Government bond yields and the US dollar continue to trend lower after the US February CPI came in weaker-than-expected (core: 0.1% m/m, cons: 0.2%). Nonetheless, tech stocks (NASDAQ 100: -0.04%) lag value (Russell 2000: 1.8%), suggesting a greater focus on the reopening trade after US Congress passed the $1.9 trn coronavirus relief bill.
Relatively benign conditions—stable yields, a weaker USD, equities trending higher—should persist in the near term, especially if today’s ECB meeting triggers a rally in EURUSD. Indeed, lower rates volatility is having the predictable soothing effect on markets.
However, an environment of more benign risk sentiment underpinned by stable UST yields should prove short-lived after US stimulus checks are distributed ahead of very strong Q2 for US activity and inflation.
The March 16-17 FOMC meeting could provide a trigger for a renewed selloff in US rates if the FOMC continues to echo its laisse faire view of steeper yields. And while investors have brought forward expectations for a rate hike, agreement from FOMC participants is not necessarily expected and I don't think that will be an overall game-changer as the street refuses to buy what the central bankers are selling when it comes to 2023 rate hikes.
Today’s ECB meeting brings a communication challenge for the Governing Council, but any dovish expectations are unlikely to be met, possibly sparking near-term gains in EURUSD. But it all depends on how the US yields play out.
I don't think investors have the ability to shake that yield monkey off their backs.
China Risk
Still, fear of earlier US rate hikes and a narrowing China-US yield spread could continue to pressure Asia stocks and FX. And higher-than-expected local government debt issuance and budget deficit targets announced during China's National People's Congress continues to flame fears of tighter funding conditions. Economic data remains strong, but appears marginally toppish and are not further boosting the sentiment.
OIL
Oil has retreated from the 13-month highs achieved following the OPEC+ meeting. The decline in prices is probably driven by profit-taking after a good run, but there are also some fundamental triggers. The EIA published its monthly Short Term Energy Outlook this week, in which it raised US production estimates for 2021 and 2022, and suggested that the market could be oversupplied in 2H21.
This estimate is based on a relatively conservative view of global demand on the assumption that shut-in OPEC production returns relatively quickly, which I think is unlikely.
Saudi Arabia and the group as a whole have demonstrated a commitment to accelerating the draw-down of global oil inventories, and it seems improbable that OPEC+ will allow a surplus of oil production
MARKETS
US equities rose again Wednesday, S&P up 0.9% heading into the close as a calmer session in bonds continued to lead the way. While rates are only down a touch, it's the fact that they have stopped charging ferociously higher, which seems to have been enough to calm frayed nerves, helped along with the US House of Representatives passing the stimulus bill also designed to alleviate child poverty in the US.
The Dow soared more than 450 after new inflation data left The Street struggling to find it in a place you would most expect it; the data itself. And the muffled increase eased fears of another vicious rapid rise in rates while providing a less bumpy runway for stocks to lift off.
The past two weeks have been extremely volatile for equities which have gotten challenged multiple times, driven by the initial spike in yields that led to a subsequent positioning unwind in long-duration growth. Indeed, US yields have acted like an anvil around inventors’ necks lately.
While certain parts of the market (profitless tech / High Growth SaaS / SPACs / Renewables) have performed very poorly (and could continue to lag), the re-opening/value trade has continued to do well complimented by dip-buying even in the mega-cap tech space.
So, for all the talk about a bubble in equities or an increase in yields prompting a wave of selling in risk assets, the actual performance has been quite damning for risk asset bears.
The US 10-year auction went off well, providing the more visible Alka Seltzer moment for the risk market as the resulting lower yields allow investors to breath easier.
But the recent calming in yields may also have to do with the commodities reflation taking a breather with (copper down 7.6% from the recent peak, iron ore down 12.4%), taking some of the pressure off of the nearer-term inflation risk premium that has been fueling steeper central bank paths, and the easing of this pressure point has encouraged better bond market uptakes.
As the market moves past fiscal stimulus as a driver (the infrastructure bill looks like it could be substantially watered down if Senator Manchin has his way), and as central banks try their best to stick to the script, look for economic data to take the driver's seat increasingly. If the last US payroll release is any indication, markets will likely not yet have seen the last of the rates reflation. I can't help but think that we are in for a very bumpy ride.
