Markets Outlook: A Cluttered Environment for Risk

Market highlights:

• A week where the economic calendar is packed with important data points
• Caution hits oil markets ahead of key OPEC+ meeting
• With a torrential downpour of dollar supply for month-end, it’s time to pick your favorite short dollar plays
• Everything that was pointing us towards caution on the Euro in September has now turned

This week’s economic calendar is packed with important data points, namely Friday’s employment report for November. We’ll also hear from Fed Chair Powell, who’ll testify in tandem with Treasury Secretary Mnuchin before the Senate Banking Committee (Tuesday) and House Financial Services Committee (Wednesday).

Though the timing is propitious given the recent decision by Mnuchin not to extend several of the Fed’s 13.3 facilities, Powell and Mnuchin will be providing their routine updates to Congress as required by the CARES Act. Both will be questioned extensively by Congress on the recent discord between the two institutions.

However, as Congress is also negotiating an omnibus spending bill for the remainder of FY 2021, we’ll also be looking for any hints as to how the political parties are positioning themselves concerning further fiscal stimulus and its importance Chair Powell will no doubt reemphasize to Congress.

US equities ended last week on a small bounce; bonds were mixed and broad USD traded slightly lower in an illiquid post-US Thanksgiving holiday session on Friday. Parsing some of the most recent developments, we’re likely still in a cluttered environment for risk in the coming weeks; Janet Yellen, as Treasury Secretary, would need Republicans to play ball on stimulus so unless the Democrats can win the Georgia run-off races – which at this stage appears unlikely compounded by Senator McConnell showing few signs of budging from the Republican 500 billion stimulus offer – the Biden administration will continue to struggle to implement a large fiscal stimulus package.

Questions around the AstraZeneca efficacy results may mean a new trial for US approval, which pushes the timeline back – though they don’t expect that to hold up permissions in the UK and EU. Anyhow, risk has so far notably struggled to follow through on its momentum since Pfizer and Moderna’s positive news.

Caution hit the oil markets ahead of the key OPEC+ meeting. The consensus seems to be pricing in an extension of the current cuts by at least three months. Still, the recent oil-price rally may have reduced OPEC’s sense of urgency and, with signs of dissent in the ranks, the possibility of the meeting falling short of those expectations is real. The oil price will react negatively if a decision on cuts is delayed, likely falling below $45/b, but is unlikely to move up meaningfully if an extension is announced. An extension still seems the most likely outcome, but risk/reward is skewed to the downside.

As we count down to OPEC’s meeting on November 30th, the Axi Expert Series is pleased to welcome Henning Gloystein, Director of Energy, Climate & Resources at Eurasia Group, to discuss his views and insights in what’s an important week for oil markets.

The pound traded lower into the weekend but is still holding on to the 1.33 handles. UK PM Johnson said the UK can “prosper mightily’ without a trade deal, Bloomberg reports; as of about 30 minutes after that interview, sterling was not liking that headline. The EU representative Michel Barnier is back in London, but a deal will require engagement from political leaders; likely a Boris/von der Leyen/Merkel/Macron call or meeting at some point over the next couple of weeks. Any sign of something like that happening would be very positive, but the longer the stalemate continues, the more ‘no-deal’ might become the path of least resistance for both sides.

The street talks about how the dollar’s medium-term outlook is about as bearish as one could get. It doesn’t feel like the usual analyst’s lip service either; traders are talking about this. The analog to the 2009 post-GFC recovery remains the obvious historical comparison.

For context, the Bloomberg Dollar Spot Index (BBDXY) dropped 16.5% off the highs in 2009 alone, while the dollar is only 12% off the highs this year despite an arguably worse outlook. The surprisingly high efficacy of vaccines brings forward the timing of the full global recovery and, with it, equity inflows to the rest of the world. Also, the twin deficits have historically led to dollar declines, and the combination of a Yellen Treasury/inflation-targeting Powell reinforces the dollar downtrend.

There was huge corporate USD demand before Thanksgiving, causing the dollar to rip higher earlier in the week on what’s normally a nothing data point for FX markets (i.e. the strong US PMI). Now, the USD demand has been fully stopped up, and there’s about to be a torrential downpour of dollar supply for month-end; it’s time to pick your favorite short dollar plays.

With EUR/USD close to the highs, conditions suggest a sustained break of 1.20:

1. Positioning is no longer extreme longs
2. The virus wave in Europe is likely peaked; the US is still raging
3. European equity inflows will pick up on rotation from Tech US to cyclical heavy EUR
4. The existential risk premium around the Euro break-up is at its lowest in years

Beyond that, the vaccine rollout has increased confidence on the positive cyclical outlook, which should favor a weaker dollar across the board.

Bottom line, everything that was pointing us towards caution on the Euro in September has now turned.