In terms of equities, the 'three pillars' of the rally (stimulus, earnings, and vaccines) are still placing upward pressure on prices and buyers are jumping back as investors start viewing the winter of despair from the rear-view window. And with the PBoC walking down any talk of a policy pivot it is also helping risk breathe easier in Asia.
CHINA CPI
Deflation driven by pork prices
China's CPI inflation moderated to -0.3% y/y in January, below market consensus of 0%. This is the second y/y decline in CPI over the past decade —the first was in November 2020. The drop was mainly due to the higher price base last year and relatively rapid decline of pork prices, -3.9% y/y, as supplies primarily recovered from the swine disease. CPI inflation could remain low in the coming months on falling food price after the Lunar New Year and a high base effect. Still, the PBoC would possibly look through such pork price-driven deflation, and extremely low CPI should not deter its policy neutralization plan.
OIL MARKETS
In the absence of shale oil producers re-entering the picture, OPEC can call the shots. At current price levels, the big risk event that could limit top side oil market ambitions over the short term could be that traders start to price in Saudi Arabia's unilateral February/March cut to be rolled back in addition to supplemental drip-feeds of +500 kb/d increases to be agreed by the producer group at each of the March, April, and May meetings. But the big fear is that Russia may then drive OPEC+ discussions towards broaching the possibility of an early unwind.
Outside of the worst-case scenario where Russia starts driving the discussion, neither Saudi Arabia rolling back production curtailment pledge nor OPEC drip feeding the market should present much of an obstacle for the oil price reflation especially with US producers sidelined due to CAPEX constraints.
GOLD MARKET
Gold rallied in response to the weaker USD, while platinum climbed to its highest in more than five years. Although a fabrication supply rise is likely this year, strong investment demand should again push the platinum market into a deficit. Other drivers include real low rates, a weaker USD, and global economic recovery thanks to aggressive stimulus measures.
XPTUSD has taken out $1200 and is now at levels going back to 2016. There's very little in the way ahead of $1230.
EQUITIES
US equities were little changed Tuesday. Most reflationary assets took a breather as investors naturally thought it worth reducing some equity market risk after the recent volatility in rates to take a more in-depth peek into the looking glass. But the primary structural themes of more fiscal stimulus, an accommodative Federal Reserve, and vaccine optimism confirms that everything should eventually come up roses. With that said US markets are off early session lows with the guiding light now getting carried by crude prices as we emerge for this winter of despair, the hope of spring should prove eternal especially for oil prices
Adding to the positive cross-asset vibes, and on the vaccine front, Europe is only a few weeks behind the US. There is no evidence that new strains compromise protection against severe illness and positive signs that consensus is shifting to re-opening once the most vulnerable are protected.
Some pause for the reflation/re-opening trade is healthy. And without question, it is immeasurably tricky for investors to take that next leap of faith higher, especially at the index level with so many mixed signals enveloping the ongoing rotation trade. The reach for yield amid the most attractive policy mix in decades has generated the most improbable market pricing with bullish expectations at an implied level not seen since before the 2008 GFC.
Rotation in itself, this is not surprising. It is arguably healthy – since a broadening out of leadership and an apparent reaction to what we have been talking about and seeing in terms of breakeven expectations in the market. The only surprise was that the market moved up at the Index level in the past week despite this rotation. But I think what we are seeing is what we should have expected all along given the weight of the rotation cycle in versus out, that is a bit of consolidation with a soft selling skew on rallies as expensive and more broadly held names sell to make room for the less costly counters to be bought. And certainly nothing sinister, just investors sitting tight allowing the macro backdrop to shine a bit more brightly before getting their toes wet again on the more significant ticket items.
Given the absence of tier-one macroeconomic data to feed the market consumption machine, it was always going to be difficult to dial up the festive mood music this week especially coming off Friday's NFP double clunker which may have left investors wanting more economic proof in the pudding before they take the next leap of faith as we gradually return to a world where domestic information matters.
OIL
The American Petroleum Institute reported a decrease of 3.5 million barrels of crude from US inventories. That print will not dissuade oil prices from heating up further as Brent goes "up up and away "pushing through $61 and keeps climbing floated higher by vaccine and stimulus balloons. Although I continue view oil in overbought territory at these current levels and ripe for profit-taking
There is seldom one sole factor at play at any given time whether its the oil curve offering up and attractive alternative in the chase for yield or oil contracts providing a favourable inflation hedge after all at every market street corner discussions around inflation protection continues resonate.
