Barring a late rally on Wall Street, the major global indices are set to close lower for the second consecutive week, with technology shares being the weakest. Gold and silver were also down on the week, after the US dollar index staged a recovery attempt, as bond yields rose again on the week. Crude and copper prices eased off their highs amid a mild risk-off tone emitting from the stock markets, but the ongoing reflation trade kept these commodity prices near their recent highs. Cryptos had a down week for a change as investors took profit but were coming off their lows when this report was being written.
The top 3 key events and factors to watch in the week ahead include:
- Bond yields: Will the bond market sell-off continue, pushing yields further higher?
- Key data: US monthly nonfarm jobs report is the week’s key data release, but we will also have global PMIs and other important data to provide a snapshot of the health of the global economy as investors speculate about the timing of QE reduction.
- OPEC + dilemma: Ease production curbs too quickly and risk a price reversal, while moving too slowly could mean risk of losing more market share to US and other non-OPEC producers.
The key talking point in the week ahead will again be centred on the rapidly rising government bond yields. The bond market sell-off accelerated this week, pushing yields to fresh highs on the year:
Source: ThinkMarkets and TradingView.com
Speculation has been growing that inflation will be the result of a potentially strong economic recovery when lockdowns slowly end with the vaccine rollouts, and with so much stimulus money flooding the financial markets. The rationale follows that central banks will then have to tighten their belts faster to prevent prices from overheating.
Soaring yields are not good if you are bullish on gold and to a lesser degree silver, as this increases the opportunity cost of holding assets that pay no interest or dividends. So precious metals are in danger of potentially dropping sharply next week, unless yields ease back.
In so far as the stock markets are concerned, well it is without a doubt that rising bond yields are starting to erode the attractiveness of certain sectors. The dividend yield on the S&P 500 is estimated to be around 1.5%, close to what the 10-year bond is paying. So, if bond yields continue to rise, this could be bad news for stocks, as yield-seeking investors could make equally good or better returns by holding longer-dated government debt. Obviously, banks being excluded because lenders tend to rise in share value when interest rate expectations are on the ascendency. This is because charging interest is banks' main source of income.
One particular sector that could be negatively impacted by further rises in yields is technology. Growth stocks, especially in technology, were the main driving force behind the 2020 stock market rally as investors piled into the “stay-at-home” trade, as shares of companies such as Netflix soared. We also saw big gains for delivery businesses and e-commerce. But over the past week, we have seen techs underperforming, falling faster than other sectors. Keep a very close eye on this sector in the weeks ahead.
But if worries over policy tightening grows, other sectors could also underperform. It is possible that the markets may have already priced in much of the prospective global recovery, spurred by vaccines and stimulus. If rising inflation expectations become a reality, then the major central banks could start ending their emergency easing programmes from as early as the second half of this year, before potentially embarking on a tightening cycle in the years ahead.
This is the key risk facing the markets in the months ahead and so trading could become two-ways again rather than just up, up and more up for major US equity indices.
That being said, for now central bank heads are continuing to dismiss early taper talks and tightening cycles. It is important to mention that central banks are historically always behind the curve. Most tend to have a reactionary policy response rather than anticipatory one to changing market and economic conditions.
So, what the markets need is a steady economic recovery and low and stable inflation rates, in order to encourage central banks to keep monetary conditions loose. If things don’t turn out to be as rosy as the markets are currently expecting, then this could be a reason for yields to drop back, keeping stocks supported.
In any case, the focus will now turn to incoming economic data as investors speculate about the timing of central bank QE reduction.
There are a few key data releases to keep a close eye on in the week ahead, not least the US jobs report on Friday. The other main event is the OPEC meeting on Thursday, which should move oil prices sharply. Here are the data highlights:
- Monday: Manufacturing PMIs from China and US (ISM), as well as final PMIs from Europe
- Tuesday: RBA, German retail sales and unemployment change, and Eurozone CPI
- Wednesday: Aussie GDP, US ADP private payrolls, crude inventories and services PMIs from China (Caixin) and US (ISM), as well as final PMIs from Europe
- Thursday: OPEC-JMMC meetings, Fed Chair Powell speech and unemployment claims
- Friday: German factory orders, US nonfarm payrolls report
Crude oil has been on an amazing run since the initial lockdowns back in March 2020, much like all other risk assets. After dropping into the negative in April, WTI oil is now only a couple of dollars shy of the 2020 and pre-lockdown high of $65.60ish and Brent is also very close to its corresponding high at $71.20ish. Prices have risen mainly because of the record production cuts from the OPEC and on-OPEC allies, such as Russian and Kazakhstan, collectively known as the OPEC+. Demand has also recovered as countries have slowly re-opened. Optimism surrounding the vaccine rollout programmes have helped to accelerate the rally in recent weeks as investors look forward to more normal times ahead. But this also means that the OPEC+ will be keen to ease production curbs, especially as prices have risen so sharply. Where will oil prices head to next?
For now, crude oil continues to remain supported as investors look forward to the March 4 OPEC+ meeting, when the group must decide whether to provide more crude oil to the market from April and onwards.
In December, the OPEC + restored 500K barrels a day as part of the gradual process. The new national lockdowns meant the easing of productions curbs were paused in January. Just over 7 million barrels of oil per day remains withheld which will need to be pushed back into the market in the coming months.
With oil prices having recovered nicely and lockdowns likely to ease in the coming weeks and months, the OPEC+ will likely agree to the gradual easing of output. They obviously don’t want to scare the market, but equally wouldn’t want to lose market share to US shale producers. So, I doubt oil prices will sell-off sharply, unless the cuts happen to be much larger than expected, or the group signals quicker rollback of cuts in the near future.
Talks are likely to be tense, especially with Saudi Arabia already providing additional cuts to drive prices even higher while Russia is keen to retain its market share. I think Saudi will try to encourage everyone to increase production minimally. But if that strategy fails, this time it is very unlikely that Saudi would be willing to provide further voluntary cuts.
In terms of demand, I think this will rise sharply as the global economies re-open and travel re-starts. But the rising levels of demand for oil will be offset as OPEC supply is likely to rise proportionally. So, the net impact of this will be neutral on prices. It is important to remember that oil prices have been going up in anticipation of a sharp global recovery. Thus, the rally is likely to slow or even reverse soon as the higher prices attract fresh non-OPEC supplies to hit the market.
As things stand though, I think both Brent and WTI will hit their pre-lockdown highs first, before we potentially see a sizeable correction. In any case, I think the upside for oil looks limited from here.
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