Asia open insights: Navigating the last major data release of the year

Markets

U.S. stocks rebounded on Thursday following the most significant daily sell-off in months. The market responded to reinforced expectations for deeper interest rate cuts from the Federal Reserve ahead of crucial U.S. inflation data.

The S&P 500 surged at the open, sustaining those gains, partially recovering from the most substantial single-day loss since October. The market's movement suggests a comeback driven by investors reacting to the possibility of more pronounced interest rate cuts by the Federal Reserve.

Wednesday's decline lacked a clear culprit, and commentators proposed various theories, including concerns about the U.S. economy after FedEx's pessimistic revenue forecast, year-end profit-taking, and zero-day options trading. While the latter appears to be the more probable cause, a combination of factors likely contributed to the sell-off.

It's important to remember that the decision to sell at 2:00-2:30 in the afternoon in New York, outside of a surprise on Fed Day, is seldom a collective choice driven by a sudden market-wide realization that the rally had extended too far. However, the picture becomes more transparent with insights from zero-day options derivative traders.

The most talked-about and controversial derivatives trade of the year, zero-day options, took center stage as the suspected culprits behind Wednesday's abrupt end to the U.S. equities rally. Constrained by holiday-related trading limitations, market observers pointed to substantial volumes in "put" options with a 24-hour expiration, known as 0DTE options, as a trigger for the sharpest market pullback in almost three months. According to this theory, these trades prompted market makers on the opposite side to hedge their exposure, thereby driving the market lower. 

Nevertheless, the sell-off and ensuing rebound likely positioned market participants at or near the center of gravity, where natural pre-event position squaring might have occurred ahead of the crucial PCE data.

The Federal Reserve's preferred inflation measure surged to around 5% at the start of the year, surpassing policymakers' 2% target. Despite a 4% six-month annualized pace for the first half of the year, this is expected to drop sharply to just 1.9% for the final six months, as various economists on Wall Street suggested.

The week concludes with the last major data release for the year, the core PCE price index. If projections of a 0% monthly change for November hold, the six-month annualized calculation would settle at 2%, aligning with the Fed's definition of price stability. One might be left perplexed if this doesn't set the stage for a Santa Rally and a weaker U.S. dollar.

On the flip side, however, a surprisingly hot PCE reading can potentially and significantly disrupt the proverbial bullish rate-cut apple cart.

Forex market

The U.S. dollar is considerably weaker ahead of the US PCE data as traders continue to catch a more pronounced case of Federal Reserve rate cut fever.

The recent price action in the Yen aligns with our perspective that a postponed exit from negative rates by the Bank of Japan (BoJ) is unlikely enough, given the current external environment, to prompt a sustained sell-off for the Yen. This comes as there is growing speculation that other major central banks, primarily the Fed, may initiate rate cuts earlier and more aggressively in the coming year. The prevailing market dynamics suggest that the conditions for a significant yen sell-off are not ripe; hence, the path of least resistance for USDJPY appears lower.

Oil market

As traders keep a close eye on the geopolitical risk premium, providing support for oil prices leading up to an extended holiday week, upward movement is encountering obstacles due to another bearish Energy Information Administration (EIA) inventory report. The report disclosed a significant increase of 9.5 million barrels (bbl) in total U.S. oil and petroleum product stocks last week, coinciding with domestic oil production hitting a new record high of 13.3 million barrels per day (bpd).

During the week ending December 15, domestic oil stockpiles (excluding the Strategic Petroleum Reserve) increased by 2.9 million bbl, which was unexpected as analysts had predicted a 2.5 million bbl decrease. This rise has resulted in approximately 1% higher inventories than the five-year average. The increase was due to a surge in U.S. oil production, reaching a new record high of 13.3 million bpd the previous week. This is an increase of 200,000 bpd from the preceding week's average.

According to the latest Drilling Productivity Report from the EIA, oil production in the bountiful Permian Basin is projected to reach a new record high of 5.986 million bpd at the beginning of 2024. This represents a substantial 38% increase from January 2022, with an additional 218,600 bpd. Similarly, Bakken oil production in North Dakota is expected to rise by 2,000 bpd in January, reaching a new record high of 1.308 million bpd. This projected output signifies a 19.6% year-on-year increase of 214,500 bpd in oil production in the North Dakota basin.