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Trains, Planes, And Automobiles

Stephen Innes

So far, US equity markets have continued to react at the sector level and not at the broader index level. This is probably due to the bulk of the market risk concentrated in stocks not directly exposed to current market worries. If the flu does spread, then the defensive macro allocation game plans will probably kick in with full force.

In the meantime, traders are weighing the anticipated China growth fallout against the backdrop of the current global growth recovery. While the calculus is not coming up roses, it’s far from a state of global market panic. Still, if risk aversion starts to spread beyond Chinas borders and starts to affect more than the usual suspect’s luxury, travel, and tourism, then we will likely see a more significant dive in the broader global indices. 

My head is still spinning this morning after Chinese equity markets got hammered due to concerns over the coronavirus with the CSI 300 down 3.1%. Of course, it’s hard to say fears are overblown, especially when people are dying. However, the mortality rate is around 3%, compared to SARs, which was 15%, and Ebola was 70%, so it’s hard not to argue that the Chinese sell-off was a complete overreaction due to the Lunar New Year effect. As such, price action throughout the rest of Asia should be the better proxy to gauge risk. 

Oil markets

Oil market virulent sell of on the back Wuhan flu scare was mollified by a timely decline in US crude inventories as the prompt contract recovered some lost ground after falling some 3.5% amid demand devastation fears. But is it enough to limit the carnage into the weekend, it will very much depend on the stream of outbreak headlines?

But it was a pretty vicious sell-off, and at some stage, profit taking will likely set in, even more so as traders start to contemplate if the China market sell-off was overblown. 

However, oil prices could remain on a slippery slope as traders remain incredibly twitchy about the effects of the Coronavirus outbreak could have on Chinese GDP and air travel more broadly with current estimates implying 250-300kbd of demand at risk.

China remains the most significant driver of year-on-year oil demand growth, so it’s fair to assume that the Oil markets will continue to bear the brunt of the China flu fall out. And if the virus stunts economic growth in an echo of the SARS epidemic nearly 20 years ago, the falls could be even more precipitous than projected. And there are two reasons why: 1) consumption is now a more substantial part of China’s GDP, and 2) the overall growth trajectory. In 2002, retail sales accounted for 34% of nominal GDP. This share is now 40%. 

But significantly for oil markets consumption of services, like transport (related to tourism), has also increased exponentially. Using the SARS epidemic as a lens: In 2002 from a sector perspective, the transport sector was the worst-hit, followed by accommodation and catering, and other services (culture, entertainment, education, social service, etc.)

There is an extremely tight linkage between Chinas economic growth and its appetite for oil.

Although the Libyan supply disruption has been falling through the cracks, their production faces falling by ~1Mbd very shortly unless the pipeline blockade is lifted – the market appears to be assuming it will.

Gold markets

Gold prices remain supported by defensive positioning due to the unknowns around the coronavirus. 

The patterns can look random. But some health experts have predicted, based on the SARS epidemic 17 years ago, that the coronavirus has now entered a more explosive phase of growth, which could potentially reach its peak in March, before tapering off in May. The upcoming Chinese New Year holiday looks to be a sure-fire catalyst. In 2019, an estimated 3 billion trips were made during this national holiday. And despite China-wide multiple city lockdowns, the fact the virus has spread to Singapore, an overly scrutinized customs entry point, suggests the best window for controlling the infection may have passed.

So, if the virus continues to spread, and at a faster pace in the coming months, it will represent another significant headwind to growth. Given how early we are in the newfound growth cycle, more policy easing will be needed to support growth, which could be viewed as bullish for gold. A policy response from the PBoC is a given, but the big question is if the Feds need to react.  

But the virus in itself is not the primary reason to keep your percentage allocation in gold more elevated than usual. 

With the FOMC next week, all eye and ears will be honed on Chair Powell’s state of the economy address. Still, more specifically, Chairman Powell will be grilled about the financial stability risks created via the Fed’s liquidity injection via balance sheet expansion. There’s no blueprint for unwinding the balance sheet without some element of risk. But the fear heading into the next week’s meeting is a communication misstep as he will need to communicate a temporary pause in the Fed’s repo activities. Still, a misstatement could easily trigger a huge adverse market reaction. This in itself demands some protection either via long gold on downside JPY structures. 

 Gold investors appear willing to increase gold allocation on dips ahead of “Super Tuesday “US election risk. And as a hedge against trade tensions reigniting, but broadly speaking, they haven’t brought out the big guns just yet. 

But overall, it remains a very comfortable environment to own gold with US yields drifting lower and 10-year TIPS lingering around the lower end of the range. The more prolonged low yield environment continues to add to golds allure as a must-have hedge against the backdrop of a plethora of market uncertainties. 

But these strategies along with the January seasonality support might be worth reassessing on a clean break of $ 1540/oz

Currency Markets 

The Ringgit 

The BNM, pre-emptive rate cut, has triggered a strong demand for the bond market duration, and those market inflows have been supportive of the Ringgit.

 Consumption and household spending had been slowing, so the interest cut should provide a decent economic boost where it’s most needed and could prove suitable for equity market risk if the stimulus efforts prevent growth from falling below 4 %.

Australian dollar

The unemployment rate headlined stronger overnight at 5.1% (expected 5.2%), and the market drove Aussie higher. The initial assumption was that RBA would now hold back on easing during the next meeting on Feb. 4, and expectations for a cut came off from 50% to 30%. However, at a closer look, the data is no cause for celebration. The entire employment gain came from the addition of low skilled part-time jobs.

With Yuan proxy risk-taking hold, there was a relatively deep dive lower overnight before some semblance of risk appetite returned as the market started to factor in China market sell-off overshoot. 

This article was written by Stephen Innes, Asia Pacific Market Strategist at AxiTrader 

This article was originally posted on FX Empire

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