Watching US Yields

February 22, 2021 — Mitul Kotecha

Risk assets struggled to make headway last week, with technology stocks stumbling in particular.  Nonetheless, inflows into equities remain strong as more and more retail money is drawn in (perhaps signs of a near term peak).  Asian stocks started the week in positive mood despite last week’s nervousness, but equity investors will continue to keep one eye on the move in US yields.

US Treasuries continued to remain under pressure and the curve continued to bear steepen.  A combination of US fiscal stimulus hopes/expectations, vaccine progress and reduction in COVID cases, appear to be pressuring bonds. President Biden is likely to pass his $1.9 tn stimulus package in the weeks ahead, with a House vote likely this week, while the Fed continues to dampen down of any tapering talk, helping to push inflation expectations as reflected in break-evens, higher.  Indeed, this will likely be the message from a number of Fed speeches this week including Chair Powell testifying before Congress (Tue and Wed). 

Despite higher US nominal and real yields and visibly more nervous equities, the US dollar (USD) continues to struggle, failing to find a trigger to much covering of the massive short USD position still present.  We note that non-commercial FX futures positioning data (CFTC IMM) revealed only a limited reduction in aggregate USD short positions (as a % of open interest) in the latest week. Antipodean currencies led the way at the end of last week, but pound sterling (GBP) speculative positions have seen the biggest bounce over the last couple of weeks. 

Despite the USDs reluctance to rally lately, the short-term bias could shift to a firmer USD sooner rather than later, including against Asian emerging market currencies.  Indeed, several Asian currencies lost ground last week, with the Philippines peso (PHP) and Indonesian rupiah (IDR) leading the way lower.  The Asia USD index (ADXY) appears to have peaked and looks vulnerable to more short-term downside.

US economic data at the end of last week revealed that the flash estimates for the February purchasing managers indices (PMIs) stayed at fairly strong levels for both the manufacturing and services sectors.  Separately, US existing home sales posted stronger-than-expected numbers for January.

Attention this week will be on progress of passage on US fiscal stimulus as well as a number of central bank decisions beginning with China (today), New Zealand (Wed,) Hungary (Wed), and South Korea (Fri).  No policy changes from these central banks are likely.  Also of interest will be the UK’s announcement on exit plans from the current lockdown (today) and Germany’s Feb IFO survey, which is forecast to edge higher. 

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Reflation Trade Is Back

February 8, 2021 — Mitul Kotecha

A much softer than expected US January jobs report didn’t prevent US equities from closing higher at the end of last week as the reflation trade kicked back in.  One of the biggest driving forces for markets was the growing prospects that much of President Biden’s $1.9 trillion fiscal stimulus plan will be passed, albeit via a process of reconciliation, which allows Democrats to circumvent the need to gain the support of at least 10 republicans. This contrasts with prior expectations that the final stimulus was going to be less than $1 trillion. 

Pushing stimulus through this way highlights Biden’s urgency to inject more spending into the economy but could come at the cost of hurting bipartisan policy efforts. The impact of expectations of increased fiscal stimulus is particularly apparent in the US rates market, with US Treasuries selling off and bear steepening of the curve.  Although higher US Treasury yields failed to give support to the US dollar (USD) there is still scope for a short covering rally, which could still help give the USD relief.     

At the beginning of the year the US jobs market took a hit from renewed lockdowns and surge in COVID cases; US January non-farm payrolls increased 49k, and December was revised to -227k from -140k while more positively the unemployment rate fell to 6.3% from 6.7% though this was flattered by a drop in the participation rate as less people were looking for work.  According to the payrolls report there are still 9.9 million more unemployed compared to pre-COVID levels.  As such, the weak jobs data added more support to Biden’s fiscal stimulus proposals.   

This week focus will likely turn more to President Trump’s impeachment trial in the Senate than economic data.  Key data/events this week include China’s credit and monetary aggregates (9-15 Feb), central bank decisions in Sweden (Wed), Philippines, Mexico (Thu) and Russia (Fri).  Among these the consensus is for only Mexico to cut its policy rate. Also in focus are inflation readings in China (Wed), US (Wed) and India (Fri).  UK GDP (Fri) and US Michigan sentiment (Fri) will also garner attention. 

