What is the alternative to the dollar?
That's one of the most-asked questions in the markets these days, with the US at the epicenter of the Covid crisis – following a string of days with record numbers of cases recorded – and states representing 40% of the population reversing the unlock and going back into crisis control measures.
But the alternatives are not apparent. The Yen is usually the go-to under such circumstances, but it seems to have decorrelated from all of its usual patterns. At the same time, gold is already highly bid and in danger of a correction lower.
The Euro comes to mind, given the proposed recovery plans. Still, even long Euro was a bit of a pain trade last week as Europe's banking system looks fragile and is a long way from having mutualized debt, let alone spending it.
The list of reasons not to rotate goes on, but sentiment to sell dollars is still colossal.
But with the enduring USD safe-haven appeal, there might not be sufficient conviction for any other G-10 currency to make a serious run higher. In Asia, FX is a bit of a different story however, as the CNH is starting to light up again due to the reflation trade underway in China (which I’ll touch upon below).
What about commodities?
The anomaly of the rising surge commodity prices – which for the most part have been driven higher despite shaky fundamentals – has China to thank.
At the nucleus of this inconsistency is the divergence in real-time growth rates between China and the US. As both rate and growth differentials widen the dollar tends to weaken, which underprops higher oil and commodity prices.
China targets both investment and economic growth recovery by leveraging the financial markets, whereas the US and the rest of the world are relying on government-support schemes. Private investment is a more direct and quicker way to recovery, hence China's outperformance. Re-leveraging investment regenerates growth rates, which fosters reflation. This reflation allows China to accept more financial risk and domestic conglomerates re-lever. It accelerates their recovery, driving further reflation and creating a virtuous circle of growth through the continuous feedback loop.
Traders have been piling into commodities that are perceived to be less exposed to the new outbreaks in the US. We could add Europe to the positive end of the discussion but, at the core, it’s China versus the US, which is encouraging traders to go long copper, silver and steel while remaining long gold.
In this environment, China – the world's largest retail buyer – outperforms the US on both the equity and recovery metrics, which is ideal for gold as Chinese consumers will buy more physical, providing even more conviction for my $2,000/oz target.
Oil traders do like the positive medium-term outlook, but to capture the upside risk from the weaker dollar and to hedge the short term weaker oil market fundaments created by the Covid-19 outbreak stateside, traders will go long Brent-WTI spread trade to gain exposure to a more robust economic recovery in Asia and Europe.
Last week’s AxiWeekender suggested that until the US passes the virus, China will be the canary in the mine, and indeed that’s proven to be the case.
Although news of positive results from vaccine trials provided an uptick of optimism Friday amid the most pessimistic market rally the world has ever known, it’s the constant drip-drip of bad news at the moment that goes beyond the current Covid-19 situation in the US.
Indeed, investors are probably less concerned about the virus because most have adopted a defensive skew, with mega-cap tech their key performers. So, while the virus spread in the US is a risk to the outlook, the extremely low positioning outside the mega-cap growth stocks gives investors some comfort to maintain those positions front facing gnarly Covid headlines. That’s not to make light of the issue as the market is clearly concerned about the uptick in Covid cases globally but, given the ample liquidity, backdrop money is finding its way into safer pockets of the market, which continues to support the indices.
But make no mistake, if a vaccine hits the market, it will be a crucial tool in putting an end to the pandemic. As such, markets will moonshot as I expect the world to face the most enormous wave of asset price inflation recorded in history. And once that vaccine is made readily available, it’s all systems go and the incomprehensibly-large global stimulus will find its way into every liquid asset imaginable.
Friday’s Covid-19 headline de-risking was compounded as the Chinese equity market's winning streak had ended with the CSI 300 closing down 1.8%, breaking a run of eight straight days of gains.
Large-cap shares were under pressure after two state-backed funds announced plans to cut some holdings, which were taken as a sign that the government wants to slow the pace of the rally. Also last week, the regulator published a list of 258 illegal margin financing platforms while also warning investors to avoid unauthorized platforms.
That spilled over into renewed weakness in European and US equities in early Europe trade and, frankly, without the vaccine headline no one expected risk to come back into the weekend.
It’s all about the EURUSD as the week's highlight is the EU summit on Friday, where leaders will gather to discuss the recovery fund. The EURO could move higher, given the baseline is that there’ll be a deal on the recovery fund at this meeting., but with the EURUSD only sitting perched at 1.1300 it remains a close call.
There’s much to be ironed out around the ratio of grants to loan to appease the so-called "frugal four" of the Netherlands., Austria, Sweden and Denmark, who are only showing support for loans, not grants. Their support for the fund will be necessary as it requires the unanimous approval of the member states.
In Asia it’s all about the Yuan. Although the RMB complex fell prey to USD safe-haven and equity market outflows Friday after mainland regulators tapped the breaks on the stock market rally, the CNH rally has more legs to run.
Despite the recent currency movement, the PBoC has maintained its relatively hands-off approach toward the market, not being overly fussed about the stronger Yuan. Although CNY has appreciated by 0.63% against the CFETS trade-weighted basket over the past week, the basket is still ~3% below this year's high (95.5). And the flow dynamics look equally supportive as there’s no reason for the offshore portfolio flow to reverse tide as China, through the state media, hung out the "we are open for business" sign.
Of course, the tail risk to this view is US-China relations fall prey to US election dynamics, but to a degree, with Biden up in the polls, this fear has been mitigated.
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