There has been a fair bit of catching up to do after the past week spent outside of the financial market’s matrix. The biggest takeaways appear to be that the US dollar rally has run its course for now, and that the US bond market refuses to taper tantrum. In fact, US bond yields have turned about-face and headed south.
The latter appears to be vexing the minds of inflationistas everywhere. As Pantheon Macroeconomics notes, Federal Reserve buying has run ahead of US government issuance in Q2, and the end of the US debt ceiling suspension looms at the end of the month. Throw in a relentless ocean of capital looking for a home in a zero per cent world, and the answer to the bond market rally, and consequent fall of the US dollar and rally in stock markets is likely right in front of our faces.
One thing is for sure, the debt ceiling won’t be resolved by July 31st if past years are anything to go buy, meaning new issuance will be constrained. Given the Fed won’t stop buying Treasuries and mortgage back securities either, the underlying bid in the bond market will remain. One could wring one’s hands at the illogical nature of it all, and let’s face it, what’s been logical since March 2020? A less stressful strategy is to accept the momentum for what it is and run with it. That likely means capped US yields, a lower US dollar, higher stocks (of course), and a solid bid on commodities and precious metals. The momentum will be what it will be, until it isn’t.
That doesn’t mean that everything is well in the state of Denmark, though. The Asia Pacific remains down a Covid-19 rabbit hole and if the situation that I have experienced first-hand in Jakarta last week is anything to go by, some downward revisions of growth are inevitable for the region. Similarly, cases are rising in the US, the UK, and Europe, even as those regions ease restrictions on their freshly mRNA vaccinated populations. Time will tell on how that bet will work out.
It is easy to look at the northern hemisphere big three and their summer holiday Instagram photos and assume the world is saved. However, the rest of the world remains mostly in a very different place. One thing that is noticeable is the waning momentum in the global reflation/recovery trade as the haves have, and the have nots (most of us) have not. China sprung a surprise RRR cut on markets late Friday, which to my mind is a strong signal from Beijing that they are nervous about the fading momentum. I had pencilled in one and five-year loan prime rate hikes for Q4 in China; I am now reassessing that.
Of course, China may have shot itself in the foot with its ever-expanding technology company and foreign IPO clampdown. Restricted lending to the property sector won’t have helped, and its quiet, but relentless, withdrawal of liquidity via the MTF and repo market may have proven premature. Throw in the constant head-butting on trade and geopolitics, a strong yuan, stubbornly high energy, and commodity prices, and perhaps it’s not such a surprise the PBOC has blinked. It should all be wonderful news for Mainland equities though, and those countries in its nearby event horizon.
The world suddenly looks like October 2020 again, pre-Pfizer BioNTech announcing they had saved the world, as long as you were American or European. At this stage, I really can’t tell you if we are temporarily back to the future or a colder reality about the global recovery looms. Either way, though, it should be good for the FOMO gnomes of the stock market.
The picture will muddy further this week if US core inflation YoY climbs above 4.0%. That may increase the taper talk again, and Federal Reserve Chairman Powell also gives semi-annual testimony in Congress this week. Further hints on a tapering schedule could appear during this address, potentially signalling the US could be moving out of monetary policy sync with the rest of the world. Fed QE buying and the debt ceiling expiry mean that the US bond market is unlikely to react, but emerging markets, notably in Asia, may not fare so well. DM is likely to outperform EM this week.
That disquiet may deepen if China’s Trade Balance, Industrial Output, Retail Sales and GDP data releases this week show a slowing down of the pace of the China recovery. Singapore GDP, Malaysian Industrial Output, Indonesia Trade and India Industrial Output and Trade Balance may tell a similar story. Asian FX is likely to fade at the expense of DM currencies, and the post-China RRR cut rally we are seeing in Northern Asian equities today could quickly fade.
We have a few central bank policy decisions in the mix as well this week. The Bank of Canada will buck the trend by further tapering their bond-buying. Along with firm commodity and oil prices, that should see the Canadian dollar outperform this week. The Bank of Japan and Bank of Korea will remain unchanged, especially after the China RRR cut and the ongoing pandemic woes at home and across the region. Those same factors, along with the extended Sydney lockdown, will also stay the Reserve Bank of New Zealand’s hands.
