With equity markets racing to fresh highs supported by series of upside surprises in 4Q20 economic developments and positive news on vaccinations driving the action, risk will always be exceptionally precariously perched with economic reality still trying to catch up with the high market pricing.
Risk markets stepped back after news reports saying that China is looking at ways in which it can “hurt US defence contractors” by limiting its exports of rare earth minerals – used in components of high-tech devices.
And while it doesn’t look like too big a move zooming out on the chart but given sentiment and flows over the last few days stocks are pivoting lower as negative news on any front could cause sentiment to shift slightly, and perhaps some freshly minted longs to be challenged.
Recall there were already restrictions in place since around Q4, it’s still unclear how these will be different/additive. Nevertheless, it could be an excellent opportunity to fade for those looking to step back into the reflation trade.
European markets looking flat
European markets look set to open flat to lower after Asian equities gained on China entertainment stocks following a positive session in Europe on Monday, where major indexes rallied amid favourable Covid-19 headlines.
Sentiment remains upbeat on recent themes around accelerated vaccine rollout, improving infection rates in Europe and the US, and US fiscal stimulus expectations.
But there is still plenty of wood to chop this week as the equity market’s strength, led by ongoing steep gains since last summer in tech stocks, and the current rotation into Value has led many to ask what is already in the price. And of course, is any of the inflation narrative real?
Keep an eye on US retail sales
Retail sales will be the marquee data point in the US this week. And It would be a considerable understatement to say there’s a concern in some corners about the US consumer. The January jobs report suggested the services sector remains mired in a recessionary wet blanket.
So, an upbeat US retail sales could provide the all-encompassing “proof is in the pudding” investors need to take the next massive leap of faith. In contrast, a miss could offer a nasty consolation prize to stocks. Suggesting investors could temporary defer back to the “wait and see.”
Oil trades lower
Oil prices are moving lower tracking global risk markets negative skew on the China trade war escalation story. Still, it’s almost in a predictable fashion with the street knowing full well Mother Nature nor Middle East tension price boosts especially amid a supply glut is likely to have the legs to support oil prices alone as both types of price bounces historically have typically faded as quickly as they come on.
So, we could expect some natural downward price moves as oil markets supply or sentiment naturally rebalance to the current equilibrium.
The focus will soon shift to the OPEC+ meeting taking place in early March. It will be necessary for the group to continue to present a unified front and convey the impression that it is still enforcing supply discipline.
I suspect behind-closed-door discussions will be focusing on how to add more oil back into the market without upsetting the proverbial apple cart.
Higher oil prices in themselves can be a drag in the global growth narrative especially for the substantial consumption engines in Asia (India +China+ Korea) that right now are only getting a modicum of relief via the weaker US dollar.
The rare earth story triggered some mild safe-haven demand across AsiaFX that is bleeding into broader G-10 currency markets as the last thing the global recover need is for US and China to bring out the boxing gloves again.
Risk sentiment supports the Euro
Risk sentiment is keeping the euro supported. Given the positioning and the underperformance in US Treasuries, the EURUSD might not be the best pair to express a “risk-on views” in this current environment. Still, at minimum, it lends itself to a “range trade “proclivity as traders could look to fade the extremes in EURUSD.
My view is that EURUSD is mainly a dollar story. The euro has weakened against sterling given the heavy vaccine divergence, and even the Swiss franc, despite a massive repricing of Italian sovereign risk.
I continue to expect the US Treasury curve to steepen further with 10yr yields going towards 1.50% if not 2% this year. But even if that happens, as long as the Fed stays on its ultra-dovish message, I think risky assets can keep performing well.
On the FX side, this suggests that carry remains a crucial driver with EURUSD probably remaining in range though with a slight upside bias due to the gravitational pull from Asia FX and other high-quality G-10 risk betas.