Asia Open: Fed policy uncertainty clouding the viewfinder

Markets

US equities were stronger Friday, the S&P up 0.3% with positive data surprises helping sentiment. Not so in Europe though, with equities ending lower after weaker than expected PMIs for August. US10Y yields fell 2bps to 0.63%, oil was down and gold up slightly into the close.

Most investors like to peer into the crystal ball and look well ahead while anticipating high percentage outcomes and speculating on new trends are patient to ride the pandemic winners. At the same time, zero interest rates offer them the luxury to wait for the rest of the pack to play catch up over the coming months and years. 

Not only is this a market that doesn’t want to fight the direction of future monetary policy, but investors have no interest in betting against technological ingenuity nor the expanding role that medical health sciences will play in our future – hence a likely reason why the S&P 500 continues to make new highs. It’s a brave new world and technology and healthcare optimism remain supreme as investors have little interest in shorting the hereafter.

Although there wasn’t much market reaction Friday, the US administration signaled US firms could use the WeChat platform in China; that was a bit surprising given there was uncertainty around whether companies like Apple could offer WeChat to local customers in China. The downside would have been a significant risk to AAPL if Chinese customers no longer purchased iPhones because they wouldn’t have WeChat, but this seems to say they can. And it continues to frame US-China tensions as politically/election motivated, but perhaps not to the extreme. 

Jackson Hole Symposium 

While this week's data docket will provide an initial read on Q3 economic activity, the Kansas City Fed's Jackson Hole Symposium will be the critical focus for Fed watchers, particularly with Chair Powell headlining the event with a speech on Thursday morning. 

This year's symposium titled "Navigating the Decade Ahead: Implication for Monetary Policy" could provide the perfect platform to outline topics of discussion from the Fed's ongoing policy framework review, so all eyes and ears will be trained on Chair Powell's speech  

While the policy review results may be released along with Powell's appearance, it’s more likely the results will be released at the September FOMC, which should codify the view of the Fed's pivot to a soft average inflation target. With inflation running persistently below target in recent years, this shift will reinforce Powell's dovish message that the Fed is "not even thinking about" raising rates. But this is not likely to surprise anyone, with investors already convinced central banks would stay with "lower for longer" on interest rates.

The Fed minutes were quite clear on inflation – it’s expected to stay low as the pandemic demand shock will outweigh any supply chain disruption in terms of price effects. 

Asia Oil: OPEC+ quota catch-up adjustment effects, Libya cease-fire, and Fed policy uncertainty are clouding the viewfinder

WTI has opened up higher following the general risk mood after the FDA authorized the use of blood plasma from Covid-19 survivors to treat sick patients; there’s some thought this could improve the therapeutics regime and help with survival rates.

Oil prices struggled Friday on weaker than expected PMIs in Australia, Japan and Eurozone had tempered risk appetite, which looked set to finish the week on the front foot after Pfizer confirmed that its Covid-19 vaccine remains on track for a regulatory review in October.

Not only has the uptick in Covid-19 case counts globally caused oil traders to look over their shoulder, it has the same effect on purchasing managers around the globe.

However, the US PMI data was better than expected and provided a modicum of comfort to the global recovery, but it wasn’t enough to completely lift the oil market gloom as North American traders are concerned that the improving case count trends in the US may not continue through school reopening and into autumn months as social activities move indoors.

Also clouding the view is that wandering eyes and intense scrutiny is now shifting to the potential effect of OPEC+ quota catch-up adjustment effects through August/September, where laggard compensation is even more critical as Libya looks set to unleash more barrels. 

A new cease-fire agreement in Libya suggests the nation will be able to resume exports once the military blockade is lifted and will likely release more barrels on the market at a critical juncture when the OPEC +alliance is easing production curbs. 

Even uncertainty over Fed policy, which has strengthened the US dollar and less optimistically for oil prices, is also clouding the viewfinder. 

With the markets moving into a soft contango and the front-month struggling to break out topside – even as broader risk market stabilize – traders have been reducing extended long position risk waiting for more precise signals on the OPEC catch up adjustment effects; the market hasn't turned bearish, it‘s just not as bullish.

In the meantime, storms Marco and Laura are moving towards the Gulf Coast, where they could make landfall as hurricanes as early as Monday, prompting the evacuation of offshore rigs and seeing the Panhandle residents hunkering down for another hurricane season.

Currency Markets 

With the market caught short USD and the FOMC minutes signaling that YCC is off the table, barring a significant economic downturn, the USD found support. 

Weaker than expected PMIs in Australia, Japan and the Eurozone had tempered risk appetite, which looked set to finish the week on the front foot after Pfizer confirmed that its Covid-19 vaccine remains on track for a regulatory review in October.  

The vaccine is potentially a potent game-changer if it allows the global economy to return to business as usual.

EUR-USD dropped through 1.1800 on disappointing PMI data raises questions about whether the "bird's wing" recovery is broken. And with the US Market PMIs for August beating expectations, it will provide some relief in terms of the global recovery. But it also suggests a more balanced growth outlook from the US vs. EU differential perspective as we approach September.

The EU PMI weakness comes alongside worrying virus case counts. The fall in momentum is particularly troubling as autumn and winter weather will force social activity indoors with higher infection risks. At this stage of the game, the consensus remains to add to longs at better levels, suggesting the downside is limited.

Gold Markets 

Risk around The Jackson Hole Symposium has seen gold investors with relatively short horizons scaling down positions. And a vaccine breakthrough could be a potential game-changer if it allows the global economy to return to business as usual.

The gold investment case remains robust, but unusual holders and competition from multiple financial products will ensure higher volatility.

Sticky demand between $1,875-1,925 remains alive and well – even more so heading into the weekend as bonds turned bid (yields lower) after USTs regained some of their economic betas after selling off the week before to make accommodation for an increase of supply going into the auction.  

If there’s ever something of a known in economics, it’s that the Fed funds rate will be low for an exceptionally long time. That’s not to mention the Fed has made it exceedingly clear that it will continue its current easy policy well into the recovery. In short: the Fed is not leaving the party anytime soon as the markets further bifurcate the economy into haves and have nots.

Because Fed funds rates will be hugging 0% for as far as the eye can see, 2-5 year yields will remain depressed so we should expect real rates to remain negative for several years and will likely shift profoundly negative as the global economy moves on a steady upward path out of the coronavirus recession. That’s not only the standard recipe for dollar weakness, but for gold higher.  

Gold's phoenix will rise again, but the yellow metal will need some help for higher inflation breakevens or renewed US dollar pressure.

Gold and the dollar could consolidate within current ranges this week if no explosive headlines cloud the short-term horizon. 

Over the next few weeks, the recent consolidation between EURUSD 1.1750-1.1950 may continue due to uncertainty around Covid-19 management, the Fed policy outlook, and US politics. 

US Covid-19 case counts have steadily improved, primarily reflecting the easing of outbreaks in the Sun Belt. Still, case growth has picked up elsewhere, including continental Europe and parts of Australasia. The better US trends may not continue through school reopening and into autumn months as social activities move indoors, but the drop in the US curve could reduce pessimism around domestic growth over the short-term. 

TIPS yields have started to move sideways as markets have debated the Fed policy outlook, hence the reason why gold has been held in check post FOMC. This week's annual Jackson Hole conference could be a tradable event as the market will remain sensitive to any questioning of Fed support for the Treasury market. 

The Republication National Convention starts this week and could be USD supportive if Trump narrows his deficit in the polls as the view that a Biden administration would raise US corporate tax rates has likely weighed on the greenback – or even if President Trump makes significant new announcements on US policy toward China. 

So, short term traders who speculate on relatively short horizons have been scaling down USD shorts until these event horizons pass.

The pursuit of inflation: the standard recipe for dollar weakness and gold higher?

The FOMC minutes did not reveal any rush to move on YCC and forward guidance, but the consensus is that we’ll see movement in September, at least on inflation targets. 

The US curve steepened initially but has since re-flattened in line with the TY bounce. It’s now high time for steeper curves. The policy will stay very loose as far as the eye can see, given the economic context has changed favorably to the degree that we could now see central banks shift to pursue inflation goals quietly but effectively.