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Beneath the Glossy Veneer of US Equity Markets

Stephen Innes
Appearances can be deceiving, while the devil is always in the detail.

When it comes to low-grade GDP prints, Friday’s US Q1 report was mediocre at best. On the surface, the 3.2% GDP print was far better than the expected, but don’t pop the champagne corks just yet as beneath the hood, and a glossy veneer of US equity markets sits the sputtering US economic engine running low on gas  as personal consumption slowed dramatically while the GDP deflator showed even weaker inflation pressures than expected.

But at the end of a hectic week for earnings reports, investors are left scrutinizing the good with the bad and despite nascent signs of GDP growth braking over the next 12 months as fiscal stimulus updraft fades, US stocks closed at record highs supported by an increased likelihood of an indefinite Fed pause.

While employment and US growth data are very passable, however, it is the feeble inflation prints which suggest a Fed policy which could move in any which way but higher.

I think everyone agrees that we are getting much better than expected Q1 earning beats after over 50% of the market cap has announced, but with S&P positioning getting overly extended, from a pure gut instinct perspective, much to my quants chagrin, I’m getting a tad nervous.

We have flipped from a state where it is a stock rally no one wants to take part into a frenzied paced splurge where hedge funds and investors alike continue to chase markets like greyhounds to the mechanical rabbit.

While this could be more of a function that many funds had remained seriously underinvested and that April equity inflow was an exposure normalization function, it doesn’t alleviate the fact that this market is bordering on recklessly bullish as early warning signals about the flagging state of the US economy are gradually sounding off.

Oil markets

When Trump Tweets, Oil markets take note.

Oil markets are not receptive to surprises or uncertainty, and there was certainly enough of that flying around on Friday when oil futures suffered the most significant drop in two months after Trump pledged to put pressure on OPEC and drive oil prices lower.

However, before the Trump twitter tirade, the rally was showing signs of fizzling out after reports surfaced that there were ample supplies at hand to replace the Russian contaminated oil, a catalyst that pushed Brent +$75 this week. While the gradual recognition that OPEC has more than enough spare capacity to offset all but the most severe of scenarios from the loss of Iran barrels was starting to take hold. Which of course continued to dampen sentiment.

But indeed, it was the Presidents tweet suggesting he “called OPEC” insisting the cartel push prices lower that toppled a  top-heavy positioned market and triggering a massive long liquidation squeeze heading into the weekend. Regardless of whether he spoke to OPEC or not the President sure does have a weird way of catching Oil markets completely wrong-footed for his self-serving policy agenda.

After selling out on a break of $ 75 last week we have been sitting idle looking to buy on the next move higher,  but this long liquidation squeeze does offer up some intriguing possibilities.  Historically these types of moves are typically associated with weaker and or freshly minted longs heading for the exit. So subject to market follow through at the London open, and despite all the market noise on Friday, this significant dip could look attractive.

We still think OPEC will be careful not to signal a rapid supply response to the Iran waivers, having a preference, regardless of President Trump’s consternation, to let prices drift higher until demand side pressure starts to mount. Keeping in mind, the market has been tunnel vision focused on Iran sanctions waivers, but we should not lose sight of the swamp in Venezuela nor the tenuous state of affairs in Libya as both these hotspots should continue to support oil prices.

China markets

Chinas unbridled economic stimulus is but a distant memory

With the days of China’s unbridled economic stimulus is but a distant memory, it is clear policymakers are moving to a more neutral policy in the wake of last weeks Politburo Economic Committee statement implying any further stimuli should be more cautious and targeted. This shift is very much in line with the latest Pboc policy statement. And the proof is in the pudding with 7-day fixed repo rate teetering just below 3%, reflecting this less dovish stance, but with that said, rest assured it’s unlikely we will see any tightening given mainland’s soft landing is just starting to show up in the data.

But stimulus anxieties were weighing on investor sentiment last week as everyone is on tenterhooks patiently awaiting the next series of crucial economic data to give the always fidgety China bull market a fresh set of catalysts to move on.

On the currency front and not out of line with past policy measures ahead of what could be the final lap in these marathons like trade talks, as US-China trade negotiations resume this week and likely leading to a Trump -Xi summit. The Pboc printed a much stronger Yuan fix last week followed by President Xi’s comment that China will not purse RMB depreciation policy. China watchers will take this as a significant currency signal as President Xi seldom if ever weighs in on currency policy. Not only did this move halt the surging Greenback in its track but it cements our view that topside risk for the USD/RMB is minimal. Given the fundamentals should remain positive amid various “ inclusion” inflows which are expected to pick up, the path of least resistance appears lower for USDCNH for here.

So, with a trade deal around the corner and a much sooner than expected cohesion in China growth, we continue to favor USDCNH lower.

The Rest of Asia

But within the broader EM landscape, Asia continues to sit at the high end of the teeter totter

Some EM contagion ”heebies jeebies” on the back of Brazil, Turkey and Argentina are probably the cause of  Asia EM worrisome outflows; higher oil prices and the surging US dollar looking poised to move through EM Asia like a wrecking ball, notwithstanding.