The return of the reflation trade, rally in risk assets and decline in cross-asset volatility bodes well for emerging markets (EM) assets.  However, there are definitely various cross currents impacting asset markets at present especially with US Treasury yields rising, which could potentially support the USD and pressure EM local bond rates markets.  EM assets were clearly favoured towards the end of last year, and while the positive story has not dissipated, EM assets may take a pause for breath before pushing higher again.  

In Asia, the Chinese-new-year holidays this week may dampen activity while China’s PBoC also appears to be limiting liquidity injections around the holidays, which could limit some of the gains in Chinese and impact China linked assets.  Chinese authorities have re-focussed attention on preventing an excessive build-up of leverage and credit metrics have peaked as a result.  As such, they may be less keen to inject a lot of liquidity into markets at present. 

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The Week Ahead

January 24, 2021 — Mitul Kotecha

This week the difficulty of trying to pass President Biden’s $1.8tn stimulus package through Congress is likely to become increasingly apparent.  Many Senate republicans are already balking at the price tag and contents, adding more weight to the view of an eventual passage of a sub $1tn package of measures (see my explanation of why Republican support is needed). One of the most contentious issues is likely to be a federally mandated $15 minimum wage. 

At least, the Senate won’t be juggling the impeachment of Donald Trump, at the same time as debating administration nominations and President Biden’s fiscal proposal, with the impeachment trial now scheduled for the week of February 8.

The contrast between US and European data at the end of last week was clear in the release of Markit purchasing managers indices (PMI) data.  US PMI’s registered strong flash readings for January, with both the manufacturing and services indices rising while in contrast the Eurozone composite PMI fell in January, sliding further into contraction.  A disappointing UK retail sales report highlighted the pressure on the UK high street too. 

The reality is that many developed economies are struggling into the new year, with a sharp increase in virus cases including new variants, slower than hoped for rollout of vaccines, and vaccine production shortages, all pointing to a later than expected recovery phase. 

This week, the Federal Reserve FOMC meeting (Wed) will garner most attention in markets. A few Fed officials mentioned tapering recently, clearly rattling markets, as memories of the 2013 “taper tantrum” came back to the surface.  After tamping down on any taper talk Fed Chair Powell is likely remain dovish even as he expresses some optimism on growth.  Growth in Q4 will have looked weak and US Q4 GDP (Thu) will be in focus, with most components likely to have slowed.  A plethora of earnings releases will continue this week including key releases from the likes of Microsoft, AMD, Tesla, Apple and Facebook. 

A dovish FOMC will do no favours for the US dollar (USD), which came under renewed pressure last week.  However, risk assets appear to be struggling a little and should risk appetite worsen it could boost the USD, especially given extreme short positioning in the currency. Emerging Market currencies will be particularly vulnerable if any rally in the USD is associated with higher US real yields. 

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Sell On Fact

January 19, 2021 — Mitul Kotecha

It was a case of buy on rumour, sell on fact at the end of last week, with US equities falling the most in over a week on Friday in the wake of the much anticipated but largely priced in announcement of President-elect Biden’s $1.9 trillion fiscal plan.  While the amount of stimulus is significant the reality is that it will be difficult to pass through Congress even though Democrats will have control of Congress and the Presidency. Something in the region of $1 trillion fiscal stimulus could end up being the price tag that is eventually passed in Congress given Republican opposition to some of the measures in the stimulus plan.  This would likely be followed by a possible $2trn+ plan for infrastrucutre/green spending.

Note that a 60-vote supermajority will be required to pass the fiscal legislation in the Senate, meaning that several Republicans will need to support the bill given the 50/50 Senate split.  Hence, a likely lower than $1.9trn eventual stimulus bill will be what is eventually passed. However, Democrats can pass the spending bill via “reconciliation”, but they would have to remove unrelated measures such as the proposed increase in the minimum wage, which they will unlikely want to do. 

