No one should be surprised if there is no cut
The oil market has turned bid yet again in Asia supported by a combination of China going back to work, the PBoC preparing to hose down risk markets with a deluge of money, and as Covid-19 risk turns more benign by the day. As well, traders are betting that Russia plays ball and, at a minimum, agrees to supporting the JTC proposals, which should at least stop the hemorrhaging.
Honestly, every time I read an OPEC headline I have thoughts of The Little Dutch Boy putting his thumb in the dike.
Russia says Nyet
However, surprising is the fact that focus has not shifted to the ineffectiveness of previous OPEC cuts. The elephant in the room for OPEC, and unmentioned in virtually every risk market discussion, is that OPEC’s market share of global crude output has fallen to match historic lows near 35%.
So, of course, Saudi Arabia can't go it alone and need Russia and OPEC+ support. Surely this is an essential context for whatever output decision is made. And while members would find it easier to stomach cuts if relief were right around the corner, they do not want to give up more market share to the U.S. However, the fact is that U.S. oil growth is still running at +1 MMB/d yoy, effectively satisfying the bulk of annual global oil demand growth as long as this remains the case OPEC production cut is but a Band-Aid on a broken leg.
This may well be the premise for Russia’s balk.
However, Novak is now making overtones regarding the severity of the market conditions. Still, when it comes to Russia, commitment lip service is more comfortable to deliver than an actual supply reduction.
Reversals are, of course, not unknown, but no one should be surprised if there is no cut.
Bubbles do funny things to bank traders
Yesterday, U.S. equities were a touch stronger but trading was well off intraday peaks with the S&P 500 up 0.1% heading towards the close. U.S. Treasury yields rose—the 10-year was up 2bps to 1.59%. With gains in European equities and most of Asia as well, the market looks increasingly willing to look through concerns about coronavirus, newly named Covid-19 overnight by the WHO. In his Congressional testimony, Fed Chair Powell noted the Fed is "closely monitoring the emergence of the coronavirus, which could lead to disruptions in China that spill over to the rest of the global economy."
However, it was too early to make a full assessment. BoE Governor Mark Carneywas similarly cautious but noted the virus had not led to any tightening of financial conditions for UK banks.
But it could be the degree to which investors are willing to look past weak China high-frequency data in the coming weeks will that help determine whether the risk rally has the legs to run.
I was relieved this morning to see the markets hadn't gone stark raving bonkers and taken the S&P 500 closer to 3400. However, risk parity bubbles do funny things to bank traders who appear to be borrowing a page out of the George Soros playbook "when I see a bubble forming; I rush in to buy it."
Six weeks into 2020 and already the S&P 500 has hit the mean of strategists forecasts for the year-end of 3355 points. On a further 7% gain, the SPX will be above the most bullish of all predictions recorded by Bloomberg, of 3600.
But the markets are probably not quite as risk-on as the record-setting pace might suggest. Growth or defensive stocks have outperformed value by 25% so far this year. Equities are indeed reigning supreme, but it's driven by the mega-momentum stocks (tech) rather than the economically-sensitive cyclical stocks. Suggesting that even if the consensus view for a sharp "V" economic reaction to coronavirus is wrong and the recovery period takes on a hockey stick shape, institution equity ownership is still pretty cautious by design. So provided the Federal Reserve has the market's back, the bulk of U.S. stock market positioning should remain relatively immune to the current market worries at this stage. So, if you're looking for a contrarian storyline, you might want to skip the next few paragraphs.
There is quite a bit of ink being spilled to say that markets are not taking Covid-19 seriously. But with 10-year yields falling to sub-1.6% and the Fed hinting that its reaction function includes Covid-19 and the PBoC already flooding markets awash with cash, papers over that cautious scenario. Such easy financial conditions with the potential for even more comfortable conditions as global central banks dovish reaction function to a temporary global growth shock has investors champing at the bit.
Why are equities up and bonds up too?
The S&P 500, the NASDAQ, and the Dow Jones Industrial Average are all trading around record highs while the 10-year U.S. Treasuries yield is at 1.59%, from 1.9% at the start of the year. For that, everyone can blame the central banks, who have succeeded in dampening volatility by guiding markets successfully in the direction they want them to go.
The U.S. Federal Reserve, in its bid to avoid another repo market meltdown reminiscent of September 2019, had probably overflooded things when it injected billions of dollars of cash into the system to push rates lower. This monetary policy overcooked state of things left banks with heaps of money, which they are putting to work buying bonds. And as such, equities, particularly growth stocks, are reveling in the afterglow of the Fed easy money, and have only been able to gain "because" Treasury yields are low.
And with everyone thinking the Fed is either on hold or cutting with a rate hike a long way off, as such traders continue to look for optimal bullish risk-reward and continue to shrug off the likely economic impact of the Covid-19.
