Listen to what the Fed says
The Federal Reserve’s policy meeting tonight is important as it will set the theme for the market to trade on for the near future.
The Federal Reserve’s policy meeting tonight is important as it will set the theme for the market to trade on for the near future. They will be releasing a new set of economic projections, with the last set released in their meeting on 17 March. (LINK See here for our thoughts on market impact of possible changes)
Any changes, if at all, will be yet another micro-step in the long journey towards tapering of their ultra-easy monetary policy. Any over-reaction (barring big unexpected changes in their outlook) should be opportunities to get into the long term trades that have been working thus far.
Treasury General Account Holds Clues.
Rising yields have been beneficial for the dollar lately. However, over the next 4 months, the Treasury General Account or “TGA” is projected to fall considerably, which all else being equal is likely a dollar-bearish variable. So far, it has only just started.
When the Treasury Department borrows (i.e. issues bonds) at a faster rate than it spends money, it builds up cash in its TGA account. Then, when the Treasury spends at a faster rate than it borrows, it draws down cash from the TGA. The fact that the TGA has been drawn down over the past few months, we believe that the Treasury has not had to issue a large amount of net Treasury bills, notes, and bonds, and along with the Fed purchasing $80 billion of them per month, it means that there has been very little in the way of net Treasury issuance for the private market to absorb.
In the second half of this year, starting in Q3, we’d get a bit more concerned about the possibility of long-duration Treasury yields bouncing back up. Issuance was low enough in Q2 that the Fed basically bought as much as the Treasury issued, but that won’t be the case in Q3. That means the private sector has to step up and buy more Treasuries.
In terms of risk awareness, some of the big things we’ll be watching in the months ahead are
1) how the economy performs with stimulus support fading away,
2) whether the Senate can pass an infrastructure bill or not,
3) how tight the energy market gets later this summer if at all, and
4) the TGA drawdown and Q3 net Treasury issuance.
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The Federal Reserve is expected to keep policy unchanged (Wed) and will likely stick to the narrative that “substantial progress” still needs to be made on the employment front before it will start tapering. Fed Chair Powell will be telling us if it’s time to talk about talking about tapering in his press conference.
1. Currencies: CAD is a currency that will do well as Oil prices climb higher. With Bank of Canada being one of the first major central banks to start tapering, CAD is a currency to be long of in the weeks ahead. With resistance at 1.3350–60, the level to start scaling in short USDCAD positions is 1.3240–50. Watching for USD rallies to get into this new position.
Keep short USD and long NZD, & CNH. Resistance for USDCNH is at 6.40–6.42 level. NZD is testing recent near-term support at 0.7100–0.7110, and the next short-term support is at 0.7040–50. Caution is warranted for now.
Stay short USD and Long CNH & NZD.
2. Commodities: Uranium — Long Uranium and energy stocks. Uranium stocks are correcting due to the uncertainty caused by overblown fears of a leak in a China reactor. Stay long.
Gold — Long Gold. Support for gold at 1840–45 is being tested, but is holding for now. Stay long.
Key risks: Possibility that the Federal Reserve may change its tone and dial back its message that “Inflation is transitory’’. This would increase fear of tapering and lead to higher US bond yields and a stronger USD.
Equity Index: Long Nasdaq futures. Support is at 12,950–13,000. Market is trading caustiously ahead of the Fed meeting later today. Stay long and patient while looking for substantial dips to buy.
Single Stocks: Risk assets are grinding higher, and cash is trash. Don’t miss out on the asymmetric opportunities we have highlighted in our TrackRecord Model Portfolio.
Key risks : Higher US yields due to inflation fears and geopolitical worries are the key risks.
WHAT HAPPENED YESTERDAY
- US Total retail sales fell -1.3% in May (expected -0.6%) after an upwardly revised 0.9% increase in April (from 0.0%). On a year-over-year basis, retail sales were up 28.1%.
- Producer Price Index for final demand increased 0.8% m/m in May (expected 0.5%) after increasing 0.6% in April. The Producer Price Index for final demand, less food and energy rose 0.7% m/m (expected 0.5%) for the second consecutive month. On a year-over-year basis, the Producer Price Index for final demand was up 6.6% in May versus 6.2% in April while the Producer Price Index for final demand, less food and energy was up 5.3% in May versus 4.6% in April. It shows a continuation of broad-based price pressures at the producer level, which will fuel continued concerns about overall inflation.
