Markets
With the middle east escalation firmly planted in the rear-view mirror for now and the risk backdrop remaining supportive – namely, improving macro, central bank easing, and receding tail risk around Trade, Brexit, and the Middle East, the path of least resistance remains up. So, barring a significant hic-up on tonight's NFP, investors could embellish the moment and notch another S&P 500 record on their belt, U.S. payrolls permitting.
This morning Asia equities made further gains, but investors were probably a bit reluctant to push the envelope ahead of tonight U.S. payrolls data. The jobs report comes as a most welcome distraction and will provide an essential update on the pace of U.S. job gains. With U.S. economic growth mostly dependent on the consumer, a healthy labor market is crucial to any constructive "risk-on" narrative.
Oil outlook
Oil prices dropped on Friday extending days of losses as the threat of war in the Middle East receded, and investors switched attention to economic growth prospects and the rise in US crude oil and product inventories. But things haven't strayed too far south suggesting markets have seemingly found a tentative geopolitical risk balance. On the one hand, we are only 48 hours away from what appeared to be a full-blown US-Iran war, so it's difficult to be cheerful, especially given the existing levels of risk.
The markets have called the end to Trump's battle against Iran, but I think it's not very likely this is over. The reality is the current US -Iran friction is merely the latest episode in a forty-year war, don't believe for one moment the US has forgotten 1979
But what could be significant for the near term is that given the militias loyalty to Shia cleric Muqtada al-Sadr, they will likely honor his request to stand down? This dovetail might reduce a significant proxy retaliation risk for supply disruption, especially if there are no apparent attempts to disrupt oil supplies during the weekend. Given the current compounding effects of middle east risk fading to dust and the piling-on impacts of this week's bearish EIA inventory data, oil prices could be under the cosh early next week.
The global oil market is expected to be well-supplied in 2020 and demand growth could stay weak, keeping a lid on prices, the head of the International Energy Agency told Reuters on Friday. "We are expecting a demand growth of slightly higher than 1 million barrels per day," said the IEA's executive director, Fatih Birol, adding that growth could remain weak, compared with historical levels.
There is also an implied surplus of 1 million bpd oil, ensuring that the global market is well supplied, he said. "Non-OPEC production is very strong. We still expect production coming from, not just United States, but also Norway, Canada, Guyana, among other countries," Birol said, referring to oil producers outside the Organization of the Petroleum Exporting Countries (OPEC). "Therefore, I can tell you that the markets are, in my view, very well supplied with oil, and as a result of that, we see prices remain at $65 a barrel."
But for those of us who still have risk appetite left, oil on a correlated risk basis looks a tad cheap. Global growth momentum remains skewed to the upside, and a P1 trade deal will be signed next week. And given that there is some residual threat of disruption to physical supply, I think this is a reasonably solid floor, and if not here, it's not much further south of today's current midpoint.
Gold
We've seen quite a reversal of fortunes in gold, but similar to my oil trade for those with gold risk appetite left, this could be an excellent contrarian entry point for gold longs. If the likes of UBS, Citi, and Deutsche Bank, who are big guns in the gold market like gold and are calling for multiple Fed rate cuts this year, take notice. When it comes to gold's bullish ambitions, and in its purest pursuit, it always boils back to real yields. So, when the Fed blinks, you will probably look back at current levels with nostalgic longing in H2 2020.
Asia Update 2
Indonesian Rupiah
USDIDR 1m NDF moved to 13757 from 13880 on the back of comments from Bank Indonesia's Hendarsah, who said the central bank would allow the rupiah to strengthen further. A similar explanation was offered up last year. Still, the central bank is having a more significant effect this time around as the Yuan, Asia's key bellwether currency gauge is shifting on a stronger tack.
There have been several broken sentiment barometers to gauge trade risk this past year. Still, the one that has yet to fail is the level of the Yuan. The USDCNH is the most defining trade risk sentiment tool in the markets/ And even as far currency markets are concerned, both EM and G-10, all currency paths cross the PBoC even more so with the Fed on hold.
The Yuan outlook
We enter 2020 amidst a backdrop of blue skies in the global manufacturing/tech cycles coming through and a thaw in the US-China trade tensions.
