Sell On Fact

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.

Fiscal Deadlock/China data

This week kicked off with a heavy China’s Sep data slate and Q3 GDP today.  The data releases were positive, revealing yet more signs of strengthening recovery. Industrial production, retail sales, jobs and property investment all beat expectations while Q3 GDP fell short. The data supports the view that China will be one of the only major economies to record positive growth this year. This bodes well for China’s markets and will likely also filter into improving prospects for the rest of Asia.

In contrast US recovery continues to be at risk, with fiscal stimulus discussions remaining deadlocked; a 75-minute conversation between House Speaker Pelosi and Treasury Secretary Mnuchin yielded no progress at the end of last week.  Pelosi has now given a 48-hour deadline to agree on stimulus while Senate majority leader McConnell has scheduled a Senate vote on a more targeted $500bn bill tomorrow. Talks are scheduled to continue today but there still seems to be little chance of a deal this side of elections. 

On the data front, US Sep retail sales data registered broad-based gains on Friday, with headline sales up 1.9% m/m (consensus 0.8%). In contrast, industrial production fell a sharp 0.6% m/m in Sep (consensus +0.5%).  Lastly, Michigan consumer sentiment rose in the preliminary Oct report to 81.2 from 80.4 in Sep (consensus 80.5).  The lack of a fiscal deal means that the prospects of a loss of momentum in the US economy has grown, something that will become more apparent in the weeks ahead. US data is limited this week and instead focus will remain on progress or lack thereof, on fiscal stimulus as well as the Presidential debate towards the end of the week. 

Another saga that is showing little progress is EU/UK Brexit transition talks.  The stakes have risen, with UK PM Johnson warning UK businesses to prepare for a hard exit while threatening to abandon talks completely.  On a more positive note UK officials are reportedly prepared to rewrite the contentious Internal Market Bill, which may appease the EU.  Credit ratings agencies are running out patience however, with Moody’s downgrading the UK ratings by one notch to Aa3. The pound seems to be taking all of this in it stride, clinging to the 1.30 level against the US dollar, suggesting that FX markets are not yet panicking about the prospects of a no deal transition.

Several emerging markets central banks are in focus this week including in China (Tue), Hungary (Tue), Turkey (Thu), and Russia (Fri).  Of these Turkey is expected to hike by 150 basis points, but the rest are likely to stand pat.  Most central banks are taking a wait and see approach, especially ahead of US elections. Reserve Bank of Australia meeting minutes tomorrow will garner attention too, with clues sought on a potential rate cut next month.  

US dollar soft ahead of retail sales

The USD has lost a fair bit of ground in February failing to benefit from a renewed rise in US Treasury yields. A more positive risk environment recently has undermined some of the demand for USDs while some negative data surprises such as the ISM manufacturing survey and non farm payrolls have also weighed on demand for the USD.

The release of January retail sales data today will give another opportunity to gauge the path of consumption at the turn of the year but unfortunately for the USD a relatively flat outcome for sales will provide little rationale to buy the currency. The consensus expectation is for headline retail sales to post a 0% monthly reading, while sales ex autis is likely to rise by a measly 0.1%.

In the near term this implies little potential for a USD rebound but over but over coming weeks I expect the USD to rally in line with higher US yields. USD index (DXY) is likely to flatline around the 80 level in the coming sessions before rallying over coming weeks.

Risk rally losing steam

The rally in risk assets is losing its momentum, with US stock markets failing to extend gains following a four day rally while US Treasury yields continued their ascent in the wake of Fed Chairman Yellen’s testimony highlighting no deviation from tapering. Her testimony to the Senate will be delayed today while US data in the form of retail sales is likely to register a soft outcome. Sentiment was boosted overnight by strong Chinese trade data in January and the approval by the US Congress allowing a suspension of the debt limit, a far cry from the major saga that took place last time the debt ceiling was about to be breached.

Additionally Eurozone markets will find some support from comments by European Central Bank board member Coeure who noted that the central banks is “very seriously” considering negative deposit rates. His view may be supported by the release of the ECB monthly bulletin today and Survey of Professional Forecasters (SPF). Coeure’s comments undermined the EUR however, while in contrast sharp upward revisions to growth forecasts by the Bank of England in its Quarterly Inflation Report boosted GBP. Suffice to say, EUR/GBP dropped like a stone and looks set to remain under downward pressure.

Risk appetite firms

More encouraging news in the US in the form of a bigger than forecast increase in September retail sales and stronger than expected earnings from Citigroup Inc. helped to boost equity markets and risk assets in general. The US data follows on from recent positive consumer confidence and housing data.

Meanwhile, the VIX ‘fear gauge’ dropped while the Baltic Dry Index continued its ascent. The latter is particularly encouraging in terms of its positive implications for global growth. This is corroborated by my own risk barometer which continues to move lower. In contrast, commodity prices dropped, with gold prices losing more ground as better US data acts to dampen expectations of the magnitude of Fed QE that will need to be carried out.

I expect the constructive risk tone to be maintained with data releases both in the US (industrial production) and Europe (German ZEW investor confidence) to be supportive of risk assets. A reports in the FT today that Spain is verging on requesting a bailout will also come as welcome news for markets although there has yet to be confirmation of such a request.

Despite the better market tone I do not see major breaks out of recent ranges, with attention on the 84 S&P 500 companies set to release earnings this week and developments at the upcoming EU Council meeting. Hesitation ahead of a slate of Chinese data tomorrow will also cap market movements today.

Firmer risk appetite is usually negative for the USD but it is notable that my risk barometer has had a positive and significant correlation with the USD over recent months. In other words, lower risk aversion has actually been associated with a firmer USD. I see the USD remaining supported especially if expectations of the magnitude of Fed QE are pared back although the USD will likely lose some momentum given growing hopes of an imminent Spanish bailout request.

Asian currencies look relatively firm against the backdrop noted above. The most sensitive Asian currency to risk is the KRW and notably USD/KRW has finally broken below 1110, which opens the door for a test of 1100. TWD, THB, MYR and INR are also major Asian FX beneficiaries in an environment of better risk appetite. I expect Asian currencies to continue to trade with a firmer tone in the short term helped by strengthening capital inflows. Firmer Chinese CNY fixings are also aiding Asian currencies.

%d bloggers like this: