Asia Morning Macro: Pro-Reflation Trade Set To Get Tested; Gold Defensive

In a test for the pro-reflation trade, social-mobility restrictions are tightening significantly in Europe and potentially in the US for the first time since the first COVID-19 vaccine was announced on Nov. 9.

Germany will enter hard lockdown on Wednesday; non-essential services will be shuttered in the Netherlands until Jan. 19, London enters the tightest tier of restrictions imminently, while New York City could be on the verge of locking down.

Reflation trades are outperforming since the vaccine announcement, with industrial metals, , US value over Tech equities, European equities, all rallying framed by a weaker .

The global economic cycle has reset in a matter of months thanks to soaring commodity prices and an environment of improving growth and still tepid inflation. This transition wholeheartedly benefits reflation trades.

Slipping back into a disinflationary environment for both activity and prices could see momentum in these longs slow or even reverse in the near term.

The latest New York lockdowns have sent a not so pleasant holiday jingle-jangle across risk assets.

Beyond testing the rotation from tech to value inequities, the long commodities trade will be tested by broadening social-mobility restrictions. Indeed this is a more immediate concern for oil prices than for industrial metals, with China’s robust supply-side recovery supporting the latter.

Front-oil is trading at the highest level since early May, rallying 18.6% since Nov. 9. Since then, US inflation expectations accelerated, with the yield on the 5y5y inflation swap rising 11bp to 2.26%. In FX, commodity-sensitive currencies are outperforming, with the , , , and leading. A near-term pullback in these currencies, within a broader medium-term rally versus the USD, is becoming more likely.

RBA To Keep Policy Accommodative

The from the RBA’s Dec. 1 meeting offer different color on its reasons for leaving its main policy settings unchanged—3y yield target and cash rate are unchanged at 0.10%. It signals a willingness to maintain monetary accommodation “for some time.” It will require significant employment gains and a move in inflation sustainably into the 2-3% range before considering raising rates. Since the meeting, AUD’s correlation with US equities—a consistent factor since February—has overwhelmed monetary policy drivers, keeping AUDUSD supported. Still, the RBA did not push back against AUD upside in its discussions.

Brexit Mood Music

The Brexit mood music is more optimistic this morning as the EU’s chief negotiator Barnier sounds almost cheerful, saying that ‘a fish compromise could see a deal this week’. Sterling reacts on cure as probabilities are seen as shifting back towards a 60/70% deal; I’d say down for 80 % last night… The lows in on Nov. 23 were 0.8860 or so, which is where it should go, and further if the optimism accelerates. The problem is how Johnson can portray any agreement as to the EU backing down, not a UK compromise.


In the euro area, front ends are lower after the positive update over the weekend of Brexit talks continuing. Vols behind are mostly unchanged in , with vols a touch softer. vols are lower for the same reason as the weights the market was pricing for this week had been rolled out, mostly to year-end with no current deadline for talks other than the hard year-end deadline.

OPEC Report Shows Falling Demand

OPEC’s somber demand outlook has caused some reason for concern in oil market circles. But oil is trading flat as a pancake in Asia trade as a market near a short term point of equilibrium as the market continues to feel the gravitational pull around Brent $50 per barrel

The OPEC monthly report overnight showed 2020 demand forecast cut by 20kb/d, Q1 2021 by 1mb/d and FY2021 demand by 360kb/d to 95.89mb/d Non-OPEC liquids production is estimated to rise 850kb/d in 2021 to 63.52mb/d.

Despite a relatively gloomy outlook, the call on OPEC for Q1/Q2 next year is forecast at 26.3mb/d/27.5mb/d, above November production of 25.1mb/d. Scope for production to be increased slightly by OPEC and non-OPEC, but coordinated action and good compliance remain important

As broader markets continue to straddle the fence between hope and reality, the world in chorus screams out,” Dear Future; I’m now ready.” Oil+FX+Gold

Equity Markets

US equities traded mostly sideways Monday, supported by talk of more vaccination rollouts and discussion of a bipartisan $908 billion US relief bill to be unveiled. But the broader indexes sold off relatively hard into the close in a case of buy rumor sell the facts. Indeed, it seems like investors are reacting in a day late and a dollar short fashion with both the US situation and COVID-19 spread shackling the economy due to a state of lockdown siege suggesting Congress needs to do much more, especially with New York lockdown headlines playing a major factor.

Again, it feels like we are stuck in the negative feedback loop. Unless policymakers overdeliver on market expectation, especially at this time of year when our risk-taking proclivities give way to profit-taking, it seems virus-related economic restrictions will never cease to weigh as the market counties to straddle that fence between hope and reality.

And while the vaccine heralds a return to normalcy, just how quickly will folk embrace that reopening normalcy remains the great unknown. Still, one would think that over time, as the virus fades from the memory, people would be happy to return to past behavior. The problem with that is whether the services and amenities that make high density living appealing to some can last that long. While consumer preference might be temporary, it could become permanent if cities become much less attractive places in the meantime.

Last week’s pullback in risk had markets primed for yesterday’s recovery as progress resurfaces in Brexit and stimulus against a backdrop of vaccine distribution commencing in the US. Brexit talks will now be extended once again, with EU chief Brexit negotiator Barnier saying a fish compromise could open the door for a deal.