RMB NEER has weakened by 7% in the past 18 months, where most of that weakness was centered around the numerous trade escalation episodes when the effective tariff rate on total Chinese exports to the US rose from 3% to a threat of 21%.
During the current trade truce, including 50% unwinding of September 19 tariffs, the effective tariff rate eases by only 1.5%. None the less, this decline should translate into relief for the RMB where most market models, have it pegged exactly where the PBoC has centered the third reference rate midpoint. That itself is very reassuring and provides traders something definitive to work with while suggesting the PBoC are at the top of their game on their policy settings.
Although I suggested all paths lead through the PBoC, the Fed's policy direction will also be a key impetus to the USD/RMB outlook. If global manufacturing activity continues to improve or dollar weakens amidst sustained weakness in US economic activity, then USDCNY will also drift lower. In addition, a Fed policy pivot would suggest a move to 1.1500 on the Euro, and given the sensitivity of the CNY to the EUR the USDCNH will then decline to 6.80
But for risk sentiment in general absent a Fed pivot, the Phase one deal ensures a more stable Yuan this year, which is excellent for Asia risk, but there will be a downside skew to 6.80 if phase 2 talks progress well. This would be excellent of global risk as the P1 deal suggest the RMB will not be a source of EMFX weakness this year and should be a boost to global equity market.
I spoke to Bloomberg TV yesterday about my views on the Yuan and its far-reaching influence on EM currencies
Dollar May Weaken Enough to Stabilize EM Currencies: AxiTrader's Innes
January 9th, 2020, 1:33 PM GMT+0700
Stephen Innes, the chief market strategist at AxiTrader Ltd., talks about the dollar and emerging-market currencies. He also discusses Federal Reserve policy and the U.S. economy with Tracy Alloway and Manus Cranny on "Bloomberg Daybreak: Middle East." (Source: Bloomberg)
Asia Update
Oil and De-risking the middle east
On the flip side to the middle east risk side of the equation, if the Militias honor the Theocracy request to stand down, and there is no visible attempt to disrupt oil supplies during the weekend, it may put further downside pressure on oil next week. But we may see that interplay gradual sneak onto the field today as oil prices are drifting lower in Asia in early trade
The question is, do you want to stay hedged or not for the weekend.
Limiting Trump's Commander in Chief powers
And with the house Democrats passing a measure to limit Trump's war power against Iraq, it would severely restrict his commander in chief forces. And outside of trade policy which the democrats don't disagree with and given the political gridlock in Congress, Trump could effectively become a lame-duck president, and we would see the middle east war risk premium fade to dust Not a bad thing really unless your long Gold.
Australian retail sales
Australian retail sales data for November was considerably better than expected, but this did nothing to bring AUD out of the doldrums. After a 15-pip spike to 0.687150 on the back of the data, AUDUSD came back offered. There are more pressing issues in Australia at the moment, with a sluggish domestic outlook, geopolitical uncertainty, and the devastating bushfires. For now, there is no real theme in either direction for AUDUSD while it trades, although I still like the catch up to the Yuan story.
Keep calm, less than 24 hours to go.
Keep calm less than 24 hours to go in a week wholly dominated by developments in the middle east. With that in mind, we’re starting with a bang again this morning as a powerful explosion was heard at the Syria -Iraq border. I have no details at this time, but like yesterday's opening narrative, I expect this to be the norm as we will be on heightened risk alert around possible rogue or proxy escalations given that the increased level of Anti-US sentiment is running thick amid Iran's crescent of influence
Other than the widely expected announcement that a Chinese trade delegate led by Vice Premier Liu is heading Washington to sign in to affect the P1 trade deal, there hasn't been a great deal else for markets to feed off. So, today's critical payroll data comes as a most welcome distraction and will provide an essential update on the pace of US job gains. With US economic growth mostly dependent on the consumer, a healthy labor market is crucial to any constructive "risk-on" narrative.
With the market backdrop remaining supportive – namely, improving macro, central bank easing, and receding tail risk around Trade, Brexit, and the Middle East, the path of least resistance remains up.
If truth be told, I can't wait for this hectic week to end, And I don't think I'm alone in that view, so traders will be excused if they decided to sit this one out electing to do little more their pre NFP position housekeeping chores.
