Two Speed Recovery

The spread of the COVID Delta variant globally holds key risks for markets in the weeks ahead.  However, as long as hospitalisation rates remain relatively low, it should be less detrimental to the path of re-opening in countries with higher vaccination rates.  As a stark example, the UK will shed almost all of its COVID restrictions today despite spiking COVID cases amid relatively low hospitalisation rates.  

This is particularly difficult for many emerging markets including much of Asia given low vaccination rates.  As such, a two-speed recovery between developed and emerging economies is occurring, with the former registering much higher vaccination rates compared to the latter.  Unlike the move to re-open in developed markets, re-opening in many emerging markets is far more difficult given sharply increasing hospitalisation rates among unvaccinated people as the Delta variant runs rampant. 

As such, the risks of renewed restrictions in many countries could put the global recovery process in jeopardy at a time when we are already past peak growth.  Maybe this is helping to dampen US bond yields or yields are being supressed by the fact that the market has a lot of faith in the Fed even as inflation has surprised on the upside in many countries.  Whatever the cause, US 10y bond yields have slipped below 1.3% back to levels not seen since mid-February and continue to edge lower.    

Event highlights this week include several central bank policy decisions including in China (Tue), Eurozone, Indonesia, South Africa (all Wed) and Russia (Fri).  No changes are expected for China’s Loan Prime Rate (LPR) though the risk of easing has increased marginally following the People’s Bank of China (PBoC) reserve requirements (RRR) cut last week. The Central Bank of Russia (CBR) is expected to hike by 75bp, with risks of a bigger move.  Bank Indonesia is likely to remain on hold despite growing economic pressure.  South Africa’s Reserve Bank (SARB) is expected to remain on hold and remain dovish while a change in forward guidance from the European Central Bank (ECB) is expected this week. 

Oil will be in focus today after OPEC+ agreed on a deal to expand output, with the UAE and Saudi Arabia putting away differences to agree upon a 400k barrels a day increase in output from August.  The US dollar (USD) is trading firmer, but overall looks like it is close to topping out.  For example, EURUSD looks oversold relative to real rate differentials.  Interest rates markets will eye US fiscal developments, with Democrats crafting the budget resolution needed for a reconciliation bill, which may see additional progress this week.

US Jobs Report Provides Comfort For Markets

The US June jobs report released on Friday provided plenty of comfort for US equity markets. Non-farm payrolls rose by an above consensus 850,000 while the unemployment rate ticked higher to 5.9% from 5.8%.  The strong increase in payrolls helped US equities close out another week in positive mood; S&P 500 rose 0.75% and the Nasdaq gained 0.81% as investors continued to pile back into growth stocks. US Treasury bonds were supported, helped by an increase in the unemployment rate, while the US dollar fell.

Despite the jobs gain, payrolls are still around 6.8 million lower than pre-Covid levels, suggesting a long way to go for a full recovery. Federal Reserve officials will likely need to see several more months of jobs market improvement to achieve their “substantial further progress” tapering criterion.  Overall, the data played into the Fed’s narrative that tapering is still some way off and higher US interest rates even further away, leaving little for markets to fret about.

OPEC+ tensions between Saudi Arabia and UAE have increased, delaying OPEC+ talks to today against the background of oil prices pushing higher above $75 per barrel.  Riyadh along with other OPEC+ members appear keen to increase production over coming months while the UAE supports a short term increase, rather than the end of 2022 which other OPEC members are looking for.

Markets activity is likely to be subdued at the start of the due to the US holiday and there seems to be little to break out of the low volatility environment that we are currently in the midst off, though the US dollar will look to extend recent gains against the background of persistent short market positioning as reflected in the CFTC IMM data.  

This week attention will turn to the Federal Reserve FOMC Minutes of its last meeting (Wed), ISM non-manufacturing survey (Tue), and central bank policy meetings in Australia (Tue) and Poland (Thu) alongside Chinese June inflation (Fri) and credit aggregates data (from Fri). 

Given the sharp market reaction following the less dovish Fed FOMC meeting, markets will look for any further elaboration on the potential timeline for tapering in the Fed Minutes.  While both the RBA in Australia and NBP in Poland are likely to stay on hold, the RBA is likely to strike a dovish tone in its statement and Q&A while the NBP is likely to announce a new set of economic projections.  No shocks are expected from China’s June CPI inflation reading, though producer price inflation, PPI is likely to remain elevated.

Growth/Risk Asset Rally Dichotomy To Continue

Happy New Year!  2020 ended with record highs for US stock markets, capping off a solid year for risk assets amid massive and ongoing central bank liquidity injections.  In contrast the dollar index (DXY) ended the year languishing around its lowest levels since April 2018.  The dichotomy between the sharp deterioration in global growth and risk asset performance has widened dramatically.  Given the acceleration in COVID-19 cases over recent weeks and consequent lockdowns, especially in the US and Europe, this divergence is likely to be sustained and even widen further over the next few months, at least until various vaccines finally manage to stem the damage.

Two of the biggest stumbling blocks for markets over recent weeks/months have been US fiscal stimulus and Brexit.  Both have now passed with last minute deals, setting the scene for a clearer path in the weeks ahead though political obstacles have not disappeared by any means, with the Georgia Senate run-off elections scheduled for Tuesday.  The outcome will be crucial for control of the US Senate with Democrats needing wins in both races to take over. However, the races are too close to call according to polls. Separately the US Congress will meet on Wednesday to declare the winner of the Presidential election. 

