Awaiting a new paradigm
The market is biding its time
Will Brexit be hard?
Or will Ms. Lagarde
Do something that’s truly sublime?
And what of next week and the Fed?
Are traders now looking ahead?
Will Jay make a change?
And thus rearrange
The views that are now so widespread
Come with me now, on a trip down memory lane. Back to a time when hope (for a vaccine) sprung eternal, the blue wave was cresting, and investors were sidling up to the all-you-can-eat risk buffet with a bottomless appetite. You remember, November. Reflation was on the menu, along with a massive fiscal stimulus bill; progress was concrete with respect to Brexit negotiations; and the prospect of another wave of government shutdowns, worldwide, was just a gleam in
petty tyrants’ politicians’ eyes. Well, it turns out that those expectations were somewhat misplaced. While we did, indeed, get that vaccine announcement, with the milestone first injection made today in the UK, many of those views turned out differently than expected. As we are all aware, there was no blue wave in the US election. Regarding Brexit, it appears that the time has finally come for the leaders of both sides to sit down and hash things out. This morning brought news that Boris and Ursula will be meeting tomorrow to see if they can agree on what each side is willing to accept as their top negotiators have clearly reached their limits.
As to risk appetite, certainly November was beyond impressive, with massive risk rallies in equities around the world while haven assets, notably Treasuries and gold, suffered significant losses. Since then, however, the euphoria has been far less prevalent, with some sessions even winding up in the red. Lockdowns? Alas, those have returned in spades, with seemingly new orders each and every day by various governmental authorities around the world.
The upshot of this mixture of news is that the market is now searching for the next big thing. Don’t misunderstand, the 2021 conviction trades remain on the table. Thus, expectations for a much weaker dollar, huge returns in emerging markets, both bonds and stocks, and continued strength in the US market are rife. Just not right now. The short-term view is more muddled which is why the price action we are currently experiencing is so mixed and until that new view develops, choppy markets with no net directional movement is the most likely outcome. For instance, let’s look at today’s activity, which is a perfect example of the situation.
Equity markets around the world are softer, but not aggressively so. Asian markets sold off modestly last night (Nikkei -0.3%, Hang Seng -0.75%, Shanghai -0.3%), but look simply to be consolidating what have been impressive gains since the beginning of November. European markets are also a bit softer this morning, led by the CAC (-0.65%) although the DAX (-0.3%) and FTSE 100 (-0.4%) are drifting lower as well. We did see some data from Europe, with ZEW readings from Germany turning out bi-polar (Expectations were strong at 55.0, Current Situation was weak at -66.5), thus showing how financial markets continue to focus on the post-covid economy while ignoring the current situation. Meanwhile, US futures are all pointing a bit lower, between 0.4%-0.5%, after a mixed performance yesterday. In other words, all that risk appetite from last month appears to have been satisfied for now, although we are, by no means, seeing serious risk reduction.
In the bond market, surprisingly, 10-year Treasury yields have actually edged higher by 0.7bps this morning, despite the modest risk-off theme, whereas in Europe, we see marginal yield declines across Germany, France and the UK. Bonds from the PIGS, however, are definitely feeling a little stress as they are trading with yields nearly 2bps higher than yesterday. And that is a bit surprising given that Thursday, the ECB is going to announce their latest expansion of monetary policy, thus guaranteeing to buy yet more debt from these nations. (We will cover the ECB tomorrow).
Commodities? Well, gold has been rocking since its nadir on November 30, having rebounded more than 6% since then, and while unchanged on the day, remains in a short-term uptrend. Oil, meanwhile, is ever so slightly softer this morning, just 0.5%, but also remains in its powerful uptrend, which has seen it rally more than 33% since its nadir on November 2nd. In fact, metals and energy overall remain well bid and in strong uptrends. Clearly, they are looking ahead to stronger growth (or possibly higher inflation) once the pandemic finally fades.
And lastly, the dollar, which can best be described as mixed today, remains the linchpin for many market expectations in 2021. Remember this; given the dollar’s place in the world economy, as the financing vehicle of choice, a too strong dollar is generally associated with broad economic underperformance. As debt loads worldwide have exploded, even at remarkably low interest rates, the need for foreign issuers, whether private or government, to acquire dollars to service that debt is perpetual. When the dollar is strong, it crimps the ability of those foreign debtors to both invest and repay the outstanding debt, with investment suffering. So, while a strong dollar may signal growth in the US economy, given that the US economy now represents only about 20% of the global economy, well down from its previous levels, and that trade continues to represent such a small portion of the US economy, just 12%, these days, a strong dollar simply hurts foreign economies without the previous benefits of knock-on global growth. This is the key link between the views of a weaker USD and strong EMG performance next year, the two are tightly linked on a fundamental basis.
But as for today, the proper description of the dollar would be mixed. In the G10, SEK (-0.45%) and GBP (-0.45%) are the leading decliners, with the latter clearly under pressure from the ongoing concerns over Brexit while the former seems to be feeling the sting of hints from the Riksbank that ZIRP will remain longer than previously expected. On the plus side, the gains are less impressive, with CHF (+0.2%) the leader, while the euro has edged higher by 0.1%. However, trying to explain a movement that small is a waste of time.
EMG currencies, on the other hand, are showing a little life, led by ZAR (+0.55%) and RUB (+0.5%) as commodity prices continue to hold the bulk of their gains. INR (+0.5%) also had a good evening after the FinMin there explained that there would be no reduction in fiscal support for the economy for the foreseeable future, and that the government would continue to work with the RBI to insure a return to sustainable growth. On the downside, KRW (-0.3%) is the laggard after the president there urged people to cancel holiday plans and stay home.
On the data front, NFIB Small Business Optimism fell to 101.4, a bit weaker than expected, but given the stories of closures around the nation, this cannot be that surprising. A little later we get Nonfarm Productivity (exp 4.9%) and Unit Labor Costs (-8.9%), although neither is likely to excite the market. There are no speakers on the docket, so the dollar will be taking its cues from the equity markets in all likelihood. Right now, with futures pointing lower, that implies the dollar may have a bit of a rebound coming. However, until that new narrative forms, I don’t anticipate too much movement.
Good luck and stay safe