Markets Outlook: Readying for a stimulus downpour

Market highlights

• US NFP provided perfect confluence from a stock market perspective and justifies a full-throttle stimulus from both monetary and fiscal policy
• Reflationary assets set to continue their upside momentum
• USD hasn’t rolled over just yet; EUR as a funder; GBP looks attractive
• Another positive week for oil, but the priced-in optimism is worrying given the way sentiment may react to bumps in the road

The Week Ahead

After all the action last week, this week's economic calendar is comparatively sparse, with the main highlights being Wednesday morning's CPI release followed by Fed Chair Powell appearing at an Economics Club of New York virtual event at 2:00 PM EST. Powell will be discussing the labour market outlook, which will provide an opportunity to gauge the Chair's reaction to the latest data that showed a 0.4ppt drop in the U-3 unemployment rate to 6.3%. But to expect anything other than a dovish lavishing would be misplaced. 

But head and shoulders above anything else – especially with the Biden stimulus stock market Energizer bunny out of the hat – inoculation rollouts and the curve flattening will drive risk. And, optimistically on that front, the latest curve data suggests the virus might finally be retreating. While at this stage it's mostly a result of lockdown abatement, the vaccine immunity effect should kick into gear over the next few months. As the Covid-19 curve flattens further and encourages more reopenings, the gale-force stimulus tailwinds should rocket risk into the stratosphere.

Non-farm Payroll Look Through

Private payrolls barely rose in January but the workweek lengthened in goods and services, indicating a substantial labour demand rise. Indeed, this suggests the concentrated losses in leisure, totaling nearly 600k in the last two months, could reverse as Covid-19 cases continue to slow and vaccination progress allows for fewer mobility restrictions.
 
But from a political perspective, the US January employment report provided the perfect confluence from a stock market point of view. It will justify a full-throttle stimulus from both monetary and fiscal policy. For President Biden's agenda, payrolls could make a big difference as it augers the go big to go full steam ahead towards USD1.9 trn to moderate Democrats. I sense that, with reconciliation, he could get relatively close to that number. And expectations around the US fiscal spending plan seem to be on the rise; more observers think the Biden administration will get quite close to the $1.9 trn, rather than sacrifice to get it approved. 
 
The US Senate on Friday morning approved a budget, the latest step towards passing the aid plan through the reconciliation process, without any support from Republicans. 
 
The bill passed 51/50, with Vice President Kamala Harris casting her first tie-breaking vote just after 05:00 Eastern on Friday. The House must now approve the budget of Representatives, and after that, some 25 committees across both chambers start writing the legislative details of the plan. The goal seems to be to get something done by March 14, when the current unemployment extensions run out – but that’s pushing it.

Currency Markets

Freshly minted US dollar longs pared on the weaker-than-expected US Non-Farm Payroll and FX traders boarded other "jumpers" in the revolving carousel of whirligig reasons "to buy or not to buy" the US dollar.

Without boring you with those thematic reasons and after the fact rationalizations, the Euro, after falling to a low of 1.1960 on Friday as speculative bets grew as the topic of US exceptionalism, became increasingly fashionable only to close out the week attracted to the critical 1.2050 pivot level as fast money long US dollar bulls threw in the towel.

In the main, this is a consequence of the dollar being a fickle beast. Investors sometimes buy dollars during risk-on and risk-off, then sell in "risk-on". And it can flip between risk toggles week-to-week – and even does the same on a time zone basis. At the moment, based on Friday's close, it's unclear what the US dollar will do next week.

However, what appears a surer bet is reflationary assets continuing their upside momentum next week; with equities up and Brent oil nearing $60/b, even the beleaguered EURUSD was up for the first time in a week.

A combination of US stimulus, accelerating vaccine inoculation and the strength of corporate earnings rolling out record high in the S&P500 is providing the reflation support. Meanwhile, a concerted effort of FOMC members, led by Chair Powell, to put taper talk back in its box has meant real rates stayed low, even sidelined. The Fed policy of anchoring the front end of the curve circulates back into inflation: lower "real rates" for longer to drive the inflation outlook.

The Dollar has not rolled over just yet

With increasing focus on US economic outperformance due to fiscal spending and vaccine rollout, risk/equities have remained supported, as has the USD. Given the broadly short USD position the market held coming into 2021, there’s been a decent size reduction of interbank short US dollar risk as that flow is predicated on shorter-term duration strategies.

The IMM Commitment of Traders report (data as of February 2) also showed investors getting caught out by the dollar rebound. Overall, the USD shorts fell from 30% down to 27% of open interest, roughly the same level as the year's turn. Non-commercial EUR net selling to the tune of USD 4.5 bn equivalent, with long positions reduced and short positions, increased. Net long EUR positioning at 20% of open interest is the lowest since July. In JPY, both long and short positions increased such that net positioning stood nearly unchanged. Since the start of the year, open interest in FX has been on the rise.

The Euro as a funder

With Europe underperforming in developed markets, the Euro is increasingly viewed as a funder, prompting more EURUSD and EURCross downside – especially against the Pound.

There was a strong reaction in GBP to last week’s Bank of England meeting, though it's not very hard to explain. The negative rates buzz was always a misguided venture. The MPC finally made it clear that their internal discussions are effectively an administrative exercise with very little or no policy implications.

As long as there’s a reasonable prospect of reaching some post-pandemic recovery this year, I don't think any major central bank will look at further easing. Instead, there will be nudging communication on pushing back pressures to tighten rates without obviously letting the taper genie out of the bottle.

The Pound looks attractive

For the pound, the principal argument has been that the UK will come out of lockdown earlier than the EU. Real money is arguably still underinvested; there is scope for more positioning catchup via the stock market route. Maybe we get a bit of a pullback now on EURUSD and EURGBP, but unless the EU starts to do a lot better on Covid vaccinations, or the UK somehow stumbles, 0.85 EURGBP could come into view.

Oil Markets

Oil had another positive week. WTI traded either side of USD57 a barrel on Friday and closed the week up about 9% amid support from OPEC+, US fiscal stimulus within reach and a weaker dollar.

Spreads, as well as the outright, are showing continued strength. The WTI Dec21/Dec22 touched a high of USD3.42 earlier and the same spread in Brent hit a high of USD2.90. They ended the year at USD1.44 and USD0.96 respectively.

The weakness in gasoline gets reflected on the cracks, where the Mar21 is back to USD12.66.

Refiners at least have the option of switching to heating oil which has held to gains a lot better. Despite a considerable retreat from this week's high of USD15.84, this remains a viable option, currently at USD15.09.

With prices hitting chart-toppers I suspect we’ll start dancing to the tune of a different supply beat as we make haste to the early March official OPEC meeting where production increases, not production cuts, will likely be the day's topic.

Brent above $59/b is pricing in a level of optimism that worries me a bit – not because I’m concerned about oil fundamentals, but because of how sentiment might react to the inevitable bumps in the road as the market moves back into balance and production ramps up. According to the IMM Commitment of Traders, investors selling WTI crude strengthened for six weeks running, so I would expect oil future long de-risking and profit-taking to grow over the next few weeks considerably.