On the data and events front the week begins with an OPEC+ meeting tomorrow, with officials deliberating on whether to expand output by up to 500k barrels.  There are also a series of December Markit manufacturing purchasing managers indices (PMI) tomorrow including in various countries in Asia as well as the release of the Caixin manufacturing PMI in China.  US data will take centre stage with the release of the ISM manufacturing survey (Tuesday), Federal Reserve FOMC minutes (Wednesday) and non-farm payrolls (Friday).  Overall, markets are likely to begin the year much as the same way they left 2020, with risk appetite remaining firm. 

One interesting observation as we kick off 2021 is that so many investor and analysts’ views are aligned in the same direction (long Emerging markets, short USD, long value stocks, etc), and positioning is already looking stretched in various asset classes as a result.  While I would caution against catching a falling knife there is a clearly a risk of jumping on the same bandwagon as everybody else in a market that is increasingly positioned in one direction.  Overall, while the risk rally is likely to continue to have legs in the months ahead, investors should be on their toes in the weeks ahead given risks of a positioning squeeze in various asset classes.

A Stellar Month

November has turned into a stellar month for risk assets, with major equity benchmarks globally, especially those that are dominated by value/cyclical stocks, performing particularly well.  Investors have been willing to bypass the escalation in Covid infections in the US and Europe and instead focus on the upside potential presented by new vaccines and a new US administration, with a line up including former Federal Reserve Chair Yellen, that is likely to be more trade friendly.  Ultra-low rates and likely even more moves in a dovish direction from the Fed as well as plenty of central bank liquidity continue to support risk assets.  While challenges lie ahead (weakening growth, Covid intensification, lack of fiscal stimulus, withdrawal of Fed emergency measures) as well as technical barriers to further short-term gains, the medium-term outlook has become rosier.   

China’s economy has led the recovery and provided plenty of support to Asian markets, commodity prices and currencies. This week’s data and events kicks off with China’s official manufacturing purchasing managers index (PMI) (consensus. 51.5) (Mon) which is likely to remain in expansion, providing further support for China linked economies and assets.  However, the impact on oil will also depend on the OPEC+ meeting (Mon and Tue). Despite the sharp 30% rally in oil prices over the month further output increases are likely to be delayed as producers look to solidify gains. That said, a lot of good news appears to have been priced into the oil market already.  In contrast, the US dollar has been a casualty of the improvement in risk appetite and has shown little sign over reversing its losses. Subdued over recent days by year end selling, the USD may show more signs of life this week. 

The other key event this week is the Nov US jobs report (Fri) where a slowing pace of job gains is likely (consensus 500,000, last 638,000), with new COVID restrictions taking a toll on employment. US Nov ISM surveys are also likely to soften (Tue & Thu), albeit remaining firmly in expansion.  In Canada, the federal fiscal update (Mon), Q3 GDP (Tue) and jobs data (Fri) will be in focus.  Australia also releases its Q3 GDP report (Wed) while In Europe the flash Nov HICP inflation reading will garner attention but most attention will be on ongoing Brexit discussions, which seem to be stuck on remaining issues such as fishing rights. Central bank policy decisions in Australia (Tue), Poland (Wed) and India (Fri) are likely to prove uneventful, with no policy changes likely. 

Look Past The Data At Your Peril

Markets have been willing to look past weak economic data despite the spate of dire economic releases recently, even as economic forecasts have been not been revised as aggressively lower as they should have been.  Reality may come back to bite. It is one thing to look past the data, but a reality check may lie beyond.

Economic forecasts continue to come in below expectations in the US; the Citi US Economic Surprise Index (a measure of data releases relative to consensus expectations) fell to a record low last week.  Among the key releases last week was US weekly jobless claims, which revealed another 5.245 million Americans filing first time claims for unemployment insurance. The total has now reached over 22 million, highlighting that the US jobless rate could reach above 15%.

Weak data has had little bearing on equity markets, which continue to rally on signs of virus curve flattening, expectations of economic re-opening, stimulus measures and vaccine hopes.  For instance the S&P 500 is now almost 30% above the lows set on March 23 having rallied strongly over recent weeks. This week attention will turn to Q1 corporate earnings though the signals will be more difficult to discern as increasingly companies are withdrawing forward guidance and ranges for earnings expectations look very wide.  Against this background earnings outliers are likely to provoke a bigger response.  Key earnings this week include IBM, P&G, Netflix, Snapp, ATT, Delta, and Intel.

Sentiment will also be directed by moves to open up economies.  However, this is likely to be a very drawn out process, suggesting scope for disappointment. For example, in Harbin, China, a new cluster has recently forced the authorities to reverse opening up measures. In the US there has been growing demonstrations against lockdown measures. Some states are about to ease restrictions, but they only account for a small proportion of GDP.  While there is a growing push to open up economies to avoid further economic pain, to do so prematurely, would threaten to inflict a new wave of infections.

Meanwhile oil is continuing to garner plenty of attention and unlike stocks, maybe more reflective of the economic pain ahead, with prices continuing to slide, and near term prices for West Texas Intermediate (WTI) trading at major discounts to later contracts. Fears that storage facilities in the US will run out of capacity are keeping the pressure on near term prices despite the OPEC+ deal to cut 9.7mn barrels a day of output.  Demand fears are adding to the downdraft on prices, with China’s Q1 GDP data, which revealed that growth fell by 6.8% y/y, highlighting the intensifying demand pressures on crude.

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