Divergence

Biden promises more stimulus

President-elect Biden signalled his intention to spend “trillions of dollars” on Friday, notably increasing direct payments to American taxpayers to USD 2000.00. As I have touched on previously, the Byrd Rule will make that harder than the markets want to acknowledge unless the Democrats can muster 60 votes in the Senate. Not least because some of the Democrats Senators themselves are very much more to the centre-right of the political spectrum.

The stimulus talk was music to the ears of the equity market buy-everything, global recovery, FOMO-nistas, with Wall Street enjoying another positive session. The response was less enthusiastic in the US bond markets, where US yields continued to grind higher, with the key US 10-year rising above 1.10% to nearly 1.12%. Someone must pay for those trillions. The expectation that the US government will become the Caligula’s of bond issuance is fraying nerves and causing the buy-everything trade to diverge into just almost-everything.

Energy markets continued to track higher with the Biden “New Deal” expected to boost US consumption, dovetailing nicely with the anticipated vaccine-led global recovery. Mostly, it is because of Saudi Arabia’s unilateral production cut, which is squeezing backwardation in the futures markets. Base metals also remain near highs, driven by the consumption-boosting factors outlined above.

Rate-sensitive currency and precious marks though are diverging from the script. It is a strange world we live in, when a rise through 1.0% by a US yield benchmark sparks panic in some corners of the financial world. In nominal terms, let alone real terms, that is still almost free money the US government can borrow at for ten years. Still, it is expectations that count, and some parts of the financial markets are clearly worried that the rise in yields is just starting. Above market expectations for US inflation prints later this week would likely increase the disquiet.

Currency and precious markets are the most notable casualties of the divergence in market sentiment. As US yields have risen in the past week, so has the US dollar. With the next FOMC meeting not until the end of January, the squeeze in US yields and by default, the US dollar could still have a few weeks to run. If no signal emerges from that meeting about where the Fed is happy for rates to rise to, the pain could continue for US dollar shorts well into February. That pain is, in no small part, driven by the world being short US dollars to the eyeballs against everything, having been happy sellers for most of 2020.

One small consolation to dollar bears is that in my experience, which dates to before mobile phones- sorry, I mean devices – the first big move of the year is almost always the wrong one. As a proud US dollar bear, a two-month washout of long positions to start 2021 will perversely, make me a happy bunny.

Precious metals are also suffering, with gold extremely sensitive to the real interest rate differential versus US yields. US real interest rates became less negative on Friday. That pushed gold down through USD1900.00 an ounce with a short-term market having got itself very long last Monday. That produced a chart that looked very Bitcoin-esque on Friday, with gold plunging USD64 an ounce, or 3.35% to USD1840.00 an ounce. The misery continues today, but more on that later.

President Trump is now a higher risk factor than ever. I fear that markets are not pricing in just how much of a finale President Trump intends to make his last nine days in office. Ties with Taiwan were eased over the weekend, and I have a sinking feeling this story may have more to give. The President will almost certainly generate more fireworks this week. That could spur flows into haven US dollars, possibly cause equities to wobble, but may provide a lifeline to a beleaguered gold market.

We could talk about the nuances of the world inflation releases this week. I’ll summarise though so we can move on quickly. China’s appears to have bottomed this morning, driven by commodities. Europe and Japan have none, and Godot will probably arrive before it does. The US should print around 1.60% but may print higher. Oh yes, US earnings season starts on Friday.

With that incisive analysis now out of the way, we can concentrate on where the real source of risk and volatility this week lies. And that, dear readers, is well and truly centred on the White House and Washington DC.

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