see and a still improving economic backdrop with sectors of the local economy emerging from the MCO should keep the ringgit in good stead even though Asia FX interest remains low over Chinese Lunar New Year.
Can gold hold above $1800 level?
Gold came close to breaking back below USD1,800/oz. A second break below that level this month would have done some psychological damage to the market, I believe.
It should be clear that rising US yields see investors showing less interest in the yellow metal.
Market analysis and insights from Stephen Innes, Chief Global Market Strategist at Axi