The pre-eminent macro question for the United States in 2021 is: Will the medium-to-large burst of inflation and economic activity that is practically baked in the cake for the next six months be durable or transitory? A quick spurt or a long boom? I don't think we can know yet, but: It's of primary importance, and attempts to solve this puzzle will be the overriding theme for the macro in H2 2021.
As Chairman Powell continually reminds us, the problem for policymakers and speculators alike is that solving this puzzle will take a long time to figure out. Probably 6 to 12 months.
For now, the idea that the Fed would recalibrate policy via Twist or YCC seems way off base to me. Unless stocks collapse, I think the Fed will stay on autopilot for ages as they try to decipher the transitory vs durable question. So, yields and market-based inflation signalling will be left to them on devices, not necessarily advantageous for stocks from a rates perspective when the US is on the cusp of an economic revival for ages
That said, the cat and mouse game between the Fed and the market continues, and there are widely varied opinions on what comes next for the Fed. So far, the Fed sticks to a consistent message: Higher yields positively reflect the improving outlook. My guess is this will be the official policy line until stocks are down 20% from the highs (S&P 500 at 3167), at which point the Fed will be forced to pivot like it did in 2018/2019. I'm not forecasting a move to 3167; I'm just saying that's where the put is.
We are in the blackout period, but The Street knows the Fed has one trick up its sleeve and this could hold yields in check. If we get a wipeout on the UST 10Y auction, the Fed can extend the SLR. This should provide some relief to fixed income and funding markets, and it's an easy win for the Fed if they decide they need one. And don't hesitate to sell USD if you see that Red Flashing headline.
The March 17th FOMC meeting has become a big event as the market is already actively wondering if the Fed needs YCC or calendar guidance or something to calm the move in yields. As mentioned above, unless stocks are in freefall at that point, I strongly doubt it. For the Fed to add more easing just as the US economy is about to blast off is not the favoured choice, I'm quite sure of that at least.
A China-driven reprieve from the rotation of growth to value is matched by lower government bond yields after a solid auction of 3Y notes in the US, while USD weakness is broad-based. These trends—a weaker USD and growth outperforming value—could continue in the near term on weaker-than-expected US CPI and a more hawkish-than-expected ECB (Thurs). However, this week’s cross-asset price action represents more of a reprieve than a reversal, 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. Either way, equity markets staged a strong recovery led by China and capped by a 3.7% rally in the NASDAQ 100.
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FOREX
If you follow my blog, I've generally been very bearish on the EURUSD. Still, I feel a bit more comfortable buying EURUSD here for one-week view as the dollar may have peaked with the extreme US macro focus fading and US yields consolidating for now. But what my turn this into a longer-term trade is if the stars align on the vaccination front. Europe could dramatically catch up vaccinations to the US, as the ECB will be unable to match the Fed's dovishness
ECB faces a communications challenge when it delivers its monetary policy statement and press conference on Thursday. However, any dovish expectations will probably not be met, triggering a rally in EURUSD. The Governing Council’s communication on whether to step in and lean against the selloff in the region’s bond markets with its available PEPP envelope is muddied by whether such moves are justified. Moreover, there appears to be no real agreement on what the shape of the yield curve should look like.
A rally in EURUSD could also benefit EM FX in the near term. The correlation between EURUSD and EM FX remains high, a dynamic that represents a continuation of 2020 and breaks from 2019 when short EUR vs long EM FX positions outperformed. Put another way, EUR beta to broad-based risk sentiment has switched from negative in 2019 to positive. The corollary of the link between EUR and EM FX is that broad-based USD weakness should prove short-lived as the US enters a solid macro phase in Q2, while the Fed takes a hands-off approach to the steeper UST curve that will likely follow.
MARKETS
US equities were stronger Tuesday as a massive relief rally on the oversold NASDAQ unfolded due to a reprieve on the bond market rout.
We thought it was going to get choppy but not to the tune of 4 % intraday moves. But even in recovery mode, it perfect illustrates just how fragile sentiment has become driven by the absolute uncertainty throughout both interest rates and inflation outlooks.
In what may have amounted to a short-covering reversion of the past few days, Growth & Momentum stocks snapped back from oversold conditions as rates pulled back slightly. And likewise, the NASDAQ has managed to bounce back resoundingly overnight, led by the same names that have been beaten up most over the past week. Still, I can't say there is a ton of quality buying in these names, given the more immense Macro forces very much driving this market.
With short-term Bond market positioning oversold, any reason to rally ahead of auctions is not surprising. However, a 4% NASDAQ snapback rally is unquestionably a surprise given the macro powers in play.
One can easily paint a picture of this market rebound as complete dependant on rates with fast money and speculative momentum types chasing the moves. As whenever there are these dislocations, active investors remain hesitant to react.
All the while, some folks are making some pretty big assumptions about what the Fed will do next week. But the more significant point is that you shouldn't assume you know what the Fed will do or the cause and effect if they tried.
To assume that this current bout of yield curve steepening will be similar to the past three is probably reasonable—but still, far from a guaranteed assumption, mind you.