Oil markets
Oil markets are trying to stage a come back after prices continued to sell off hard in the wake of President Trump's de-escalation. And what seems to happen so often in oil markets, when things turn upside down, they head south in a big way. This week's additional piling-on to the crude market was the EIA inventory data showing a surprise build in oil and more substantial than expected builds in gasoline and distillates.
The compounding effects have been pretty gnarly for oil bulls over the past 48 hours. And while it is challenging to quantify what, if any, residual risk premium is left priced into crude markets for political risk. However, given prices had retraced back to mid-December levels overnight. I think that infers that there is now very little risk premia left to sell-off.
The precedent of the attack on Abqaiq in September was the template the market has chosen to model this week with low 70's on Brent capping out buying appetite and the initial price response reversing despite the lingering geopolitical effect likely to persist for a few months. So, with Brent at $65, the market is probably not fully pricing in supply risk factors. With this risk skewed to the upside and the chance of proxy or rogue threat of disruption to physical supply still elevated, we could see a floor start to build around current levels. At the same time, traders will now turn the focus back on the relatively pedestrian views around trade and data, which remain positive for oil.
Gold Markets
A key factor driving gold was the turnaround in oil as both commodities remain highly correlated to middle east geopolitical risk. But for gold markets, a variety of underlying uncertainties around data, trade, the Fed on hold narrative, and even the lingering effects of the middle east fracas has cushioned further losses so far. In addition, with the house in gridlock, President Trump has two areas of policy control under the commander in chief powers – trade and military policy. So, it could be wise to assume these areas will remain in the market's focus for some time. And the uncertainty around these shifting dynamics given the President's mercurial nature will likely support gold for the time being.
With that said, it might be worth keeping an eye on the new war powers measures legislation tabled by Pelosi, which would limit Trump's power to take military action against Iran.
However, with a stronger USD, surging equities, and higher US yields greeting Asia market this morning, it makes for a compelling reason to sell not buy gold.
Despite the fast money meltdown to $1541 oz on the back of a considerable “risk-on” cross-asset move, yesterday's net flows were still into buying territory, so it seems like the technical levels appear to be good contrarian entry points for gold bulls. On the technical scrim, look for $1550/oz pivot with $1530 the next primary level of support.
Critical to that long gold view, traders are keeping an eye on the US dollar, which is currently being viewed as the global barometer of risk. Finally, we could traders adopt a wait and see approach as the market pivots to tonight’s critical NFP report.
Currency markets
FX flows this week have been characterized by risk-on buying of USD.
One notable exception that I'm a bit puzzled by is CHF, which is trading very bid as large flows are going through the market during European hours despite the risk-on tone. Other than to suggest hedge funds view the franc as fair value at current levels and an excellent hedge against all the ills of the word, I’m a bit perplexed.
The Euro and Swiss Franc
None the less, there has been a lot of interest in EURCHF topside structures. The feeling here is that since the Swissy benefitted disproportionately from recent tensions in the Middle East, perhaps because Japan's dependency on oil imports from the Persian Gulf (c. 85%) made the yen an unreliable haven. So, as the middle east tensions de-escalated, the EURCHF could fly on a more pronounced long CHF unwind. But it hasn't worked out that way so far.
The Japanese Yen
Long USDJPY has worked out well, and I still don't see any reason not to play if from the long side. The markets should remain in buy on dip mode with stop losses getting moved up to 108.50 now. On the topside, I expect a lot of two-way interest to come in around 110, but it looks like a matter of time before we test it.
The Australian dollar and the Yuan
If you were looking to get into the global growth for 2020 trade, it could be worth looking at the divergence in CNH and AUD as the Aussie has been hammered over the past four days on bushfires and Iran fears while the Yuan has remained firm. With the CNH likely to bounce after signing of the trade deal positively, the AUD shouldn't be that far behind, and the correlation could play some significant catch up in the days ahead. Even more so with risk on lights flashing green
The Malaysian Ringgit
With regional risk sentiment improving and the US-China trade deal still on course to be signed January 15, despite softer oil prices, the Ringgit will likely coattail the Yuan positive skew into the P1 trade deal.