But within the broader EM landscape, Asia continues to sit at the high end of the teeter totter. Positive PMI prints continue to lend support while investors remain ever so hopeful that a US-China trade deal is around the corner. Inflation is lukewarm suggesting it will not be a policy hindrance while capital market policy liberalization in both China and India continues to take root as both local economic behemoths look to internationalize their currencies.

Of course, the fallout from higher oil prices can weigh negatively especially for the PHP, INR and the KRW which could suffer the most significant current account abrasion, but higher oil prices don’t seem to be so much of a negative sentiment factor this time around as traders are not expecting oil prices to hold last weeks lofty levels.

The US dollar is always a concern knowing the strong dollar has the potential to move like a wrecking ball through EM Asia. When the USD starts to assert itself globally, it becomes even more expensive for  Asia EM borrowers to service their burdensome US dollar debt, so the strong dollar is usually correlated with local equity market sell-off suggesting few surprises here from last week’s equity market price action.

Oil prices should temper given they are being artificially manipulated higher, the USD dollar should weaken as the Fed pause extends indefinitely while EM contagion into Asia should remain mild as China’s economic engine fires on all cylinders on a strong credit impulse and a US-China trade deal. All of which suggests, EM Asia might not be the wrong place to hang one’s investor cap.

Gold markets

Consider the Macro perspective.

Bond market took center stage providing the clearest signal to gold traders after the release of an ambiguous US Q1 GDP. Peeling back the layers, the FOMC will disregard swell in growth and focus on n the dispiriting core personal consumption expenditure (PCE) price index, which increased at only 1.3%. The PCE is the Fed’s preferred metric of inflation and knowing that board members remain focused on inflation divergence, bond traders were quick to reprice the yield curve lower triggering a sharp short-covering rally in Gold.

However, markets had been stabilizing within the $1272-75 channel as the focus was shifting back to global economic divergence. Which saw prices steadily move higher driven by short covering and systematic buying, However, with the GDP print showing signs the US economy could slow later this year, gold could fast become a hot commodity again as the likelihood of Fed policy easing gets increasingly factored into the equation.

All the while central bank physical purchases are a growing policy trend of reserve diversification and continues to supply a reliable backstop for gold investors.

Given the markets are starting to price in a dovish shift from the FOMC, the big question now is, do the Feds support a hiking bias? Currently, the median dot shows a hike in 2020. Even Clarida, one of the blatant advocates on inflation targeting, notes that the “economy is in the right place … unemployment is near the lowest level in 50 years.” So, all eyes on will be on the Fed meeting this week.

Currency markets

US Dollar

The bar is very high for an even stronger USD response after last weeks GDP deflator miss

Since the bar is very high for an even stronger USD response after last weeks GDP deflator miss, I am still playing in the weaker USD sandbox. Which by the adverse reactions I am getting from my colleagues suggests I am either going to be a triumphant contrarian victor or an even more miserable loser as we pivot to this week’s starlit calendar of massive news flows. We have both the FED and BOE policy meeting on tap, a deluge of data including the Granddad of them all the US  NFP, as AHE will be an essential market focus. On top of all that, US-China trade talks restarts and earning data resumes on both sides of the pond. And of course, the results of Spain snap election which will come out after I publish my report,(5 PM EST) offers up a bit of political intrigue to the beleaguered  EU economic landscape.

The Malaysian Ringgit

BNM  appears pledged to right the mini-bond market panic

On the back of the lower than expected US GDP deflator the Ringgit will likely get a short-term reprieve as US bond yields collapsed when  traders repriced the US yield curve lower planning for a US FED rate cut, but we expect initial support to hold 4.1250 as lingering BNM dovish expectations persist

However, the market is starting to push back these expectations to July after the capital markets and currency volatility on the back of the FTSE WGBI. Although I am still holding my rate cut view as transitory market conditions have historically never factored into BNM policy settings.

None the less, BNM appears pledged to right the muni-bond market panic as according to their latest press release they are ready to supply adequate dollar liquidity in the face of any such potential outflows. Also, word around Kuala Lumpur suggests local funds have more than ample resources to soak up any possible offshore exodus.

Crypto markets

Crypto Coins merely display positive price elasticity

Bitcoin

While continually trying to make sense of this space, I’m more convinced than ever after the latest rise and fall of BTC that Cryptocurrencies do not correlate with anything tangible, but just like real estate prices during the housing bubble, Crypto Coins merely display positive price elasticity. When the price is rising, investors are attracted to buy more and more, and therefore I surmise the opposite holds. But to suggest that Bitcoin is correlated to anything is just not valid.

The big mystery I have is if we cannot define why we are buying, why does this market move at such feverish pitches? Technical foreshadowing? Nope. Inflation? Nope, Cheap Fed policy? Nope. De Facto currency aspirations?  Nope. Tail risk hedge? Nope. FOMO? Yes!!!!

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

This article was originally posted on FX Empire

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