U.S. investors continue to whine about the cost of infrastructure spending and potential tax hikes to pay for President Joseph Biden’s $1.9 trillion relief bill.
This weighed on investors who also fear a further downside in the market. And although oil prices have recovered a bit after plumbing the depths overnight, the higher inflation input of higher oil prices is hardly a cause for celebrations these days, given it could push US yields higher.
If You Like Choppy Range Trading, This Is The Market For You
But active investors absolutely deplore these types of conditions.
Despite record equity inflows, S&P 500 has failed to reach the 4k level and has instead settled into a choppy range. Expected pension selling of $110 bn of global equities and the overhang from higher rates expectations seem to have capped the upside in the near-term. Further, as the strong corporate buyback bid fades into month-end ahead of the Q1 earnings season, the market could be vulnerable.
However, support is coming from systematic buying given lower realized volatility and a continuously strong retail bid. All in all, it is hard to have a strong directional view, which is reflective of a 15-20% drop in volumes versus the 20-day average.
The retail story from market-making flows has been a buy skew 48 of 53 trading day in 2021. While the buying has been consistent, the underlying behavior has changed. Rather than chasing momentum on up-days, retail buying has been more pronounced on down days, i.e., retail is actively buying underperformers versus selling outperformers. In other words, retail investors are currently a liquidity provider and, in a way, contribute to more muted volatility. Beware if this changes, especially into month-end.
The momentum trade is changing. Based on 12m performance, there will be a turnover of 48/100 stocks in the top quintile of the S&P 500 The sectors that benefit from the rotation are energy, financials and consumer discretionary. Overall, high momentum will become more value while losing its high-quality bias.
Oil Pulls Back a Touch After Surge With Ship Still Blocking Suez Canal
In-line with general risk sentiment getting weighted down by COVID concerns that have seen investors seek shelter under the USD umbrella, oil prices have slipped a touch in early trade.
Since oil remains hypersensitive to demand risks, traders may think it wise to take some chips off the table ahead of any possible untoward US spring break virus headlines.
But overall, I think the tone of broader risk sentiment continues to drive the oil truck today.
Let's face it—it's not every day you can count on a wayward tanker in the Suez Canal to support oil to the tune of 6 % overnight, so the rebound was always on shaky ground.
But If oil trading is not the craziest game in town, tell me what is. In these types of conditions, if you are trading, it's hard to have a salient view one way or the other, and we might see the uncertainly play out in the price action as the market remains on defense against further headline COVID scares.
Another Price Plank Today?
DOT Secretary Pete Buttigieg will testify on the “Administration’s Priorities for Transportation Infrastructure” today. With vaccine rollout now fully priced in for the USA, and job availability is near-universal for any American willing to do a bit of Googling, infrastructure is the next catalyst for the reflation trade.
There are more questions than answers still, and uncertainty remains high around details and odds of passage. Consider today Day 1 of a long-drawn-out process that will take years.
US Shale Drillers Optimistic
This could eventually start to factor and not a good way for oil prices. The Dallas Fed released their quarterly energy update earlier, which showed a huge pick up in the business activity index. It rose from 18.5 in Q2 2020 to 53.6, the highest in its five-year history. The oil production index rose from 1 to 16.3.
There have been articles recently about newfound cost discipline among US producers (notably Shale drillers), and the pick-up in CAPEX intentions for 2022 suggests they are optimistic for the future. Average survey expectations for the year-end WTI price was $61 (range $45 to $85). The survey also looked at the price needed to cover operating expenses ($31) as well the prices need to make a new well profitable ($46-$58).
A Cacophony Of Risks Weighs On Market Sentiment
All that plus oil bounces due to increased cargo time on the water, after a container ship found itself sideways on the Suez Canal.
US equities were weaker Wednesday, S&P down 0.5%. US 10-year yields down 1bp to 1.61%. Oil rebounded 5.9% on near-term supply concerns after a container ship found itself sideways on the Suez Canal.
As risk asset remains challenged by the recent COVID-19 surge, and catching stock markets at the wrong time, some estimates predict there will be as much as $88.5 bn of month-end rebalancing out of equities and into US fixed income. These factors continue to weigh on risk.
But when the short-term wobbles, investors naturally start to fret about those lingering longer-term concerns; they are also hurting sentiment with renewed worries about US tax policy and a realization that any lingering hope of a reset in US-China trade relations is unwarranted.
The later is quite a worrying proposition as the two economic behemoths draw battlegrounds, setting the stage for a real dust-up as the superpowers shift from vying for supply chain domination to battling it out for global internet technology supremacy. Buckle in for this one as it could make the Trump-era Trade War legacy look like little more than an Axis and Allies board game.
With so much economical and growth optimism priced into Q2, the recent global growth scare has likely validated that the value rotation looks likely to peak and exhaust. Hence, any watering down of growth expectations suggests those optimistic about stock market valuation could feel a near term pinch, especially if the economic data remains less supportive or turns sour.
