It’s been a relatively sluggish start to the week as one can imagine and the lack of activity on the big-ticket market items like US bonds and stocks make it challenging to get a good read on investor sentiment.
But overall, it is this seemingly never-ending pandemic threat that continues to loom.
However, any hints of risk aversion dotting the market scrim have been little more than taking profit from winners. The dual policy puts from monetary and fiscal policy succour, and the vaccine rollout, as logistically challenging that looks to be, still points to gleaming days ahead.
It is hard not to like the sound of the Biden administration’s overarching focus on public health and economic responses to the COVID-19 pandemic. A crucial part will involve distributing vaccines to hundreds of millions during the administrations’ first year.
Indeed, it should be the Biden administration’s roll-out policy of vaccinations, not the timing of taxations that should continue to resonate with investors.
But notably, even as the coronavirus runs amok, this positive policy elixir provides a resounding backstop tempering volatility sensitive strategies while always keeping investors safely away from re-entering the pandemic doom loop.
Democrats will control Washington’s policy agenda over the next two years. Hence, investors continued to bounce Biden’s pro-growth policy against the significant pick in federal spending in response to the COVID-19 pandemic.
Most discussions revolve around who will pay for it after President-elect Joe Biden mentioned last week that everyone would pay their fair share for the stimulus package, bringing the focus back onto taxes when the market has been pretty comfortable assuming they won’t come until late 2021 or early 2022.
Still, Democrats may need to push back specific COVID-19 spending priorities that don’t get sufficient Republican support – like direct support for state and local governments – to a reconciliation measure that only needs majority approval in the Senate.
Democrats will chip away parts of the 2017 Trump tax cuts. And while the extensive scale tax rewrite is coming, the market is uncertain over the timing. But it’s suspected Democrats will use the reconciliation process to make targeted tax reforms.
This package’s cornerstone is likely to be higher corporate tax rates and higher income tax rates for wealthier Americans.
But at the end of the day, even with majorities in both Congress chambers, Democrats will have difficulty advancing a bold, progressive policy agenda due to a razor-thin narrow majority. And its likely policy uncertainty creates a high level of discord and could lead to periods of market disharmony.
Oil slips again
In a typical case of coronavirus-induced fears spreading across global markets, almost predictably oil prices are off from last week’s highs as sentiment cooled with swelling production inventories then fused with the return of COVID in China providing a not-so-rosy near-term demand signal.
Adding to the slippery drift to the downside flow is the slow roll-out of vaccines globally which are walking back the timeline for jet fuel demand to take off.
The shift lower in oil prices is a technical correction to a large degree as it is a COVID driven sentiment sell-off. And while oil market risk appetite can remain at high levels for extended periods as long as the macro environment remains supportive.
The US data has been less encouraging lately. However, yesterday’ Q4 China GDP data provided a festive reminder that China’s economy continues to fire on all cylinders and brought with it dip-buying support.
Overall, the policy mixes between OPEC+ current supply discipline coalescing with the Biden’s administration’s overarching focus on public health and economic responses to the COVID-19 pandemic, suggest oil prices can go much higher.
The current headwinds from a stronger USD and evidence that the coronavirus continues to spread are clouding the demand outlook. It should come as no surprise that Q1 2021 continues to reflect a complex and uncertain demand environment for oil. And the strong rally for oil into year-end 2020 and in the first week of 2021 has left the price-sensitive to profit-taking.
I expect oil to stabilize near the current level as progress is made on the coronavirus vaccine roll-out. As we move closer on the path to a typical demand environment, oil prices will then soar.
With the Biden inauguration stealing the limelight this week, traders are still a tad concerned about a foreign policy pivot. One of the wild cards for oil this year is the upside to Iranian production (dependent on the potential lifting of US sanctions under incoming President Biden).
The signs the US dollar upswing is about to pause as significant technical support/resistance levels continue to hold, especially as risk sentiment stabilizes lessening the demand for “safe-haven” dollars.
Despite the recent US dollar correction, EURUSD should remain supported by a robust European recovery and a large fiscal stimulus package in the US.
US Federal Reserve Chair Powell’s assessment last week was dovish and caused a push back in FED taper expectations to September for December. And with gold buying into that narrative coupled with the recent unwinding of cash and option longs and fresh downside buying, it has led to a sell-off in risk reversals.
The FX market seems set for an extended first-quarter lull if not the graveyard as the EURUSD hashes out new ranges. The 10y US yields ran out of steam ahead of 1.2% and have consolidated around 10bp lower, leaving short dollar sentiment bruised but not broken.
The immediate future for FX markets is about as “spaghetti at the wall” unclear on several fronts. Still, the next US dollar leg lower should restart in the second quarter when the taper dust settles, oil price move higher, and reflation trade soars.