After sifting through the weekend headline reels, editorials focused primarily on easing China and COVID restrictions. That positive news came hot on the heels of the US CPI on Thursday and gave risk assets a further boost. Commodities had a solid end to the week, with almost everything from oil and copper to soybeans rallying strongly as the rally bus steamrolled across multiple assets. Often after a day like Thursday you'd see some mean reversion; however, the E-Mini's on Friday broke through the highs set the day before as traders still think it's too early to fade these moves. Investors were far from being positioned for good inflation, and China COVID news occured with massive amounts of cash on the sidelines. So the broad-based chase higher could extend.
The good news for stock investors, especially if US rates remain contained, is that a softer landing looks more achievable because it will likely suffer less damage in part due to a slower implied tightening cycle in the near term and a more systematic hiking path. That said, the move probably extended beyond what is justified by the fundamentals as short covering, and the FOMO was a colossal contributor to the rally under the surface. Still, investors think lower inflation is the only way to break out of the FCI Loop in a constructive direction.
But it seems too early to load up the stock market party wagon or back up the truck at the local gold refinery as the Fed job is most likely still ongoing.
It was always clear that it would be easy to bring inflation down from 9-10% to 4-5%. Pushing it back to the 2% could be much more complicated and require higher rates for longer. Hence, the central bank fight is far from over. But for now and until an indication of inflation proves stickier than expected, risk-on could roll on a bit further.
*FCI is the widely followed US financial conditions index (FCI) compiled by Goldman Sachs, which factors in borrowing costs, equity levels and exchange rates.
Oil
Over the past week, signs have emerged onshore that Chinese officials are preparing to unwind the zero-COVID policy. This policy pivot will help limit downside fears of a protracted restrictive approach to on-onshore activity, but it doesn't eliminate the immediate demand hit from current lockdowns.
However, trimming the China growth tail risk, as opposed to an on-the-spot fundamental shift, matters significantly for prices as it reduces the damage to the economy.
And, for oil traders, these actions speak louder than words.
Gold
Gold's beta to rising real rates has not driven the yellow metal materially lower this year. However, gold should glitter enormously with declining yields and implies that gold is well-placed to benefit from a Fed pivot, with prices poised to rally as real rates peak and eventually head lower. Dollar weakness against G10 currencies would be a tailwind, with gold also acting as an alternative currency/asset to the dollar.
Foreign Exchange
The dollar on Friday experienced its most significant two-day drop since 2008. where currencies that have been demonstrating a high beta to US yields, particularly Asia FX, rally hard While the latest dollar sell-off can extend a bit further and the odds of soft landing have increased on the margin, we continue to look for renewed dollar strength over the coming months as US yields most likely resume their climb.
Crypto
Although investors are tentatively rummaging through the crypto train wreck, smoulder embers could reignite last week's dumpster fire, with markets left digesting a series of unauthorized withdrawals of funds after FTX filed for bankruptcy, leaving investors entangled in yet another crypto unregulated mess.