Resilience!
US equities' resilience in the face of elevated UST yields and proposals for higher US corporate taxes is impressive. Looking at the give and take between equities and yields in the context of the White House’s infrastructure proposals suggests that investors expect stronger economic activity from the fiscal boost (higher inflation breakevens and stable real yields) but are unconcerned by the impact of higher corporate taxes on net profits.
Attaching higher taxes for corporates to an infrastructure bill a year ago would have reduced the chances of moving through Congress. In a sign of how much the tides have shifted on the tax issue, Amazon (NASDAQ:AMZN) CEO Jeff Bezos voiced his support for the bill, “both on the specifics of what’s included as well as how it gets paid for.” On a related note, reports overnight suggest that US and European economies are close to agreeing on a framework for a minimum tax rate for companies and taxation of the digital economy.
The FOMC’s Mar. 18 meeting minutes could test the recent drift lower in UST yields, so there remains another big box to check off on the road to recovery. But this sitting Fed has witnessed enough policy mistakes to know at this stage of the recovery, is wiser to sit tight.
Anecdotal evidence suggests China is moving more meaningfully into a post-pandemic phase focusing on asset bubbles and financial stability that entails slower credit growth. The risk remains that the consensus will be disappointed, as Beijing cools what it deems excessive lending.
More broadly, for EM assets, a slowing credit impulse from China is arguably more of a risk than higher UST yields driven by a pick-up in US economic growth.
However, that view is getting challenged by the Malaysian ringgit today, which continues to pick up momentum after MSG (Malaysian government bonds) was removed from the FTSE Watchlist amid the country's central bank's (BNM) recent focus on their currency liberalization mandate to encourage FDI. And that mandate appears to be finding an echo in currency markets as the MYR strengthens out of the gates this morning.
So what is happening in the oil market today? Well, nothing sinister. Oil is just acting like a perfectly normal commodity with the market caught between the competing narratives of U.S. growth and Europe’s catch-up recovery versus the uncertain supply conditions. Liquidity is still low across all markets post-Easter, which may be exaggerating moves and keeping speculators sidelined as volatility and choppiness rises again.
MARKETS
US stock futures are taking a breather after the latest surge to another set of highs, supported by a recent run of exceptional US economic data. Still, there are many more economic data boxes to be checked off to confirm what markets have been pricing up until now. With the SPX closing in on some significant interim targets, investors could be exhausted from chasing strength and have instead started to trim some of the higher beta parts of the markets while possibly looking to add into weakness.
And while equity and risk markets can remain at highly elevated levels provided the macro data support, but at such lofty levels, investors likely need a little more confirmation at precisely what stage of the recovery we are at, and more specifically for bond yield concerns, exactly where inflation sits as the technical correction lower in US 10-year bond yields is finding a base around 1.65%
Europe and the rest of Asia came back from the Easter holiday and were generally playing catch up yesterday. There's a cyclical tilt to the tape in Europe; however, that too could pause in concert with US markets where lower US yields amid more robust US economic data was the accelerant that stoked markets higher. With yields basing, so too could the chase higher in stocks.
And Asia investors will continue to digest the softer credit impulse from The People's Bank of China who has asked banks to temper lending activities while simultaneously bumping capital requirements on systemically important banks. In the face of recent risks to global financial markets from the Archegos incident, the PBoC might believe its prudent to fortify their own house of cards against similar incidents in China. A softer China credit impulse is not great for risk and especially through the commodity channels.
Oil Markets
The oil market has trouble finding its feet, let alone an equilibrium, as the apparent buyers strike continues after the API reported an unexpected hefty build in gasoline inventories.
On Tuesday, oil prices were knocked lower after American Petroleum Institute reported a larger than expected build in gasoline inventories. And the gasoline risk comes at an inopportune time as the market frets about more barrels coming back to the market, be it rebranded Iranian oil via the China supply chain or OPEC + revisiting a tapering strategy.
Despite a slightly weaker US dollar, oil and energy sectors are having trouble shaking Monday's brutal move lower. There are many reasons for the changing sentiment, be it OPEC+ revisiting their taper strategy, US/Iran talks hanging ominously over the supply side of the markets, the rising US rig count, or even China softer credit impulse.
The reality could be that investors are turning face on thoughts of riding a glorious oil supercycle and are now backpedalling on a very bumpy road to recovery but mounting a wobbly unicycle. There was so much optimism repriced in the reopening narrative. With COVID-19 continuing to raise its ugly head globally, thoughts of a summer travel boom could bes still a pipe dream as governments worldwide will continue to impose strict quarantine protocols. And without jet fuel picking up the slack, oil prices could remain on the revolving carousel of headline risk.
The start of Q2 has not been kind to oil prices. Getting little impetus from the gnarly news flow and still struggling from the profit-taking hangover as the sellers drift down from $70 and buyers strike was accelerated as prices dropped down through $67/bbl on February 18, triggering a cascade of profit-taking after the year-long rally.
Indeed, the physical market showed fewer signs of tightness. Still, investors focused on momentum strategies changing direction into Q2. The move was doubtlessly exaggerated as large producers hedged the highest prices for the cal-22 strip (March 25) seen since November 2018. And this is bearing out in the recent CFTC data suggesting producer hedging strategies could limit topside ambitions.
Oil traders may find comfort buying dips knowing OPEC+ will closely monitor macro conditions via monthly meetings on the flip side of the coin. There should be little doubt the group will step in to put a floor on the oil price macro conditions deteriorate.
Dare I say range trade beckons?
FOREX
The dollar seems to have turned a small corner on the euro with month-end demand and rebalancing in stocks out of the way. Europe's delays on vaccination and renewed lockdowns are priced by now, and eventually, there should be more positive headlines to support the euro.
And indeed, the euro's relative resilience may reflect headlines that suggested better days ahead for the EU's stuttering vaccination program.
The foremost opportunity in G10 FX markets could be positioning for European activity's likely recovery. Vaccinations look set to accelerate significantly in April and May, and experience suggests current lockdowns will lower COVID case numbers relatively soon. Indeed, this should be positive for the euro.
Malaysian Ringgit
The ringgit remains mired between the competing forces of softer US yields and lower oil prices as energy sectors struggle to shake Monday's sneaky but ferocious sell-off. And with US yields basing, the fuel that drove the MYR higher could be evaporating. And with the higher oil prices and lower US yields, stars don't both align. The ringgit could struggle to break higher ground. And as worrisome for commodity expoerters like Malaysia is China telling banks to reign in lending, which softens Chinas credit impulse, and not favorably for the MYR as Malaysia has strong export ties with China.
The US Dollar
USD seems more influenced by risk-on / risk-off than under the "US exceptionalism" theme. This partially explains why the USD did not rally despite excellent unemployment data last Friday, followed by a sizzling ISM. And with US rates not following through higher, it suggests the market is reducing long USD positions by not entertaining Fed policy normalization "exceptionalism" from the FOMC statement at this stage of the recovery. Even though the data was stellar, the market knows Chair Powell has witnessed enough mistakes at the central bank to see that he needs to be patient with policy.
All of which is good for shiny things like gold!
GOLD MARKETS
Gold jumps as USD and yields fall, and with USD not responding to "US exceptionalism," it still leaves room for further price climbs.
Gold prices firmed in volatile Asian and European trading as the Easter holidays ended and full trading got back underway. Gold received support from the FX markets as EURUSD retained Monday's gains, putting gold on a firm footing. And as we all know, Gold in a dollar-weaker environment tends to remain tethered at the hip to the euro.
But ultimately, it was USD weakness and an easing in yields during US trading that effectively provided the accelerant to rally gold and silver.