A neat feature of the oil market is that it is cyclical. It does tend to gather momentum. And it rarely if ever settles into a comfortable equilibrium as we saw from overnight price action.
But it might become more apparent that OPEC sees $60 as the low end of the price range that incentivizes sufficient new production capacity to the market offering attractive producer returns. Still, they may also support this level as something of an anchor by only drip-feeding spare capacity back until the US demand starts doing the heavy lifting.
I, however, see the March 4 March OPEC+ meeting as a risk to the current view at which time I expect Saudi Arabia's unilateral Feb/Mar cuts to be rolled back.
Comments by Trafigura's co-head of oil trading suggests real physical demand is underpinning the market, which is the best signpost and the most pro bullish reflection for oil prices as total cargo orders supplants any forward-looking glass view. By the same token, while inventories are dropping, OPEC+ keeps an unusually high production capacity from the market, mainly via the latest Saudi Arabia February and March production curtailment.
While this gets echoed as a game-changer by most market copywriters, I suspect oil bulls will be sitting with fingers and legs crossed that the OPEC meeting in March, which is likely to take on a higher level of importance than usual, continues to see member producers setting political difference aside and continuing to work in a coordinated effort to sustain elevated prices despite the obvious temptation to up production. As mentioned above, Saudi Arabia will roll back their curtailments while verbally climbing down on post laggards to make up for production overshoots from their prior commitment.
But Saudi Arabia rollback is not going to change the oil view at the more significant picture level. As Brent prices rise above USD 60/bbl, there is little reason to doubt that demand fundamentals will justify further recovery in oil prices to long term equilibrium of USD 65/bbl and likely beyond by year-end as we are just starting to rev up the reflation trade engines. For the oil market, we could be entering the most hyperinflationary stimulated market in what might be dubbed the "Year of Brent" (oil) where would be looking back at current $60/bbl levels with a nostalgic yearning from possibly $80 /bbl in June-July if OPEC continues to keep a leash on production and the US dollar corporates by weakening off as it's supposed to.
FOREX
One week after "US exceptionalism" became the trade of the week of, "USD weakness" has seemingly regained its pre-eminence. A handful of days last week saw the USD move higher alongside US equities, fostering a misguided belief that both could remain, compatible bedfellows, amid a global growth synchronized storyline with the EU in vaccination catch up mode.
The so-called "risk-on" imposter the GBP is looking stellar in this environment.
The pound has remained very well bid even against US dollar strength last week mostly due to the Bank of England meeting, though it's not very hard to explain. The negative rates buzz was always a GBP bears fools dream. The MPC finally made it clear that it's effectively an administrative exercise with very little or no policy implications.
But for the pound, the critical argument has been that the UK will come out of lockdown earlier. Real money is arguably still underinvested; there is scope for more positioning catch up is colossal.
I would expect the US dollar sell-off to diminish somewhat today as one potential hurdle for USD bears is tonight's US CPI. It's a well-known fact that economist forecasts are worst at turning points because complex models need time to be tuned to handle regime. And the folks submitting predictions to Bloomberg and Reuters tend to exhibit anchoring bias.
I think it's safe to assume we are on the cusp if not already entered a more prominent inflationary global macro regime than we have seen in many years. Australia, Germany, and New Zealand inflation all came in higher than expected recently, and I would assume the USA will do
the same.
If US inflation comes in hot, many will argue it doesn't matter because the Fed will look through it. But at some point, the Fed will blink, sooner or later. Still, it might be hard for dollar bears to wantonly sell the buck as if the CPI prints hot tonight today, logic says the earlier the Fed blink.
ASIA FX
The ringgit traded well overnight in line with other petrol dollar peer currencies and got a double whammy boost from the stronger yuan on robust credit demand expectations in China of January. Higher oil prices are also a boon for Malaysian fiscal position US$60/bbl; this compares with government's 2021 budget assumption of US$42/bbl for 2021, US$45-55 for 2021-2. It could also provide the government with a meaningful wiggle room to pump prime and fund some of the large infrastructure projects that have been a topic of ongoing discussion in Kuala Lumpur. Indeed, this should eventually see the ringgit trade much stronger this year.
The PBoC offers up a little obstacle for stronger yuan. Yuan bulls continue to set sights on 6.25 on the confluence of positive flow dynamics. The ongoing shift to liberalize the currency and lighter positioning after last weeks' short dollar position clear out. Although the authorities have taken some steps to slow the pace of RMB appreciation, these measures are soft and not intervention aggressive styled push back and should not affect RMB's travel direction.