China’s market rout yesterday provided a taste of what central bank liquidity withdrawal means to investors. The Shanghai Composite Index tumbled ~1.5%, while China rates sold off sharply after the PBoC unexpectedly drained CNY78 bn from the banking system. Interbank borrowing costs soared, with both the overnight and 7d repo rate jumping to 10% which is a relatively rare occurrence.
However, local media published a front-page commentary this morning urging the market not to over-interpret the PBoC’s short term liquidity operations. It commented that the inverted money market rate curve (1d vs 7d repo) reflects that the market does not expect the liquidity tightness to continue. If history is any guide, the PBoC normally releases liquidity two weeks before the Chinese New Year holiday (starts from Jan. 28 this year).
By then, OMO will be the top priority for the PBoC. The commentary also noted that the money market rate will eventually stabilize around the policy rate (current 7d OMO rate stands at 2.2%).
Australian Inflation Accelerates
Australia’s inflation accelerated more-than-expected in Q4 on tobacco and childcare costs. The CPI advanced 0.9% q/q vs 0.7% consensus. The annual CPI also beat forecasts, similarly rising by 0.9% vs an estimated 0.7%.
Australian prices have been hit by declining rents, as vacancies rise amid the covid pandemic, while areas such as childcare are now picking up as government assistance ends. The RBA has adjusted its inflation framework to allow the economy to run a little hotter and doesn’t intend to tighten borrowing costs until inflation is sustainably within its 2-3% target.
MARKETS
US equities were little changed Tuesday, with the S&P flat heading into the close after waxing and waning all day on stimulus background noise. US 10-year yields lifted 1bp to 1.03% following Monday's bond rally, which saw yields fall around 6bps to their lowest close since the Georgia Blue Sweep.
On stimulus, US Senate Majority leader Schumer suggested Democrats might be prepared to move forward with a stimulus vote as early as next week with Democrats able to use budget reconciliation measures to sidestep more pushbacks at least partly from Republicans about the $1.9T plan.
After a very spooky start to the week due in part to Angela Merkel's comment " the pandemic has slipped out of control" coalescing with fears that the vaccines may not be as effective as expected, cross-asset markets are finding their footings again thanks to the supportive policy backdrops and clarification from vaccine makers on some vaccine efficacy headline confusion. But markets may continue to struggle for near term direction as COVID concerns continue to cast a pall over the proceedings, creating an unpleasant situation for both risk and healthcare concerns.
With the virus spreading like wildfire in parts to the world, it is now possible that Q1 will be a lost quarter and part of 2Q also. Some are even concerned that vaccines may not prove useful enough to eradicate the virus. And these concerns will continue to linger over markets like a dark cloud until vaccine distributions get ironed out, and a definitive drop in contagion levels can thoroughly support the vaccine efficacy results.
The mood music has become quite gloomy on vaccinations, which may not be surprising given we are in the clutches of the pandemic's darkest days. Still, I think it's important not to lose sight of what matters from a medical perspective: the vaccines work and are adjustable to the new strains.
While recent COVID -19 news has been horrifyingly discouraging, the big picture does not change in terms of markets outlook. Namely, an unprecedented amount of monetary and fiscal stimulus, a structural shift towards much more spending, a potentially unmatched economic rebound—whether starting in Q2 or Q3—and a reasonable chance of inflation for the first time in several decades.
As we move back into the " look through" trade environment supported by monetary and fiscal puts, investors are quickly rediscovering that not all growth assets are created equal in a COVID downtrodden economic climate, and the forever fickle FX market is testament to the thesis that nothing goes up in a straight line.
On the data front, things are relatively light ahead of the FOMC where the risk could be that the market is overly complacent for a dovish Powell.
OIL MARKETS
Oil received a timely fillip after the API reported that US crude supplies declined 5.3 million barrels bullishly against consensuses. Still, problems may continue to linger under the hood as the data also reportedly indicated gasoline stock rose by near 3.1 million barrels. At the same time, the draws at Cushing make sense in backwardation markets.
Even when mired in the pandemic's darkest days, oil prices remain incredibly resilient in no small part due to OPEC's dogged determination to stay in damage control mode adjusting supply constraints to alleviate the currently projected level of attrition to global demand.
However, not to be misinterpreted as a rallying cry, OPEC policy actions are critical price planks and much-needed policy "puts" to prevent oil prices from moving significantly lower as renewed concerns about the pandemic's lingering impact in China and elsewhere have hit both sentiment and oil fundamental expectations.
Both benchmarks traded surprisingly bid at times overnight as WTI above USD53.00 and Brent above USD56.00 a barrel for most European mornings only to relinquish gains after the US Open as vaccination efficacy concerns and the general pandemic dark days of winter narrative dampened the mood.
One thing to note is that Mar21 Brent will expire this Friday. It is not unusual for the front-month to move quite dramatically heading into expiry.
While the general upward direction of travel in the market makes sense, it's difficult for oil traders to make a definitive near term shift to the next price level higher given the very uncertain near-term demand outlook.
FOREX MARKETS
The USD could struggle for direction today alongside uncertain risk appetite, with few significant developments to provoke any reappraisal. Even on the day before an FOMC meeting, the FX market's policy focus remains on fiscal rather than monetary policy.
The EUR is trading higher after a strong performance of European equities overnight.
Commodity currencies are trading firmer finding traction from resilient equity markets and stabilizing commodity prices, particularly oil, which might be the reason for some relative outperformance in the Canadian dollar.
The ringgit remains ensnared in relatively tight ranges as struggling domestic economic concerns offset the benefits from stabilizing commodity prices, particularly oil.
The long, long march toward central bank policy normalization has begun. Central bankers have the same information we do: The sole reason for the massive balance sheet expansion—COVID-19—will be mostly gone in 6-9 months. If the policy works with long and variable lags, it will soon be time to dive and start normalization. The central banks are slowly climbing up the ladder to the top of the 100-foot diving tower, and those that are already there are waiting for someone else to take the plunge to go first.
The emerging theme across central banks (ECB, BOC, Norges) has been a recentering of focus towards potential upside policy scenarios around upcoming vaccinations and economic reopening. With the RBNZ still priced for cuts, the Kiwi will undoubtedly attract some attention under this scenario as push back on negative rates could be the central theme leading up to the next RBNZ meeting in about one month.
The Bank of Canada usually moves to the Federal Reserve's impulse, but this year it's likely to become by degrees more hawkish. Indeed, The Bank of Canada is already sounding more hawkish than many of its peers. After all, it has much less work to do to monetize government borrowing. Hence the BoC can focus on economic recovery.
So, in the race to policy normalization, Bank of Canada is wearing the yellow jersey and at the head of the peloton, while The Reserve Bank of New Zealand's is the quickest of the chase group riders.
GOLD MARKETS
Gold market's remains mired in very tight ranges as investors look to the FOMC policy inputs for gold near term direction