If investors are correct in anticipating better economic performance this year, and markets reflect that view, the trend for rates is up, and it probably isn't over. Rising inflation and growth expectations should push interest rates higher, triggering investors to sell bonds and gold along with other long-duration tech stocks sensitive to rising rates and buy more growth-sensitive investments. Given the immense Macro forces at play in the rates markets, a great day in NASDAQ is hardly a trend.
Still, there are also two crater type events the market will need to navigate later today that, if successful, could cement a short-term bounce back; the CPI print and the US 10y auction will be keenly in focus. If markets emerge unscathed from those events, it may continue to relieve some short-term pressure.
One of the things about inflation is that we keep hearing that there will be a boom once everyone gets a vaccination, but the street has a hard time finding it in the place you would most expect it, in the inflation data itself. The direction is right, but the level is still pretty anaemic. Maybe that changes tonight, or perhaps it doesn't?
This too shall pass
When robust US data comes along, the Treasury market should steepen as it adds inflation expectations. Investors need to get hold of that—the data is excellent, the Fed is leaving rates on hold for a very long time in market terms, consumers are getting mailed stimulus cheque, and the president is spending money. And with every American about to be vaccinated by the end of the year, that should be the cause of celebration, and that's something that the markets will eventually revel in once the rate rise start to slow a bit as we edge closer to 1.75-1.85 in the ten year UST.
OIL MARKETS
Oil prices slid further on a build in crude oil inventories of 12.792 million barrels for the week ending March 5. But I think it best to interpret the API data with a pinch of salt as it is unclear whether yesterday's reported stock build is a laggard effect of EIA's large build printed last week or whether we will see another large build from the EIA today.
The catchup plays to OPEC recent supply cuts have called it a day. The next leg of the oil price recovery will have to be carried more and more by real economic growth, as fiscal stimulus and vaccine optimism is reflected in the price. Still, I don't think improving economics is too big to ask with the US GDP forecast improving by the month, so I suspect oil prices will remain Teflon so long as OPEC keeps conditions tight. And that is where the debate will always lie when OPEC brings more barrels to market?
Oil demand is gradually recovering but is well below pre-pandemic levels. So far, the price upswing has been supported by OPEC pursuit of a tight oil policy. But higher prices are not being universally well-received amid the economic recovery, even more given the considerable room for OPEC+ to unwind supply curbs.
I suspect even OPEC must be waking up and smelling coffee that too high oil prices are in themselves a possible threat to the outlook as product demand falters when prices rise to fast too quickly, especially since demand hasn't caught up. And with only a couple of weeks before the next Monthly OPEC meeting, the supply debate will pick up again, and it's back to the OIL market rinse cycle again.
But I wonder how many calls from world leaders are going on in the background, reminding OPEC higher oil prices are most unwelcome at this juncture of the recovery.
It was much easier to tell when Trump was in power; all it took was a tweet aimed at Saudi Arabia to send oil prices lower.
FOREX
The USD is weaker this morning on a combination of lower US yields and mostly more robust equity markets. The saving grace for stocks may have been lower US yields, with 10Y Treasury yields now 8bp lower in the last 48 hours. It is not clear what the catalyst was for the reversal lower in yields, but it has taken the USD lower in sympathy. My guess is with the market looking into their FOMC viewfinder and today's ten-year auction and CPI print garnering more attention than usual in this extremely yield-sensitive USD market, short Bonds pared, and along with them, some long dollar profit-taking was the order of the day.
With next week FOMC squarely in the market's crosshairs, If the Fed truly believes inflationary pressures are nowhere near what they seem, then they should make it abundantly clear they do not intend to raise rates anywhere near as early, as fast or to a level currently being priced by the street.
Asia FX sentiment is much more stable this morning, led by USDCNH after the PBoC Deputy Governor Chen Yulu reiterated that China will steadily and prudently push forward capital account convertibility and promote yuan internationalisation. Which provided the succour to the US yield onslaught that had caught local Asia FX traders leaning the other way thinking the PBoC was open to a weaker yuan.
After getting battered and bruised most of yesterday, touching above 4.13, the Malaysian ringgit improved inline with ASEAN peers on the back of softer US yields and FX risk-friendly comments from the PBoC. But this morning, the local unit isn't getting much help from oil as prices have fallen as positions have gotten a bit too stretched. Look for more range trading ahead of today's US bond auction and CPI data.
GOLD MARKETS
The relief rally has extended on the back of softer US yields, and with ETF and Comex, speculative net length reduced by the tune of 12.5 mn oz year-to-date positioning is much cleaner.
And a lot of physical gold supply coming to market is getting absorbed by real money allocators below USD 1700; things might not be as bad as they seem.
According to Gold Wholesalers in Zurich, India demand has been incredibly robust, and bars destined for the region has increased – the 5-percentage point reduction in import duty helps. Still, the key has been demand elasticity, with rupee-denominated gold now at desirable levels.
China demand has recovered this year. Premiums are hovering around USD10 above London. And from what I currently understand, the authorities are yet to award import duties, but I'm hearing that local stocks are close to being depleted on a post LNY buying bonanza.
While the elephant in the room remains EFT selling as US bond yields move higher and investors sell gold in favour of cyclical stocks, the gold price may have found a floor here and could be comfortable in the $1700s range for a bit as physical demand remains stout.