Europe is light on cyclical-Growth stocks. If Value doesn't perform, it isn't easy to see Europe outperform over the medium term. Historically, in periods of outperformance of cyclical when Value lags Growth, Europe has struggled to keep pace with other regions due to this relative lack of cyclical-Growth stocks.
Exposure to short end rates continues to be a massive forward-looking overhang; small firms would take a significant earnings hit once the Fed starts raising rates, possibly as early as 2022.
Until we get a better idea of month-end mobility data on both sides of the pond, the risk backdrop could remain challenged by the economic knock-on effect from the COVID-19 scare, even though some, if not all, the headwinds are transitory (i.e. re-openings are delayed, not derailed), And even if the broader constructive narrative remains intact, some areas of the market, like travel and leisure, were priced for a near-perfect recovery and are very susceptible to a reopening delay.
For example, Airlines' pressure is becoming acute as British Airways need to offer their lucrative 'crown jewel' landing slots at London's airports as collateral to secure funding. Other airlines have already headed this way, but it is the first time BA and owner IAG (LON:ICAG) have needed to offer such valuable collateral.
Oil Markets
An unlikely course of events has come to the rescue of the oil market in the form of a wayward vessel. Oil rallied on the news of a giant ship blocking the Suez Canal, disrupting a primary supply chain conduit. And positive European economic data assuaged some of the newfound growth implications; EU backyards and factories remain super busy despite being in soft or rolling lockdowns for most of the year.
But one of the possible vital contributing factors to the bounce-back might be Germany's Merkel announcing she would cancel the stricter Easter lockdown restrictions after the decision received widespread criticism. To the extent that European lockdowns may have triggered the recent pullback in the oil markets reopening optimism, this could, on the margin, help to calm some of the negative sentiment around the demand impact.
The front spreads are back to backwardation, and the Dec21/Dec22 have rallied by $0.90/$0.95 for Brent and WTI, respectively.
As it became apparent the canal will not reopen as quickly as initially envisaged, prices continued to rally despite a negative oil stockpile report; however, gasoline demand has increased, which tends to be a reliable soothsayer.
For crude, this means increased oil on the water— either queuing for the canal or diverting around Africa. The extra voyage time is akin to "filling a pipeline" and should support the very jittery market that has seen the rush for the door over the past five sessions.
While it's a bit early to guess what cards, OPEC is holding up their sleeves. Still, oil's weakness this week seems to have validated the cautious view expressed by Saudi Arabia at the last meeting. And it increases the probability of yet another rollover of current production levels.
Forex
US Dollar
The USD has extended its rally overnight, with FX traders fixated on equities to signal broader risk sentiment. The news flow around the US economy has not changed. And the Fed's upbeat message on growth—without sounding any alarm bells on inflation—provided a solid backdrop for the US dollar beyond its safe-haven appeal.
You don't have to look too far to support that view. Even the robust March PMI data from the Eurozone failed to deliver any lift higher in EUR as COVID-19 concerns persist.
Malaysian Ringgit
The resilient US dollar is likely the biggest obstacle for the ringgit and USD/Asia right now as even higher oil prices are failing to boost traditional oil currency betas overnight, with the Canadian dollar only improving marginally despite a 5.7% underlying price recovery. While higher oil prices could stem the ringgits bleeding, it might not be enough to trigger a bullish revival.
The re-imposition of lockdowns in Europe and the resurgence of COVID-19 in hotspots around the world does little to improve the prospect of regional travel and leisure sectors. Now even what glimmer of hope there was around summer travel reopening would be questionable given the new global spread and concerns over the new variant.
Risks In Markets
Most risk in the market falls into two places, volatility and short-dated US Treasuries.
The direction of the dollar is the lowest conviction trade out there. Most buy into the twin deficits triggering dollar weakness argument, but it hasn't worked. The US economic strength argument should work, but history says no. However, my view is that the dollar strengthens, whichever version of events is proving correct, EUR/USD can't stay here.
By association, a more robust/weaker dollar has implications for all other assets. Vol is too low across the board. The very moment the market decides on the USD's next major direction, a.k.a. what the Fed's real intentions are, there'll need to be wholesale repricing across all markets.
3- & 5-year Treasuries, and especially rates, are in a dangerous position. They have been well behaved and buying into the Fed story of lower/longer mantra, but the Fed is forever economic and inflation contingent.
Strong payrolls, strong retail sales, vigorous activity, and the Fed will be able to activate "on track" for sustained progress. Despite the quick move lower in yields of late, the market is at risk of regional Fed presidents breaking ranks on the policy call.
If this version of events plays out and data improves, then the front end reprices higher again, the dollar gains big; equity volatility goes through the roof, and EM suffers a Tsunami of risk aversion.
Gold Markets
Gold shrugged off USD strength overnight and finally reversed some losses thanks to lower US yields. Bullion could see further upside traction if US bond yields stay sluggish, especially in this risk-averse environment with US-Sino tension starting to bubble again.