Equities: New extremes and a challenging opportunity set
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Head of FX Strategy
Summary: The Fed delivered about all it could in countering recent taper talk and Biden is set to outline a larger than expected stimulus plan later today, and yet the US dollar has largely firmed, especially against the euro, which has stumbled a bit here on new drama in Italian politics. Sterling remains near pivotal levels against the euro, as EURGBP is pushing on important support.
FX Trading focus:
USD: the market largely shrugs off purported Biden mega-stimulus. US rates the key.
Just about all of the available ducks lined up for encouraging some USD selling yesterday with very little reaction in the markets. First, fed officials nearly universally pushed back against any urgency in sending out a tapering signal at this time (Brainard: more purchases “for quite some time” and economy far away from where Fed wants it to be. Harker: wants 2% inflation before taper talk and dmost importantly Clarida: “greater than 2% inflation for 12 months before rate rises”. The last of these is very interesting, as it sets up an interesting outcome hurdle that could very well come into play and test the Fed’s mettle already this year, if the inflationary outcomes many are predicting. A JP Morgan analyst on Bloomberg TV predicted at least 3% inflation and possibly 6-7% GDP as the Fed enables MMT-esque spending. This is a reasonable list of the factors that could drive that outcome and fits with our picture if the vaccine roll-out gains momentum and is reaching completion for key portions of the population by the end of this quarter. So, let’s say we get a couple of months of 2% inflation in April-May on basing effects from the collapse in prices during the pandemic panic months, and then it begins rising toward 3% within six months, US yield expectations will be rising aggressively and the Fed will find itself in a bind.
Another USD-negative development is the report from CNN that Biden is planning a larger than expected, $2 trillion stimulus. (Senator Schumer has been circulating a $1.3 trillion plan). There were no details on this (though Biden is set to speak today – should be more meat on the bone imminently). Next, we will have to await comments from key Senators on whether it can pass, given the 1-vote majority there for the Democrats. US treasuries responded to the stimulus talk with a sell-off, but the 10-year treasury auction on Tuesday and especially yesterday’s 30-year auction went off without a hitch, so there is no immediate sense that US treasuries are set for a significant tumble that would send yields up to destabilizing levels. And that really is the key for USD bears, who will need for US yields to stay orderly. Even a move above 1.25-30% could begin to stress asset markets and keep the greenback on the resilient side or stronger.
Another gaggle of Fed speakers is out today, including Chair Powell himself, but not expecting any new signals after the ten or so of the last few days have made it clear that only one or two wants to even talk about tapering, while the rest are in wait and see mode.
I would also like to see this weekend and Biden’s Inauguration Day next Wednesday come and go quietly.
As of this writing, EURUSD Is below local support and the ideal technical test level lower is 1.2065, with the bulls only coming under major fire on a test of 1.2000 and needing to capitulate if below 1.1900.
Italian politics present modest headwinds for the Euro
The Euro is somewhat more on the defensive than many other currencies this morning in the wake of Italy’s Matteo Renzi pulling his small, centrist party out of the country’s coalition. Italian BTP traders bought the dip yesterday, but they’re under pressure again today. There are any number of scenarios in the wake of this development, from the least likely (new elections) to the government finding another party to join, to even Renzi’s party rejoining if the coalition takes up specific policy initiative. Then there is the most intriguing: a broader alliance of parties who appoint a technocratic government with Mario Draghi (!) at the helm. The last is likely to extract the most out of the EU. Stay tuned, but my assumption is that there will be no new EU existentialist blow-up over this.
Chart: AUDNZD weekly
AUDNZD has made an interesting move this week in finally getting some separation to the upside from the 200-day (40-week) moving average. Both currencies have benefitted from the association with the resurgent Chinese economy and rising commodity prices. With global markets trying to look beyond Covid-19 now, despite on-ground realities even in China now with the virus, the premium that NZD received for its early success against the virus is no longer present. As well, AUDNZD yield differentials bottomed out in December and can’t go lower unless Australia plans negative rates without New Zealand doing the same – hardly likely. Then there is Australia’s historic shift to a current account surplus in late 2019 after running large external deficits for decades, move not mimicked by New Zealand, although the latter’s current account has improved to the upper end of the twenty-year range. Further mean reversion from a valuation perspective could take the pair into the zone above the key 1.0800-50 level and even to 1.10+ in the next few months, with longer term potential above 1.1500 if we see an extension of the commodities inflation in iron ore, coal and LNG for the balance of 2021.
The vaccine race
As we noted on the Saxo Market Call podcast this morning, Israel bears watching as the country farthest along of any complex economy in vaccinating its citizens, with nearly a quarter having received at least the first dose of a vaccine. Perhaps no coincidence, the Israeli shekel (ILS) has been on an absolute tear in recent weeks, and just before pixel time, the Bank of Israel is out announcing that it will buy $30 billion in foreign currencies through 2021 – oops, squeeze risk.
In the US, a handful of states have administered the first dose to more than 5% of citizens, and the most populous states are mostly in the 2-3% range. Too slow. Elsewhere, sterling could be getting a boost in part due to its aggressive move on vaccinations, while the EU is stumbling badly on the front in aggregate. Watching that EURGBP range support below 0.8900 for further developments – I like the pair lower for two to three figures.
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