Looking at the bond yield forecast for 2021 from the likes of Goldman Sachs, UBS, and Deutsche Bank, who are predicting 10-year US yields topping between 1.85-2.25 % and even taking the more conservative route, it's hard not to think we will continue iterate through this churning process as rates go higher.
Sure it is scary when it happens too fast. Still, when the pace slows or yields back down, investors realize higher rates are fundamentally good economic news and a natural by-product of a rebound and start loading up on stocks again. I suspect we will ride the rates roller coaster for some time to come.
US crude inventories have built for the last two weeks due to the current imbalance in the US energy system, with many refining units still offline.
Commercial oil stocks continued to build, bearishly adding 13.8 mn barrels last week, having added 21.5 mn barrels the week before, according to the US Energy Information Administration. Meanwhile, gasoline stocks fell 11.9 mn barrels provided the bullish offset and eventually sent oil prices higher on the strong demand for end products, hence an economic recovery. And given the powerful signals from the US re-opening narrative, it still suggests that the path of least resistance for oil prices is higher.
And with figures crunched, all combined, US commercial crude and product stocks are built by 1.3mb on the week, with the large build in crude once again offset by a large product draw, leaving total oil stocks relatively flat.
But if refining outages persist, there is a risk of entering the driving season with seasonally low gasoline inventories, which will continue to put upward pressure on energy prices even more so as lockdowns get lifted.
But the latest market moves suggest we are nowhere out of the woods just yet. Investors' main concern is the rebalancing of the market and the outlook for prices in the coming months remains tethered to OPEC+ cohesion. It's entirely possible that global demand could be 5-6mbd higher in the second half of the year than in 1Q, but that has to be seen in the context of roughly 8mbd of OPEC+ supply curbs still in place under the agreement. And with Russian Deputy Prime Minister Alexander Novak says Russia will increase output from April (Reuters reported), the current agreement could start to look a bit dodgy.
Indeed, this hints that there are real risks that the agreement frays in the coming months as the group looks to bring back more supply—several member countries have histories of poor compliance with allocations and of pushing for higher supply sooner than the likes of Saudi Arabia with Russia leading the charge. And as traders pivot to the April OPEC+ meeting, this debate will get louder and potentially more cantankerous, proving to be the ultimate rally capper in the weeks ahead.
EU CARBON EMISSION FUTURES
There was a spike in carbon emissions futures of EU Allowances (EUAs, or carbon credits) today, with the Dec21 contract rallying to a record high of EUR41.85 before easing some. Carbon credits were pushed higher by better energy prices and technical triggers. Today's auction saw Poland sell a total of 2,575,000 allowances at an all-time high auction price of EUR41 with a cover ratio of 2.02 and the highest bid of EUR44. The futures closed up 2.2% at EUR41.54.
FOREX MARKETS
The US dollar is trading weaker as US yield pressures abate, and risk sentiment improves squarely on the back of muted US inflation data. But we remain very much in a broader range trade mentality as the FX market stays much more cautious on US yields. Many traders are still viewing this week's cross-asset price action as representative more of a reprieve than a reversal, a "dead cat bounce" if you will. And with the US entering a solid macro phase in Q2 with the Fed taking a hands-off approach, steeper UST curves will likely follow.
It seems that everyone was expecting the same outcome in terms of weaker-than-expected US CPI. A better bond auction with inflation risk premiums' tempering on the back of the fall in commodities as FX reaction was relatively muted to these risk hot spots.
However, what could be more poignant for FX markets are comments from the RBA illustrating the battle central banks may face reaffirming their dovish patience. AUD/USD moved lower on this affirmation of a dovish stance but has since reversed that move. The difficulty remains that the growth outlook is improving in Australia and elsewhere. So, the guidance for unchanged policy on a multi-year horizon is proving hard to sell to markets.
FX Trading desks are hearing last week's echo, "we are not buying what the central banks are selling."
GOLD MARKETS
Gold continues to rebound on lower USD and the easing in US yields. At the same time, there is room for more gains if yields fall convincingly below UST 10-y 1.50%. But with the US entering a solid macro phase in Q2, while the Fed takes a hands-off approach to the steeper UST curve that will likely follow, it suggests this week's move in gold could be little more than a reprieve rather than a reversal of fortunes. And with the equity market doing well and yields abating, there will be less urgency for the Fed to step in and push back on the current steeper yield curve narrative.