Market Quick Take - August 28, 2020

Macro

John Hardy

Head of FX Strategy

Summary:  Markets reacted in choppy fashion to the Fed Chair Powell speech delivered yesterday, as Powell rather under-delivered on specifics with the new flexible average inflation targeting regime, but markets were rather quick to right themselves, save for long US treasuries, where yields remained higher into this morning. In other news, the yen strengthened as Japan Prime Minister Abe announced he resign after his term ends in a year, citing health reasons.


What is our trading focus?

  • S&P 500 Index (US500.I) and NASDAQ 100 Index (USNAS100.I) – the US indices put in a choppy session yesterday after Fed Chair Powell’s speech (more on that below), but in the end, traders decided the Fed had said nothing to stand in the way of the existing trend and the major US equity markets closed broadly near unchanged levels on the day and tacked on gains in futures trading overnight. Small cap stocks put in another uninspiring session, underlining that it is only the large caps that are carrying the market higher.

  • STOXX 50 Index (EU50.I) – the major European indices have been coiling and coiling in a range since early June and really need to make a statement one way or the other here to excite new technical interest. The STOXX 50 is close to the top of the local range near 3,377, but the cycle high since June was a brief spike up to 3,451 back in July.

  • Walmart (WMT:xnys) - Walmart’s stock price jumped over 4% yesterday after it announced that it was joining Microsoft in a bid for the US operations of Chinese ByteDance’s TikTok application as a bidding war has been engaged with Oracle that could see the deal reach north of $30 billion in size. This underlines Walmart’s attempts to increase its presence in the on-line world, as it has moved strongly with an e-commerce offering that could bring in advertising revenue.

  • Spot Gold (XAUUSD) & Spot Silver (XAGUSD) rose yesterday after Fed Chair Powell said nothing that could hurt the medium-term prospects. Higher inflation tolerance with the Fed seeking an average inflation of 2% could see rates stay low for the next five years. In the short-term, the no mentioning of yield-curve control saw US ten-year nominal yield move above 0.75%, thereby potentially reducing the appeal for precious metals. Key however remains the developments in real and breakeven yields. As long real yields remain anchored around –1% while inflation expectations (break evens) move higher, gold should be able to withstand the mentioned rise in nominal yields. Having found support earlier in the week at $1900, the market is still range-bound mode $2015, the big level that needs to break in order to attract fresh technical buying.

  • WTI Crude Oil (OILUSOCT20) & Brent Crude Oil (OILUKOCT20) - edging lower as Hurricane Laura missed the regions energy infrastructure. The slight change in direction before landfall kept key refinery installations out of harm's way with RBOB Gasoline (GASOLINEUSSEP20) at $1.21/gal having given back all the earlier gains. Another two potential storms are currently on route across the Atlantic, and these may support and prevent both crude oil and products from deeper losses at this stage. Brent crude remains stuck within a narrowing range defined by the 50-day moving average at $43.75 and the 200-day at $45.80.

  • USDJPY and other JPY crosses the yen was jolted this morning to the strong side on the news that Japan Prime Minister Abe announced his resignation, citing health reasons, although some of the sting was taken out of the news as he apparently intends to serve out his term as party leader, which does not end for another year. Abe has been the longest serving Japanese prime minister by a long shot since the war and was therefore one of Japan’s strongest leaders and more likely to pursue a determined fiscal stimulus regime in indirect coordination with the Bank of Japan. The yen is stronger on the immediate reaction to this news first and foremost because of uncertainty, but also because any new leadership may have a hard time galvanizing the government to act. For USDJPY, we focus on the 105.00 area if the yen rally continues. The news came this morning after treasuries were under strong pressure overnight in the wake of the Fed Chair Powell speech, which had actually driven the JPY weaker late yesterday and overnight.

  • AUDUSD - the AUDUSD poked to a new high just short of 0.7300 as of this writing as the market decided that Fed Chair Powell’s unveiling of the Fed’s new flexible average inflation targeting regime was no real hurdle for the background narrative on the Us dollar after some choppy trading in the wake of his speech yesterday. With this fresh move higher, the downside pivot moves all the way up to perhaps the +0.7300 area and there are few points to the upside offering notable resistance, perhaps the round number of 0.7500.

What is going on?

  • Japan Prime Minister Abe announced his resignation due to health reasons. As noted above in the comments on the Japanese yen, this is huge political news for Japan, as Abe brought the forceful “three arrows” programme to address Japan’s economic challenges starting in the late 2012 election, which, combined with the Bank of Japan’s huge activism, engineered a massive slide in the Japanese yen, which helped to grow the Japanese economy in nominal GDP terms consistently for the first time in two decades. While Abe apparently intends to serve out his term as party leader that ends in a year, longer term political and policy uncertainty has just suffered a shift.

  • US Fed Chair Powell unveiled the conclusion of the Fed’s long-term policy review in a speech yesterday, declaring that the Fed is now running with a “flexible average inflation targeting” regime, really nothing new relative to expectations, and the lack of explicit levels and of any direction mention of any opinion on the desirability of a yield-curve control policy meant that this speech and the Fed’s conclusions were well-flagged and offered nothing new. Nominally, the speech is “hawkish” relative to more dovish potential outcomes, but perhaps Fed Chair Powell was reluctant to egg on financial markets, which are looking frothy here.

  • Another strong week for commodities with the Bloomberg Commodity Index rising for a sixth consecutive week to a six-month high. An unprecedented amount of Central Bank stimulus, rock bottom U.S. interest rates, a weaker dollar and demand for inflation hedges all seen as key reasons behind the current revival. All major sectors trade higher on the week, led by grains and industrial metals. Current dry weather conditions leading to downgrades of the final yield estimates while strong Chinese buying of corn and soybeans have supported the demand side. Industrial metals also doing well with tight supplies in some markets, unprecedented stimulus and U.S. interest rates stuck at zero providing the support. Major commodity ETF’s to watch: DBC, GSG and DJP.

What we are watching next?

  • Safe haven bond yields – In the wake of Fed Chair Powell’s speech yesterday, most markets reverted back to where they came from prior to his speech, save for US Treasuries, which sold off all along the curve, though most notably at the long end, helping to steepen the US yield curve. At some level of bond yields, we would argue that the narrative supporting incredible valuation multiples for equities and especially growth companies could come under pressure if yields continue to rise, so all investors should keep an eye on long yields as long as the US 10-year benchmark sustains this move above 0.75% - and especially if it approaches the post-COVID-19 outbreak crisis high of 0.95%.

  • State of US election polling after Trump delivered his acceptance speech yesterday – the Democrats are calling for a “return to decency” and “turn to the light not the darkness” while Trump and the Republicans are generally running with the narrative that the election is a choice between order and chaos. The tendency in polls for the coming couple of weeks could prove pivotal ahead of the presidential debates starting in late September for giving the markets a sense of whether election odds are shifting.

  • Ongoing questions over fate of next round of US stimulus  - with the two US political party conventions for this election season now out of the way, US Congress and the President will need to come up with a new round of stimulus or risk a second wave of economic weakness in the US for those worst impacted by the COVID-19 crisis.

Economic Calendar Highlights for today (times GMT)

  • 0800 – Norway Aug. Unemployment Rate
  • 0900 – Euro Zone Aug. Confidence Surveys
  • 1230 – Canada Jun. GDP
  • 1230 – US Jul. PCE Inflation
  • 1345 – US Chicago PMI
  • 1400 – US Aug. Final University of Michigan Sentiment

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