Asia Market: Powell says “not now”

Market highlights 

• Stock markets paused at all times highs as investors collect their breath
• Oil prices rise to a fresh ten-month high on US stimulus expectations
• USD is back at the centre of the attention, with Europe coming off the boil and China surging ahead.
• Forthcoming stimulus news should be a positive for gold

Markets

US stocks edged lower Thursday as investors awaited details of the incoming Biden administration's plans for a new coronavirus relief package.

After many dovish comments the chair of the Federal Reserve, Jerome Powell, finished on an optimistic note, saying there are many reasons to think the economy could recover and that it could be back to pre-virus economic peak reasonably soon.

Still, US equities were slightly weaker Thursday as investors continue to fret over rising US yields; US10Y yields reversed yesterday's losses, rising 5bps to 1.13%.

Why the cautious tone?

It's difficult to say with complete certainty, but investors might need a bit more convincing through multiple critical fronts as it’s never comfortable taking that next leap of faith, especially when we’re already within the grasp of some year-end targets on some stocks – and we’re only in the middle of January.

Investors may want reassurances that the trickle-down effect from the government stimulus efforts reaches the parts of the economy where it’s most obviously needed, such as the devastated service and hospitality sectors, and the bulk of the deluge doesn't get moped in speculative fervour and other unnecessary concerns. Main Street, not Wall Street, needs the majority to drive the full-throttle recovery.  

But perhaps the most simplistic of economic principles could apply to this situation. Given investors have priced in so much economic lift-off in 2H, they might need a little bit of convincing that those blue-sky expectations will come to fruition via a relatively seamless distribution of the vaccine. In the meantime, the dual policy puts monetary and fiscal policy backstops, making it challenging to shorten the market with any gusto.

And, of course, different parts of the world are moving at a different pace, leading to more rotation uncertainty. China leads the pack, the US is playing catch-up while Europe is still in lockdown mode and, worryingly, has fumbled the vaccine rollout efforts.

The sharp rise in US bond yields is a troubling topic of conversation but, for now, the impact has been felt more in the currency markets than in stocks. However, if US yields shift into a hyperbolic model and provide lift-off to the US dollar, risk markets will have something to consider – especially if the USD chokes off the reflation trade. 

So, stock markets are pausing at all times highs as investors collect their breath, maybe even hoping the market sheds a little bit of over-exuberance so they can buy in at cheaper level. 

The support from vaccine rollout, the dual policy puts via monetary and fiscal backstops and the likelihood of more fiscal stimulus paints a very compelling picture for the US economic recovery, hence earning growth this year which should pave the path equities to shift higher. 

Oil Markets

Oil prices rose to a fresh ten-month high on US stimulus expectations as consumers could spend a portion of their direct deposit on gasoline purchases. But it’s perhaps the infrastructure component of the US stimulus efforts that will resonate more with oil markets, given the current Covid-19 concerns that are pushing back on gasoline demand. 

With Saudi Arabia providing the cornerstone and bridging the gap to vaccine oil market lift, the renewed enthusiasm about the US demand situation – due to the prospects for more stimulus and the new administration's pledge to focus on the vaccinations' rollout – has oil prices lifting higher. 

We’re entering a critical phase as oil remains sensitive to the news, with negative implications for the demand recovery. How seamlessly the market shifts from OPEC’s rally cry, out of the stimulus bounce and into the vaccine distribution lift off-channel will be critical. Vaccine distribution will put more planes back in the air, which is the missing piece in the jigsaw puzzle and the key to drawing down on the omnipresent product side of the equation. 

The oil market recovery is vital for blunting the effect of higher nominal yields through the reflationary channel: if oil doesn't fly higher the reflation trade could fall flat on its face. 

Currency Markets

The US is back at the centre of the attention, with Europe coming off the boil and China surging ahead.

As expected, Fed chair Powell was careful to stay dovish, echoing the sombre tone struck by the Fed’s other essential voices who pushed back on any talk of taper just yet while sounding less prosaic about the US economy than the likes of Raphael Bostic. And while the street shows a lot of respect for the US stimulus's hyperinflationary impulses, Powell continued to emphasize the path ahead is far less from certain given the nature of the pandemic and the recovery. Hence, he continues to remind the street that even a minor policy shift from the Fed is unjustified at this moment.

However, I think the FX street has found a comfort level in the "Clarida Rule":

"We are not going to lift off until we get inflation at 2% for a year. We are trying to tie our hands. We are saying we are not going to hike until we get to 2%."

Though not an unalterable rule, it’s about as clear a statement as we’ve gotten so far on what AIT might mean, and a commitment that hasn't been seen from the Fed before.

EURUSD continues to trade on the softer side relative to G-5 peers. It's interesting to see the street apply some short US doll differentiation in the areas where the path is more stimulus-specific. Higher beta currencies perform better – notably CAD, which makes sense as it should benefit from exposure to a fiscal push in the US via cross border trade and engineering dynamics.

The lack of broad USD strength suggests you could make some argument that the short squeeze might be over and flows herein might be risk adding with the high growth betas leading the charge. After all, the USD can still underperform in the current environment, with twin deficits a key driver. 

Some long EURUSD positioning has washed out, and it seems the street is still in fade the Euro rally mode as political pressure and uncertainty about life after Chancellor Angela Merkel build. But for a material shift lower it will take two to tango, and USDCNH will need to go higher. Frankly, that doesn't appear to be in the tea leaves with mainland growth differentials leading the currency pack.

The Malaysian ringgit – as is the case with all oil sensitive currencies – should trade favourably on the infrastructure commodity boosting element of the US stimulus package, despite fears over the domestic growth outlook due to the resurgence of Covid-19. Also, China’s steady economic rebound resonates well for key regional trading patterns, where Malaysia does stand out. 

Gold Markets

US fiscal stimulus news out overnight should be a positive for gold, though the reaction late in the US session yesterday and in Asia today seemed to be negative at first.

Gold still seems to be trying to form a base around $1,840-1,820, while hovering at the 200dma. But I suspect investors will need to see a clear break above $1,867 again to commit to longs via the US stimulus package impulse. There’s been a fair amount of selling over the past two to three days as investors continue to fret over rising US yields. 

What I'm looking at today

I tend not to enter any new trades on a Friday unless cheapness is too tempting, but it's hard to find lemons at these lofty levels. 

Investor enthusiasm for risk assets is undiminished, underpinned by a New Year’s sense of confidence, renewed jubilation that the end of the Covid tunnel is in sight and the promise of brighter days ahead.