Treasuries and the US dollar (USD) benefited from a worsening in risk sentiment at the end of last week.  USD positioning is at extremely low level, suggesting scope for some short covering. The VIX equity volatility index ticked higher and continues to remain well above its pre-COVID lows.  Given that many key equity gauges were in overbought territory according to their relative strength index (RSIs) some pullback/consolidation could be on the cards though the glut of global liquidity suggests that there is still plenty of money ready to buy on dips.  Yesterday US markets were closed due to the Martin Luther King Holiday, but Canadian and European stocks ended higher and futures point to gains today. 

US data isn’t helping sentiment, with yet more evidence that the economy was under pressure at the end of 2020.  Retail sales fell for a third consecutive month, the New York Empire manufacturing index fell for a fourth consecutive month in January. Lastly, University of Michigan consumer sentiment fell modestly early January.  Market direction today will likely come from the release of China’s December data dump as well as Q4 GDP.  In contrast to weakening US data Chinese data yesterday highlighted that solid recovery was sustained into year end, with GDP beating expectations, rising by 6.5% y/y in Q4 2020.  

The rest of this week is a heavy one for central bank decisions, with China, Malaysia, Canada (Wed), Indonesia, Eurozone, Turkey, South Africa, Brazil (Thu) and Japan (Fri) on tap.  In terms of policy action Malaysia is likely to cut, Turkey will likely tighten but the rest will likely be on hold.   The main event of the week is Joe Biden’s inauguration as 46th President of the US on Wednesday, and attendant risks of renewed unrest.  US Q4 earnings releases will also be in focus in the days ahead, with earnings releases ramping up over coming days.

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Markets Firm Despite Weak Data and Political Mayhem

January 10, 2021 — Mitul Kotecha

Following an eventful (to put it mildly) week in US politics, the main thrust for markets is that the prospects of another sizeable US fiscal stimulus package has increased as Democrats will now take the Senate following the Georgia run-off elections as well as the House and Presidency.  The Blue sweep effectively gives Democrats more potential to pass policies without the constraints of requiring Republican support in the Senate.  That said, the Senate may not be willing to pass significantly more progressive measures given that the seats will be 50/50 for Republicans and Democrats, with the deciding vote coming from VP-elect Harris.

The data/markets dichotomy was once again clear from the weakness in the US December payrolls data on Friday, which revealed a 140,000 drop (consensus +50, 000) as Covid restrictions severely impacted leisure and hospitality jobs.  If anything, this will just add to pressure for more fiscal stimulus. US markets don’t care about soft data or are at least looking past it, with key indices reaching record highs last week led by tech stocks. Stocks and risk assets overall registered a stellar first trading week of the year amid a glut of liquidity even as US Treasury yields pushed higher.  

The US dollar also finally strengthened, gaining some respite amid a market positioned short and despite very negative sentiment.  More gains are likely if the USDs positive relationship with US yields continues to re-establish itself, assuming US Treasury 10 year yields push higher amid further bear steepening as expectations of more fiscal stimulus grow. The same cannot be said for gold prices, which tanked 4% at the end of last week as gold’s negative correlation with US Treasury yields took effect.  Asian currencies and local currency bonds will likely also face headwinds in the near term as the USD consolidates further. 

Aside from steps in the US House towards impeaching President Trump for a second time and any measures announced by the US administration in its final days, markets will focus on US (Wed) and Chinese inflation (tomorrow) data this week.  Both releases are unlikely to provoke any concern about inflation pressures even as market inflation expectations push higher.  Australia (Nov) and US retail sales data (Dec) (both tomorrow) will give some colour on how the consumer is faring.  In this respect US data will likely disappoint.  Other key data and events this week include China trade data (Thu) and rate decisions in Poland (Wed) and Korea (Fri). Chinese trade data is likely to reveal another strong reading for both exports and imports while Poland and Korea policy rates are likely to remain unchanged.

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