US stocks scrounge out gains on lower yields, what does the WTI-Brent spread tell us?

Markets

US stocks scrounged out gains on the back of lower yields as investors continued to flip flop between recession and inflation fears. For today, however, given how early we are in the rate hike cycle, investors are seemingly giving the benefit of the doubt to the Fed after Chair Powell suggested he can bring down inflation without levelling the economy. But lower oil prices also appear to be providing the ultimate inflationary soothing balm and possibly triggered hopes of a soft landing parachute amid pervasive bearishness among equity investors. 

On a less hawkish note, Fed Chair Powell walked back the emphasis on headline inflation, acknowledging the Fed cannot impact food and oil, and core inflation is a better indicator of future headline inflation. When you plug headline vs core into the black box, things look incredibly more rate hike stormy on the horizon, so this is good news for risk markets.  

Still, having listened to Powell's lengthy Senate testimony today, it is clear that inflation is the domestic issue at the top of the political agenda. Powell consistently bobbed and weaved his way through commenting on anything of fiscal nature but was focused on deploying the tools within the Fed's power to address their dual mandate. So we should still position for more rate hike fallout to occur.

The risk-reward of being short has reigned supreme this year, but for the short seller to come back in earnest, they would want to have a lot more confidence that the earnings deterioration is happening now and that the consumer is faltering. Hence not only is the FED entirely in data-dependent mode but so are investors. 

Oil 

After another oil leak, the market is left grasping for straws again. 

Commodity indexes have been super weak for a while – more broadly, and it has told us for weeks the market realizes that the economy is headed for lower growth; only oil had been a bit of an outlier on the lower supply higher demand outlook. 

But I think it's a fallacy to think oil could stay this elevated given the amount of central bank-induced slowdown likely to be seen later in the year. The Fed and other inflation-fighting central banks want lower commodities, which is what they are explicitly trying to engineer.

I would also argue that Brent near $120 is super sensitive regarding supply and demand inputs, so signs of Russian Crude still hitting the oil complex is a colossal negative. 

Russia exported 3.75 mn bbl/day of oil via sea in the week of June 13 after dips in recent months. Russia's weekly oil export has increased 41% year to date. At the same time, China refineries continue to cash in on discounted Russian oil, which means more Middle East Crude for Europe.

 There is also the Big Oil /Whitehouse meeting today following Biden's letter to them to boost their oil supply. That is one of those lingering uncertainties markets don't like, as is the OPEC+ meeting next month. 

And with WTI-Brent spreads widening out, it seems the market is back pricing a potential oil export ban from the Biden administration.

Indeed a lot of noise as usual amid an illiquid oil market primes the volatility agitator.

Forex

There was relentless demand for USDJPY during the European and North American sessions on Tuesday, pushing it up to a high of around 136.70, from near 135.00.

This served as a short-term top during the Tokyo session on Wednesday, as the usual Japanese demand for USD was not as robust. Lower US yields and oil tanking have slightly benefited the Yen. 

Since last week's Bank of Japan meeting when they decided to keep policy unchanged, USDJPY has rallied from near 131.50 to a high near 136.70, an almost 4% move.

Though Japanese officials have little recourse, short of intervention, to combat a weak JPY given the BoJ's policy, one thing that will stick out to them is the pace of the move (this likely means more to them than direction). As a result, consolidation after such a significant move makes sense.

The Euro received a fillip from the US conference board of all places who said fears of a Eurozone recession are overdone.

Our view is the bear market rally in stocks will be short-lived as sentiment will turn sour on survey data starting with Friday's closely watched University of Michigan sentiment index. At the same time, increasing debates on a potential US hard landing could spook US rates and FX investors. We also think the US bond markets will be more susceptible to short covering given the positioning, which could lead to a USD long reduction. With Bund/UST spreads tightening consistently over the last few weeks, I think traders feel more confident in long EURUSD.