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Stephen Innes
Federal Reserve Building

Great jobs number aside – with the FED in total pause mode does it even matter?

Traders appear fearless knowing that Chair Powell message was unambiguously clear that the S&P strength is not going to be a policy prohibiting factor as it was all on board the US equity party bus.

So, with inflation risk premiums falling on the data, the Fed pause extends indefinitely as its clear from my chair anyway that inflation expectations are the latest embodiments of “forward guidance” for this shifty FOMC. Indeed, policy guideposts have moved from calendar-based rate hikes, jobs report signals to actual inflation levels and now to inflation expectations.

But trust me there will come a day when the Fed is staring down the barrel of a 2% + inflation rate, but we cannot say the Fed Chair did not prepare us for that eventuality.

With many of Wall Street bears toppling by the wayside, so why is this long-time equity bull always jittery?

There is the not so small matter of divergent global growth metrics.  China bounce is much less convincing in the wake of the recent data. The E.U. data is still sickly as ever while the U.S. continues to chug along. Frankly, I do not feel entirely convinced until we see the re-coupling of these historical global economic correlations without which we could see investment sentiment waffle during the rest of 2019 and beyond.

Oil markets

The broad selloff in the oil complex last was due to shifting near term sentiment as investors grew increasingly concerned about a surge in U.S. production after hitting a record 12.3 million bpd amidst swelling U.S. inventories. And as the potential avalanche of geopolitical tail risks, the primary catalysts that propelled crude above $75 in late April, have failed to crystallize.

However, the swelling U.S. production and inventories price response has amplified bearish price distortions despite the stockpile bulge primarily a function of the scheduled maintenance period. But indeed, this bearish feedback loop unfolding in the prompt contracts belies the markets bullish term structure with time spreads suggesting U.S. market tightness is in the cards.

Oil trader to a tee will tell you increasingly higher backwardation is a hugely crucial leading indicator of market supply sentient.

But at least for the time being, rising U.S. production and inventory gluts are upstaging worries that tensions arising in Iran, Venezuela and Libya would limit global supplies.

And to no lesser degree oil prices were weighed down by a combination of concerns about global demand growth, and the OPEC+ production cut deal.

Global PMI’s are weak, but with fears that China will not begin with an infrastructure-led growth spurt continuing to dampen base metal prices, there could be some spill over into Oil prices.

Russian production data for April showed a continued failure to follow the quota agreed with OPEC But this is a case of bad optics as opposed to s huge fundamental driver given the difference is small in the big scheme of things. However, OPEC+ is still committed to solidifying a floor on prices.

Despite last weeks chatter suggesting US-China trade talks hit a deadlock, but a massive catalyst for the markets and oil prices in general is whether, and in what structure a US-China trade deal is sealed. Frankly, I do not think the agreement is in the price especially one that calls for a reversal of some punitive tariffs.

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Gold markets

Gold prices surged despite the strong jobs report as trader turned focus to the implied inflation metrics as bond markets are supplying the most unambiguous signals suggesting the FED will be on an extended pause for the foreseeable future which weakened the USD and provided a boost to Gold sentiment.

With the Fed on an indefinite pause, the underlying fundamentals for gold remain strong with central banks continuing to add as de-dollarization is expected to pick up even after a solid year of buying in 2018.

While asset rotation into U.S. equity markets has dented golds glitter but in a world with low and negative real yields suggesting central bank remain incredibly vigilant about economic growth, it supplies a convincing enough signal to buy gold.

Currency Markets

The Australian Dollar

Big week for the A$ as the RBA falls under the magnifier. But when an RBA dove meets up with the soft base metals story potentially threatening non-oil-linked commodity currencies, it would suggest the Aussie is primed to move significantly below the fundamental .7000 level. This pivot point is huge since A$ has only closed below that level once in the last two years.

On the RBA rate cut front, the markets continue to flutter between 40-45 % rate cut probability whereas I have it at 70 %  for no other reason than taking my cues from the banks  CPI and GDP downgrades which suggest the RBA faces an enormous uphill battle to get inflation anywhere inside their projected bands.

So, with inflation running belligerently below targets and as the RBA is primarily tasked to keep inflation ~2.5 % over time, I am more convinced now that at any time in the past six months the RBA  will cut interest rates by 25 bps.

Also, the RBA has never been held hostage to federal elections in the past and unlikely to be held so this time around.

The Malaysian Ringgit

Despite a broadly weaker USD vs G-10 post-NFP, the MYR will come under renewed pressure this week amidst falling crude prices, slightly more nervous export sector and of course as focus shifts to the critical BNM rate decision.

However, with the Fed raising the bar for a US rate cut in2019 it could lead the BNM to pause for thought as a rate cut could lead to outsized currency volatility while preferring to delay the inevitable until July.

However, I think they will cut as inflation still is well below target amidst their downward revision to growth projections.

With US-China trade talks hitting an impasse last week although I think a deal will be signed shortly. The regional impact will come down to what form the agreement will take as far as the reduction of punitive US tariffs. The smaller the tariff reduction the meeker the impact. At this time, I view the trade deal with many tariffs held in place already baked into the currency markets so the only sizable positive currency impact will be if the first tariffs are significantly reduced beyond 25%.

But for local risk sentiment, given the high degree of focus on China stimulus, all eyes will be on to what degree China tightens liquidity after returning from Golden week.

Overall it is shaping up to be a busy week for the Ringgit.

This article was written by Stephen Innes, Head of Trading and Market Strategy at SPI Asset Management

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