US stocks dropped overnight after Monday’s sizzling rally ran headlong into the policy wall of worry as investors continued to grapple with inflation concerns and the eventual shifting tides around the US Federal Reserve policy.
As expectations around the current fiscal stimulus package have gone from grossly underpriced several weeks ago to now priced for perfection, investors are now turning worried about the perpetual stimulus machines of easy monetary policy and fiscal support throttling down.
Indeed, last week’s bond market volatility and the Fed policy curve’s ongoing repricing perfectly illustrates just how chained to the rhythm of easy money policies the market has worryingly become.
In a rebalancing trend that started last month, high flying tech shares are the first to buckle when droplets of concerns hit the ground form the foreboding gathering of policy thunderheads roiling above.
Investors’ strategy is to get out of the soup and get as far away from high valuation flyers as they possibly can.
It feels like we are in the eye of the storm before the process of intense policy repricing resumes along the bond curve. Still, there are no US Bond auctions this week, and next weeks auctions could see a more orderly outcome as the markets have had time to adjust.
But I would not count my lucky stars just yet as the dreaded bond vigilantes are eager to pounce.
How much overheating and inflation will President Biden’s fiscal stimulus generate remains at the top of virtually every market conversation.
And even though the market looks incredibly calmer but with growth and inflation dynamics as they are, one doesn’t necessarily have to be a reflation revenger to think there will be further tests of the Fed’s resolve.
The Fed is systemically the quintessential central bank for global markets. Yet, they adopt the most laissez-faire stance on higher yields while enacting a very expansionary fiscal policy and even welcoming the higher yields. Indeed, this is critical in the broader market’s purview.
The bar for the Fed stepping in to slow the move higher in yields has been raised because it is sanguine so far, and vigorous activity and inflation prints in Q2 will make bond-market intervention hard to justify. That suggests higher rates volatility, with the past week’s experience telling us this will filter through equity, credit, and FX markets. If you haven’t seen a policy unwinding tornado up close, this could be the year.
In the meantime, so long as the Fed retains its max-dovish stance, we should continue to inhabit the sweet zone revelling in the best of both worlds for equities as US vaccinations continue.
A robust economic recovery is well in sight, yet max policy support remains at full throttle on both the fiscal and monetary side. It should make it very difficult to sell this rally with a vengeance as investors are still riding on the cyclical bonanza.
Sell-off in oil continues
US oil stockpiles rose last week and product inventories fell sharply in a cause and effect of the cold snap that forced refiners to shut down Texas operations.
The unexpectedly large crude inventories build hit at a worrying time for oil bulls. This is particularly significant on the rising possibility that OPEC major oil producers could agree to ease production cuts at a critical meeting this week amid concerns that demand will likely outstrip supply as the global vaccine-led recovery gathers a head of steam.
But as importantly, to ensure medium-term success and stability of the OPEC+ initiative and keep peace among members eager to take advantage of higher prices to replenish depleted budgetary coffers due to their fight against Covid -19, additional volumes need to be fed into the global energy machine.
The sell-off in oil continues this morning, albeit at a less furious pace as worst-case scenarios are likely priced to perfection.
But I think the recent buckle owes more to general concerns about the potential for this Thursday’s OPEC+ meeting. It appears to represent some overdue caution going into the OPEC+ meeting as market participants continue to draw straws and attempt to gauge the likely rise in production.
In addition to the uncertainty surrounding the supply’s magnitude coming down the OPEC pipeline, investors jitters manifest around speculation that OPEC+ discussions this week could be contentious.
Demand for US dollar safe haven lessens
Equity markets are directionless after Monday gains, but with US yields easing and rowing back into calmer waters, there is seemingly less demand for safe-haven US dollars. And when the hard to love EUR puts in +80 pips headroom above the 1.2000 range base, you know the dollar just had a rough New York session.
AUD and NZD have risen alongside the recovery in risk appetite this week. The CAD continues to punch higher domestic data showed faster-than-expected economic growth, despite oil prices faltering a bit this week. Still, oil prices have exceeded virtually all market expectations and are always on course to move higher as more parts of the global economy reopen for business.
Gold rises on US dollar weakness
Gold rose on US dollar weakness, but the million-dollar question remains how much juice remains on the golden tank in the face of higher US yields. You don’t have to be a bond market vigilante to realize higher US yields are only a matter of time.
I expect the market will continue to fade rallies into the critical US$1760-65 range. If that gives way, it will likely be due to a weaker US dollar and or sagging US real yields on a FED push back.
Market analysis and insights from Stephen Innes, Chief Global Market Strategist at Axi