Since 2009, the Fed has focused on financial markets, hoping to impact jobs and growth. But Powell’s testimony last week suggests it now wants higher interest and inflation rates to confirm a recovery in the real economy.
Oil
Brent moved higher early in the week on news that 30mb of Texas output would likely be lost due to the freeze. It then fell back to close at $64.63/bbl. Geopolitics are likely to be key to the outlook.
✦ HIGHLIGHTS
- Market prices are now back at pre-pandemic highs – but only because of major OPEC+/shale cutbacks
- They are also within touching distance of the technical resistance level established since the 2014 price collapse
- Biden’s release of the CIA report suggesting Saudi’s Crown Prince approved Khashoggi’s murder confirms the end of MbS’ cosy relationship with Trump
- It also means Saudi has lost its veto over Biden’s planned re-start of Iran talks, which could lead to a quick end to oil sanctions
- Saudi has only limited options when it comes to increasing its exports, as Iran already has a major deal with China, and US imports are now relatively low
- Biden’s actions also mean the Crown Prince’s position may start to be questioned by other Saudi royals
WATCH FOR
WATCH FORSaudi’s leadership of OPEC+ to come under pressure if it tries to monopolise any increase in output
S&P 500
Despit a bright start, the S&P fell 2.4% to 3811, whilst the VIX volatility index jumped to 28
✦ HIGHLIGHTS
- Investors have seen themselves in a perfect world, with talk of stimulus further boosting market sentiment
- But pressure is clearly mounting on the equities bubble
- ‘Buy on the rumour, sell on the news’ is always a sign of a weak market – and news that Biden’s $1.9tn stimulus has passed the House brings that moment closer
- The major bubble stocks led the downturn, with Tesla down 14% and the Nasdaq down 5%
- Retail ‘investors’ haven’t yet got the message, though, with Gamestop doubling in a few hours on Wednesday/Thursday
WATCH FOR
Rising interest rates to continue weighing on equities.
Interest rates
The rate moved up again to 1.46%, whilst the MOVE volatility index jumped 25% to 76.
✦ HIGHLIGHTS
- The rate is now at a key technical resistance point, with any move higher likely to take it rapidly towards the 2% level
- Buffett is on the side of the bears, suggesting “Fixed-income investors worldwide – whether pension funds, insurance, companies or retirees – face a bleak future”
- Thursday was a bad day, with confidence hit by an “extraordinarily weak” $62bn auction of 7yr Treasury notes.
- At the same time, the US 5yr bond rose from 0.61% to 0.80% in a single session
- Investors are starting to realise that the Fed would now like inflation to move well beyond its target 2% level, to support its growth narrative
WATCH FOR
The Fed’s tacit support to encourage investors to push rates higher
Global liquidity
A weakening dollar increases liquidity, and generally supports rising stock markets. The chart suggests we may be close to a peak.
✦ HIGHLIGHTS
- The US$ has moved in a regular cycle over the past 40 years versus the Euro (the world’s second most important currency) and its predecessor the Deutschmark
- A rising dollar tends to decrease global liquidity, as prices become more expensive for those outside the dollar zone; and liquidity rises as the dollar weakens
- Rising liquidity is also good news for stock markets as it makes it easier for investors to obtain cash
- As the chart shows, there has been a reasonable correlation between rises/falls in the annual change in (a) the Euro’s rate versus the US$ and (b) rises/falls in the S&P500
- The cycle tends to reverse when the Euro has risen 18%, or fallen by 12%
- The Euro is currently up around 11%, so liquidity could have further to grow. But rising US interest rates would likely lead to a reversal as investors bought the US$ again
WATCH FOR
Consensus thinking is usually wrong at turning points. It currently expects a new decline in the US% to boost global stock markets.
Summary
Investors prefer a simple story and dislike uncertainty. Geopolitical developments in the Middle East, and the Fed’s support for higher interest rates, may therefore start to impact confidence.
Oil
S&P 500
Interest rates
Market view today
Some concerns
Some concerns
Expecting inflation
Our current view
Negative
Reversion to mean inevitable
Expect long-term deflation
Positioning began
December 2020
December 2020
December 2020
Confidence level
Initial
Today
.
.
.
Relevant positioning
Waiting for reality to dawn
Waiting for reality to dawn
Expecting higher rates for the 10-year and longer-dated Treasuries
Confidence level: 
= 100%, = 75%, = 50%, 
= 25%
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