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Market Update
US equities snapped a three-day win streak on Thursday amid some modest profit-taking following the week’s impressive gains, as well as perhaps an added dose of caution as European nations continue to tighten pandemic curbs (most notably the UK this week). The S&P 500 closed out the session down 0.7% in the 4660s, though that still left it close to 3.0% up on the week. In pre-market trade, S&P 500 futures are up about 0.3% and back in the 4680, while European equities also trade (mostly) in the green.
The market mood is understandably tentative ahead of an important US inflation release at 1330GMT. The median economist forecast is for the YoY rate of headline US CPI to reach 6.8% in November, though the range of estimates varies from the low 6.0%s to above 7.0%. President Biden, who gets to see important economic data a day before its release, made a public comment yesterday suggesting that the upcoming inflation release isn’t indicative of the recent drop in US energy prices, which led to some analysts speculating that Biden is pre-emptively trying to play down concerns about a higher-than-expected inflation print. According to Matthias Scheiber, global head of portfolio management at All spring Global Investments, “it’s likely the base number won’t look great, it’s quite a rise expected compared to previous months”. However, Scheiber said other indicators such as supply chain statistics suggested inflation could stabilise in the medium term.
Analysts note that any upside inflation surprise might encourage the Fed to further quicken the pace monetary tightening. Fed Chair Powell already hinted last week that the bank would discuss accelerating to QE taper at next week’s meeting. But analysts have noted an important change in tone at the Fed as of late; where the bank before emphasised that raising rates to quickly was a risk to the labour market recovery, the bank has pivoted to emphasising that high inflation may now be a risk to the labour market recovery. That suggests that the higher inflation goes, the more the bank will be inclined to control it (via higher interest rates) to protect the labour market, which (by the way) is arguably already back to full employment judging by yesterday’s weekly jobless claims report, that saw initial claims fall to their lowest since 1969 at 184K. Whilst money markets (depending on how you gauge this) are pointing at two hikes from the Fed next year, some are warning of the risk that might hike as soon as the end of Q1, which could open the door for three rate hikes. If such a hawkish Fed shift to respond to inflation was forthcoming this would probably be a big bullish driver for the dollar as short-end yields surge, while the outlook for longer-term yields and equities would be more mixed/potentially negative if investors deem the Fed’s hawkish pivot as bad for long-term growth.
Back to the markets tone this morning; the mood around Omicron remains broadly positive, hence why risk assets (stocks and oil) have managed to hold onto the bulk of this week’s gains, despite modest selling over the past day or two. Analysts at Reuters note that “the market’s optimism on Omicron could change quickly… Investors were focusing on low hospitalisation rates as reason to believe the variant would not derail global growth, but new restrictions in Europe underlined the potential threat.” As markets mull the theme of the pandemic and eye the upcoming US inflation report, yields across the US treasury curve are a tad higher, with the US 2-year pushing to a fresh post pandemic high above 0.72% and the 10-year rising about 3bps to around 1.45% (still over 20bps below pre-Omicron levels). The dollar is also trading on the front foot, with the DXY pushing back towards weekly highs in the 96.50 area. According to Chris Weston, head of research at Pepperstone, “judging by the way the dollar is trading … I’d argue traders are positioning for a higher CPI print which cements a view that the Fed will increase the pace of tapering its QE programme.”
Crude oil, meanwhile, is a little higher this morning, with WTI up about $1.0 to the mid-$71.00s, as some of yesterday’s gains are eroded. As a result, oil remains on course to post its best weekly run since August. In terms of FX markets, the tone is broadly quite subdued, with the US dollar, Aussie and Canadian dollars and Norwegian crone the best performers, with the DXY positioning itself ahead of CPI data as already mentioned, and the others performing well amid favourable underlying moves in commodity prices. For reference, copper is also higher this morning, with analysts attributing efforts by Chinese authorities to boost growth (PBoC RRR and relending rate cuts and more recent efforts to curb CNY appreciation to boost exports). For reference, AUDUSD is trading broadly flat around 0.7150 and USDCAD is broadly flat in the 1.2700 area.
You then have the rest of the G10 currencies which are between 0.2-0.3% lower on the day versus the buck and broadly trading as a function of dollar flows rather than domestic themes. In terms of the majors, EURUSD is in the 1.1260s, USDJPY is in the 113.75 area and GBPUSD continues to trade close to 1.3200. Not that there hasn’t been some interest non-US data for markets participants to keep an eye on; MoM UK GDP growth numbers were out this morning and the country posted lower than expected growth of 0.1% on the month (expectations were for 0.4%), sharply slower than September’s 0.6% reading, a concerning slowdown given that the UK has since seen the emergence of the Omicron variant in November and the reimposition of some restrictions in December.
Analysts have interpreted the UK’s pandemic curbs and weak economic data as having a further dampening effect on expectations that the Bank of England will raise rates at next week’s meeting. According to Reuters, “money market futures are now pricing in a 38% probability of a 15-bps rate hike next week, compared with 46% on Wednesday and nearly 70% at the start of last week”. Analysts at Commerzbank warn that “recent developments surrounding Omicron are now even causing doubts about a hike in February.” If the market believes that a rate hike is only being postponed to February, the bank continued, “sterling is unlikely to come under severe depreciation pressure… (but) if the BoE gives reasons to doubt this, sterling might depreciate further.” The YTD low just under 1.3200 for GBPUSD thus looks highly vulnerable, and that’s not even taking into account upside risks for the dollar amid high inflation/a potentially more hawkish Fed.
Day Ahead
US CPI at 1330GMT is of course the main event of the day, but traders should also be an eye on the release of the preliminary US University of Michigan Consumer Sentiment survey which is out at 1500GMT. Otherwise, traders should watch the latest headlines on Omicron for further information on 1) transmissibility (seems very high), 2) vaccine effectiveness (still not clear, but they still seem somewhat effective) and 3) severity (illness associated with Omicron infection seems very mild versus delta).
