The Main Event
The overly coordinated FED rhetoric will stop as FOMC members enter black-out mode ahead of the Jan. 27 . Which means the US data will need to do the talking instead. It will be interesting to see the reaction of the to any surprises. If the 2020 dominance of risk-off risk on remains, upside surprises should weaken the USD. If tapering considerations are dominant, the opposite reaction will prevail.
The week ahead is a busy one on the calendar for markets, as the administration takes office in the US this Wednesday. I think this will be the main event as he has tabled some ambitious plans. And we now have a benchmark to gauge how successfully the vaccine rollout will be as he has already announced a target of 100m vaccinations in his first 100 days in office,
The Smoking Gun
There isn’t a single smoking gun which caused the risk-off move in financial markets on Friday.
Still, contributors could be the fact every time the Taper Genie comes out of the bottle risk market always pause. That’s just the way things are hence. Fixed income markets have probably generated more excitement in the first two weeks of 2021 than they did in the whole of Q4 2020.
President-elect Joe Biden mentioned that everyone would pay their fair share for the stimulus package, bringing the focus back onto taxes when the market has been pretty comfortable assuming they won’t come until late 2021 or early 2022. So tin hats are at the ready
were weak. While weak data in December shouldn’t necessarily come as a surprise given the COVID spike, the market before rallied on vulnerable non-farm payroll prints as it implied potentially larger fiscal stimulus—now the starting details around fiscal are known, that no longer applies.
But the easy culprit to point out would merely be positioning in consensus reflationary and global reopen trades heading into this year (which I put a spin on below).
President-elect Joe Biden’s policy is highly relevant for the Fed and means that the ‘no taper in 2021’ view is unrealistic. Yes, three speakers this week—Clarida, Brainard and Powell—have pushed back vigorously, suggesting QE will not change for quite some time. However, this was in the context of no additional fiscal stimulus. If Biden launches, say, $1.5 trn in March, then the Fed forecasts will change, and a taper will come into view for June or September at the latest.
How quickly the term “risk reversal” enters the market lexicon might provide a good panic gauge. And while the technical terms like “overbought” and “oversold” get bandied around, alone these conditions are seldom a catalyst for triggering long-lasting reversals. However, when conditions are at extremes levels, they increase that risk if we get an unexpected economic shock or central bank policy pivot.
And while fear vs greed indexes are well off the extremes of January 2020, market positioning is very stretched, underpinned by a renewed sense of jubilation about the prospects for the US economy later in the year due to vaccine euphoria and the dual policy puts of monetary and fiscal backstops.
Perhaps I’m over-cautious, but nothing could be further from the truth as I think another risk on frenzy is coming by mid-year as a combination of mass vaccination and a return to some normality will synchronise with continued fiscal and monetary support.
Still, we could be entering a very vulnerable situation where 2020 gains have been substantial. However, current prices don’t match the level of market enthusiasm. And that disconnect could lead to disappointment even more so now with the market struggling to come to terms with a 2021 Fed taper even though rate hikes are likely years off.
In the meantime, the old foes of secular stagnation and structurally weak growth could come to the fore as the challenging winter month coalesce with new and extended lockdown that push back on the reflation trade.
Since March, there was three evenly-split investor types.
- The Brave of Heart who bought into the once-in-a-lifetime trade between March and May (SPX 2200-3000) via high tech flyers
- The Nervous Nellies were not strongly positioned fearing further COVID waves and
- The Johnny-come-lately where the turn of the year provided a convenient opportunity to switch narrative, and that caution has become sheer exuberance. Hence, two-thirds of investors hit the first Monday of 2021 under-positioned and forced to play catch-up. So those new entrant or “weak hands” are most at risk under my base case scenarios.
Risk appetite can stay at elevated levels for prolonged periods as long as the macro backdrop remains supportive. But when you reach lofty levels and extreme length of positioning, you need to ask your self what it takes for stocks to move higher. With expectations for 2H economic repricing hitting the stratosphere, Investors will need at least a glimmer of hope that at a minimum we are heading in the right direction.
In terms of the , keep an eye on the 3652.5 area in minis, where they were before the Georgia senate elections on Jan. 5.
Sentiment cooled in markets on Friday as the usual suspects provided the toxic combination of COVID in China and safe-haven demand for the caught oil traders too far over their skis.
But to rub salts in the wounds, the US economic data was even worse than expected.
Still, OPEC supply discipline is the linchpin to push prices eventually higher.
But it’s just not COVID.
Assume we rule out the tail risk such as vaccine not working against the new viral variants inhibiting herd immunity and leaving aside COVID uncertainty in China. The wild cards for oil this year are upside to Iranian production (dependent on the potential lifting of US sanctions under incoming President Biden) and the supply response from US producers in a more constructive macro environment.
Dollar up yields down days tend to be 24-48-hour periods (in this cycle) where risk aversion dominates. And it’s not a good currency signal unless investors start heading for the equity market door.
Last week was mainly characterised by a sudden shift in sentiment—even though it might be too early to say if this is permanent or temporary.
Long the single currency was a consensus view for much of 2020. Still, a few factors have emerged this week that, as a whole rather than individually, have put pressure on EUR and prompted some investors to reconsider. Political tension is back in Italy. There are concerns about a slow vaccine rollout in Europe. Some ECB comments on the currency as input in inflation-related considerations were all factors that weighed on the EUR, exacerbated by rising optimism around the US fiscal stimulus effect on US yields.
Treasury yields are far to low. A yield of 1.50% on the US should quite easily be possible and shouldn’t be a big problem for equities. The policy mix for stock markets remains exceptionally supportive as the Fed will continue to be highly accommodating even after tapering QE and unlikely to hike until 2022.
The one asset that’s least clear is the dollar. Longer-term, I think the US policy mix and the humungous deficit will undermine the currency hence I think EUR/USD should remain in a range of say 1.18-1.28
Still, over shorter-term, the US economy will outperform Europe as the global growth “de-synchronisation” again sets in only this time in the US dollar favour as the “Biden stimulus” and US reopening get repriced where 1.18 looks possible.
Commodity reflation trades still look attractive. Since November, I have been highlighting the long view on soaring oil prices but added to complement the idea as the EUR becomes a preferred funder Q1. But that too is wilting a touch due to the reinsurance of COVID in China which pressure oil prices lower at the end of the week.
On a combination of higher US yields and some macroprudential measure by the PboC stifling the lofty ambitions, USDAsia downward trend seems to have paused for the moment and yet what is notable is the absence of new topside interest in the vol space, which suggest local traders are willing to wait out the taper storm even staring to some decent sized profit-taking last week.
falls on firmer USD; shrugs off a dip in yields and positive monetary and political climate; but an old gold foe, the USD helps to weaken gold. The US Dollar Index (DXY) closed at 90.77, the highest since Dec. 21 (with gold closing at 1,876/oz that day.
US bond yields getting repriced higher will limit gold rise over the short term, so the street has already morphed into a seller on rallies due to
Barring the Fed easing into the recovery, it’s now unlikely gold will exceed 2020 highs. And with growth returning to trend as vaccines get rolled out, policy expectation will increase, and gold could now close out the year between $1650 and $1750 assuming herd immunity is attainable.