Are things stretched too far?
Possibly but at this time, there is absolutely no stopping equity market momentum. So far this year, investors have shrugged off patchy earnings, increased tensions between the U.S. and Iran, and the nCoV outbreak. There isn't much else you can throw at them right now. With that in mind, it seems pretty lame to think the outcome of the Democratic presidential primary is going to have much impact. Perhaps the biggest threat to the market is the consensus view that the effect of the coronavirus will be a V-shaped recovery.
Oil markets
With OPEC and friends paralyzed thanks to Russia DEC CL 20 vs. 21 in contango Brent -WTI
Although prices bounced back from a one-year low, the thought that OPEC could sit on their hands until March has brought the bears back out en mass. The OPEC + failure for now to follow the Joint Technical Committee's recommendation to cut an additional 600kb/d of production has allowed sentiment to turn cumulatively more negative.
The anticipation of an early February emergency meeting of the OPEC+ group had supported oil prices. Still, a near term meeting seems to be a view supported on little more than a wing and a prayer at this stage. And now, it appears OPEC wants to quantify the demand implication before acting. Still, with the cartel failing to act swiftly on the JTC recommendation, this has allowed the narrative to fester and create divisions within the group.
But surely, it's tough for OPEC and Russia to ignore the forward curve that continues to move deeper into contango. And traders probably wouldn't be surprised to see an emergency meeting called if WTI moves much lower.
We're at a significant inflection point for the Oil markets. If China fails to contain the virus domestically within a few weeks and or virus clusters expand around the globe, it's a whole new kettle of fish as tail risks get incredibly fatter for oil markets.
Gold markets
There has been very little interest in gold in the past few days as the stronger USD continues to sap gold momentum, plus the bulk of buying on the back of virus fears went through early last week.
With the majority of hedge positions in place, as nCoV risk turns benign and investors continue to shrug off the economic impacts from Covid-19, gold speculators and fast money accounts will generally start to trade the ranges in gold from the short side — effectively keeping a lid on price action which then ultimately triggers some profit-taking from weaker gold longs.
With markets awash with cash, the fear of creating an equity market asset bubble alone should keep the Fed parked on the sidelines, not necessarily bullish for gold. But instead, it's U.S. fiscal policy, which remains long term price friendly.
So far, global financial markets have soaked up the growth in U.S. debt. The yield on the critical 10-year has stayed well below 2% and is close to 1.5%. Interest repayments, as a share of GDP, are only half the level of the early 1990s, which puts less pressure on government coffers. That is despite the growth in debt. But this is a knock-on effect of investors' demand for safe assets, which include gold.
While Fed policy certainty is probably lessening the demand for gold, should investors' appetite for U.S. debt start to fade, gold is likely to be one of the few beneficiaries as investors seek gold as quality assets. This may not happen any time soon, but it's a good enough reason to hold gold as a prime quality asset in your portfolio.
In the meantime, look for gold to trade in the well-trodden territory as a stack of quality assets like U.S. bond and the dollar battle it out for your safe-haven flows.
Currency markets
I get it that we're a bit more cautious in Asia, especially given that we are closer to the epicenter of all the Covid-19 fears. Still, should Asia traders be 250 pips overly cautious given the broader collapse in USD-Asia (USD/CNH) that transpired after handing the book over to London yesterday?
Still, I think running Asia currency risk based on global stock market performance, which is absent a bump in economic Asia sensitive cyclical stocks, doesn't appear to make much sense given that local currency tail risk remains pretty fat. And while it makes sense to unwind some overextended long Asia weekend gamma hedges (or in my case getting stopped out on long USDCNH hedges at breakeven) given the typically robust convexity of regional currency sentiment to PBoC stimulus. However, views are immaterial to what price action suggests, and that is what we should trade on, not opinions.
Singapore dollar
Could the Sing dollar be the regional voice of reason as, despite the overnight collapse in the broader USD-Asia complex, the USDSGD remains bid around 1.3870 on local support?
Today Asia FX view
As we enter the land of currency confusion, Asia FX markets continue to beat to a familiar drum. USDAsia remains better offered on the back of improved risk sentiment. This seems to be taking hold as hopes build that China will soon reopen for business, the Zhong Nanshan scenario holds, and as the PBoC policy guides us to risk parity nirvana. Time will tell if that view is correct.
As for G-10
Forty-eight hours is the typical duration for G-10 trends these days. When it comes to painting a dominant currency view, it feels that I'm confined to an empty windswept desert. Forget trend following, home run swings or break out trades, these types of market reward patience where bunts singles, doubles and mean reversion remain the trade calls of the day. I defer to my FX reversion algorithm, which doesn't need a currency view to trade.