UK vaccine rolls out next week, and stocks should remain the asset class to own by default, oil getting stoked along with the curve+ OPEC a risk to the reflation trade EURGBP in focus.
US equities were little changed on Wednesday. The S&P 500 up 0.1% after momentum in US stimulus talks lifted the index out of the red in the afternoon. Democrat and Republic congressional leaders cited the potential for compromise on the stimulus deal. US10Y yields raised another 2bps to 0.94%. While House Speaker Nancy Pelosi and Senate Democratic leader Chuck Schumer call for immediate stimulus talks and say a bipartisan $908 billion aid proposal should be the foundation for negotiations.
FTSE outperformed overnight, up 1.2%, after UK authorities issued an emergency use authorization for the Pfizer(NYSE:PFE) / BioNTech (NASDAQ:BNTX) vaccine, becoming the first Western nation to do so. Limited distribution is expected next while.
Meanwhile, on a more ominous front, and the new Grinch that stole Christmas, German Chancellor Merkel announced overnight that Germany's partial lockdown would likely be extended until at least January 10 and cautioned against getting hopes too high for vaccine roll out in Q1. However, the announcement has had no material impact on risk as the market continues to look through recent and potential new lockdown effects thanks to the vaccine rollout.
And the November ADP employment rose 307k in the US against the consensus at 440k should have little impact on Friday's payroll outlook.
Following two weeks of terror in March, the post-pandemic market narrative has moved seamlessly from policy-driven to mobility-driven to vaccine-driven. Successful vaccines have now been developed, providing the asymmetry for markets we had hoped for ("A knockout jab?"). While vaccines do not stabilize the economy, vaccinations do. On the back of pent-up demand, we reiterate that the broadening out of the 'value' trade and diversification of risk assets to other parts of the world should continue.
The vaccine has been the big prize for risk markets as healthcare concerns see a rapid drop in the global virus counts in H2 next year, getting close to herd immunity. This will result in a collective demand lift for the world economy, and global geopolitical risk has also diminished after the US presidential election.
Combined, this has led to a swift compression in cross-asset volatility, helping risk assets. A much clearer view across the valley to economic recovery should mean more upside. However, that should be seen in the context of a 63% rally in global equities since the lows and credit spreads have retraced about 90% of their widening.
While 2020 was a lost year for earnings, not for markets, global equities are 12% higher than where they started the year as companies reshaped their internals. From a leverage perspective, corporates are better off now than in 2007. Although serious and permanent damage has been done in some areas, many companies have quickly adapted.
Indeed, this is not a normal economic downturn or recovery. But as we have noted throughout the pandemic, consumers and corporates have been speedy to adapt. As a result, growth has consistently surprised the upside, and positive surprises have been evident almost everywhere.
Stocks remain the asset class to own by default. With no coupon in the rates market, investors need to seek coupon inequities. High equity valuations are simply the mirror of low risk-free yields.
Forex
The global reflation theme is increasingly entrenched. Inflation expectations drove higher nominal UST yields, broad-based USD weakness, higher industrial commodity prices, and an ongoing factor rotation in stocks to value and support the reflation theme. These moves are justified significantly, with rapid vaccine rollouts across the major economies and renewed bipartisan US fiscal negotiations driving reflationary cross-asset moves.
Beyond a potentially disappointing outcome from US fiscal talks, it’s worthwhile considering three near-term risks for markets: (1) a breakdown in UK-EU Brexit talks (short GBPUSD, EUR/USD, long EURGBP); (2) the failure of OPEC+ talks today (short front-month Brent, long USD vs. BRL, MXN, NOK) and; (3) more hawkish-than-expected US foreign-policy vis-à-vis China (long USDCNH, short AUDUSD, short SPX, long USTs).
The failure of an OPEC+ agreement in postponed talks on production that resumes today is a near-term risk to the global reflation trade. The consensus expectation is for a three-month extension to current production quotas due to rising by 2mbd on Jan. 1, 2021. Front-month Brent is trading at similar levels to prices ahead of the March OPEC+ meeting (week starting Mar. 2), resulting in sharply-higher output after Saudi Arabia and Russia disagreed. Today, the biggest fault line is between Saudi Arabia and the UAE. The latter opposed an agreement to an extension without more stringent oversight of output cuts from other members.
Belgium, Denmark, and the Netherlands back France's hardline stance relative to Germany in conceding as little as possible in Brexit negotiations on access to UK fishing waters. GBPUSD has been well supported since late September, with dips very shallow. Negotiations are entering a more delicate stage, however. So far, investors have been willing to buy the dip, believing that a deal will eventually be reached. That confidence is starting to crack. With EURUSD well supported amid broad-based USD weakness, EURGBP is poised to break to the topside.
The Euro
With EUR/USD close to the highs, conditions suggest a sustained break of 1.2000:
- Positioning is no longer extreme longs, although starting to build
- The virus wave in Europe is likely to peak; the US is still sparing.
- European equity inflows will pick up on rotation from Tech US to cyclical heavy Europe.
- The existential risk premium around the Euro break-up is at its lowest in years.
Beyond that, the vaccine rollout has increased confidence in the positive cyclical outlook, which should favor a weaker dollar across the board.
Bottom line, everything that was pointing us towards caution on the Euro in September has now turned.
Oil
The Brent market firmed on Tuesday, led by large gains in swaps markets. Both monthly and weekly swaps tied to the North Sea surged, and the global benchmark's prompt futures spread flipped back into backwardation.
There was another curve play in WTI calendar month options, and likely many to follow, betting the contango will widen: the Jan21-Jun21 -USD0.50 Puts were bought 1,000 times per month at $0.05; total premium $300k. This same strip was purchased at $0.07, 4,000 times in one day last week for a total $1.68 mn premium.
And it appears the compromise on the table and its one that has been discussed in many market circles—taking the form of a gradual taper that would put more emphasis on the monthly JMMC meeting for guidance. But the current level of demand via global inventory status and the shape of the curve will provide the immediate tell for traders. Anything that will bridge the gap to the time when the vaccine effect while working its magic through the real economy while simultaneously OPEC+ to present a unified front should work for oil traders.