It is starting to feel like Christmas trading is beginning to kick in despite some Brexit and US stimulus risks. Exchange volumes remain fairly depressed as trader fatigue becomes a factor and investors turn predictably more selective and defensive to protect profits. Keeping in mind this is likely the real last week of liquidity this year, culminating with expiry and rebalances on Friday.

The US has started rolling out the Pfizer (NYSE:) vaccine, with health workers among the first recipients. Officials have indicated they expect 40m doses of the vaccine will be distributed by the end of the year. Indeed, this is a great start for the rollout process and should continue to provide some downside inoculation to overall market risk sentiment given the horizon looks rosy with the world in chorus screaming out, ” Dear Future, I’m now ready.”

Until the last few hours on trade in New York, risk assets point to a constructive start to the value trade this week. Commodity strength continues. Energy overtook Real Estate to be the 10th largest index weight (as of the end of last week), having been bottom of the pack for quite some time. The Energy Select Sector SPDR® Fund (NYSE:), the SPDR S&P Oil & Gas Exploration & Production ETF (NYSE:), and the SPDR S&P Metals & Mining ETF (NYSE:). are trading well on Brexit developments despite more COVID-19 lockdowns ( being most notable).

Forex Markets

The Pound

The pound went fishing for the big whopper of a deal but ended up with minnows as all fishing channels appear to be leading to an Australian type relationship. As after Xmas cheers set in over Brexit, it’s back to brinkmanship at its best as the UK is now apparently denying there has been any progress.

Although well off overnight highs, the pound is back to pre-Barnier headline levels at the start of trade in Asia. Traders tried but struggled to reapply the risk appetite that the FX market took off the table ahead of the weekend. With talks underway again, so are the multitude of Brexit headlines that continue to present the most challenging risk sentiment contours.

The Euro

EUR-USD had traded back near its recent highs, buoyed by the risk-on mood and content to ignore further COVID-19 containment measures in Europe. The single currency is echoing the global markets’ overall risk biases rather than any significant impact from the ECB meeting.

Traders might square up EURUSD shorts ahead of as no one would want to stay long US dollars just in case the FOMC delivers a dovish message, which would open the door quickly for further dollar weakness in Q1 where even the most ardent euro bears will likely concede

US Dollar

US monetary policy could steal much of the Brexit limelight this week as markets look for “forward guidance” around the Fed’s asset purchase program. And it seems that traders are trading the pre-FOMC meeting a bit cautiously as up until this point, the Feds have given no clear signal on whether they could extend asset purchases, making this potential outcome a 50:50 proposition. And traders hate those type of odds.

To a small degree, the dollar bears will need to keep an eye on the FOMC this week as the Fed speak started to sound a tad more hawkish from a low base (vaccine optimism, mention of taper even if to say it will not happen anytime soon), But the gnarly jobs data and the poor outlook for the employment sector where no one seems to have a solution should keep the Fed on the “lower for longer” course as far as the eye can see

The Australian Dollar

The AUD is trading a bit lower but not significantly worse for the wares. In China, and markets were in the headlines after concerns over official intervention in the market. The China Iron and Steel Association called on regulators to crack down on potential illegal activities amid fears the market has run ahead of fundamentals and is dominated by speculation. Thermal coal prices also slid after the National Development and Reform Commission moved to cap prices and approve increased imports. However, the approval for increased imports did not extend to Australia.

But I think the greater concern for commodity linkers is if we are incorrectly digesting the commodity upswing as a super cycle, rather than for what it might be worth, which might reflect supply chain disruption or, in oil’s case, OPEC interventions.

The Malaysian Ringgit

The ringgit has traded a touch weaker as the furious oil rally has temporarily run out of steam on the less bullish demand outlook for OPEC. While the reflationary news flow remains favorable (vaccine and fiscal), the surge in portfolio flows propelling Asian currencies since early November seems to be subsiding with some central banks on guard against high currency strength. Still, I think the catch-up plays in the MYR cleaner tactical plays to position for a sustained rise in oil prices in 2021.

Gold Markets

has veered on a defensive tilt caused by the US rollout of the Pfizer COVID-19 vaccine. The FDA and shipments’ final clearance had an immediate impact on gold, undercutting its safe-haven appeal and undermining the rest of the bullion complex in the process.

The gold market is subject to several brawny influences near-term, some of them offsetting. The impact of the vaccine rollout is gold bearish and may continue to be in the short-term. But it is also fair to say that a vaccine rollout in 2021 has been talked about for months so how long it will dominate gold is hard to say.

And as with the FX markets, US monetary policy may regain the limelight this week as markets look for “forward guidance” around the high wire asset purchase program. FOMC meetings could temper activity prior but might have a bullish impact on gold if the Fed over-delivers. The problem is the Feds have given no clear signal on whether they could extend asset purchases, making this potential outcome a 50:50 proposition. And traders hate those types of odds as it is a flip of the coin at this stage.

As we said last week, best to let the vaccine dust settle and then trade the dollar bounce. So far, the US dollar has been a non-reactive function, but it should ultimately kick in. On balance, I think gold may stay on the defensive pre-FOMC, but the downside is likely limited.

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