- The U.S. Dollar Index was relatively unchanged at 90.53. Dollar stabilised near multi-week highs on Tuesday as traders turned cautious ahead of the Federal Reserve’s two-day policy meeting, which could potentially provide hints of plans to start tapering its bond purchases. So far Fed officials, led by Chair Jerome Powell, have stressed that rising inflationary pressures are transitory and ultra-easy monetary settings will stay in place for some time to come. However, recent economic data has raised concerns that price pressure could force an earlier stimulus withdrawal. The AUD slipped to $0.7685 after minutes from the Reserve Bank of Australia’s last meeting showed the bank was prepared to keep buying bonds even though the economy has recovered its pre-pandemic output.
- US 2-year and 10-yr Treasury bond yield remained unchanged at 0.16% and 1.51% respectively.
- S&P 500 declined -0.2% on Tuesday and traded slightly lower the entire session. The Dow Jones Industrial Average (-0.3%) and Russell 2000 (-0.3%) performed similarly, while the Nasdaq (-0.7%) underperformed.
- In other developments, the U.S. and EU agreed to suspend their tariff dispute regarding Boeing (BA 246.54, +1.40, +0.6%) and Airbus, and New York lifted its state-mandated COVID restrictions after the state reached its goal of 70% adult vaccinations.
HEADLINES & MARKET IMPACT
Notable Snippet: A highly touted bill to boost the United States’ ability to compete with Chinese technology could take weeks to get through Congress, as U.S. House of Representatives lawmakers planned to write their own legislation, which must then be combined with what was approved by the Senate this month. Once the House passes its bill, negotiators from both chambers would work out differences and agree on a final version in conference. The House and Senate would both have to pass that final measure before it could be sent to the White House for President Joe Biden to sign into law.
THEMATIC CONTEXT: “As we have been saying, we are in the era of great power competition and this has invoked a “Sputnik Moment” not seen in the US since the space race (with Russia), where there is no fiscal budget too large to ensure America wins and stays ahead. This is not just a novelty, but a nature of national security and maintenance of a “world order” the US has gotten too used to. Talk about hating change, this is one where no cost is too great. Expect infrastructure, cyclicals, commodities, energy and critical tech companies to outperform in the years or even decades ahead.” — 10th May 2021
Notable Snippet: China said on Tuesday that radiation levels around the Taishan nuclear project in the southeastern province of Guangdong remained normal, following media reports of a leak at one of its reactors. Li Ning, a Chinese nuclear scientist based in the United States, said the dangers at Taishan have been exaggerated. “Because nuclear power plants, once built and in operation, are under very strict control and local areas are excluded from further development, background radiation levels around them can often be lower than historical levels,” he said.
Notable Snippet: Europe is so short of natural gas that the continent — usually seen as the poster child for the global fight against emissions — is turning to coal to meet electricity demand that is now back to pre-pandemic levels. Coal usage in the continent jumped 10 per cent to 15 per cent this year after a colder- and longer-than-usual winter left gas storage sites depleted, said Andy Sommer, team leader of fundamental analysis and modelling at Swiss trader Axpo Solutions AG. As economies reopen and people go back to the office, countries like Germany, the Netherlands and Poland turned to coal to keep the lights on.
Europe has long been at the forefront of the battle to reduce global warming. The continent has the world’s largest carbon market, charging the likes of utilities, steel producers and cement makers for polluting the environment. But even with record carbon prices this year, low gas reserves mean burning coal — the dirties of fossil fuels — has become more widespread again.
THEMATIC CONTEXT: “Traditional energy is here to stay and the ESG “dream” of having the world run on Solar, Wind and Hydro is far fetched from a practical point of view. The only energy source that can truly sustain such large energy demands while remaining “Green” is nuclear power and for that reason, we believe uranium to be the most mispriced/underpriced asset in the coming supercycle. In the meantime, traditional energy supply/demand imbalance will only be brought forward, leading to an interim bull (years) market in the traditional energy space. We remain heavily invested in this theme.” — 16th Feb 2021
Phan Vee Leung
CIO & Founder, TrackRecord