The most surprising thing about the financial markets at the start of a new week was not the surge in the price of oil or the fact that the markets are treating the Evergrande default as if it were the news of yesterday. Instead, it was the stock market’s nonchalance to the 18 basis point rise in 10-year Treasury yields that started late last week. After a late reaction to the Federal Reserve meeting last week, it looks like markets are now ready to start pricing in the run-up to a Federal Reserve and Bank of England rate hike for 2022 This sparked renewed interest in reflation trading. , where returns rise alongside value stocks. For example, the high-tech Nasdaq index fell 0.35% on Monday, unlike the Russell 2000, which rose about 1.7%. Amid all the growing risks: US debt ceilings, skyrocketing energy prices, and the prospect of higher prices hurting economic and corporate earnings growth in the third quarter, some sectors of the stock market are falling. good mood.
Debt ceiling concerns scared the Fed
Let’s take a look at US politics first. Financial markets are well aware of ignoring the twists and turns taking place in Washington, however, the United States must raise its debt ceiling by September 30, when federal government funding is expected to run out. On Monday, two senior Fed officials warned of the “catastrophic consequences” that could arise if Senate Republicans continued their plan to block a bill that would increase the borrowing limit and thus stave off the threat of debt. ‘a government shutdown. As of this writing, that vote has not taken place, however, we would expect the markets to react negatively to an outcome where there is no increase in the US debt ceiling. The Fed’s John Williams said this could lead to a rush to exits and cause an “extreme backlash” in financial markets. If the debt ceiling is not raised, the US government could default on its bonds as early as mid-October. This is not an overreaction from John Williams, in 2011, when the debt ceiling was not raised and the US federal government went into a shutdown, the stock markets fell sharply and the US government has lost its best credit rating. If it gets to the point where the United States does not pay its obligations, then we could see a dramatic reduction in risk taking around the world. Last week, Fed Chairman Jerome Powell said no one should assume the Fed can shield financial markets from a shock of this magnitude. With warnings like this coming from senior Central Fed officials here at Minerva, we are happy to be extremely selective about our choice of trades for this week, and we are wary of this latest rebirth in reflation trading. , especially when the Senate’s 50 Republicans are about to vote against the federal spending bill, and Democrats only control the Senate by the tiniest of margins. If a fiscally conservative Democrat joins his Republican rivals, we would expect all hell to break down in financial markets later this week.
No more politics and low Treasury bids
Elsewhere, we will also be monitoring the U.S. infrastructure bill, which is also expected to reach the Senate floor. Nancy Pelosi has hinted that there will be a vote on the bill this week and that she is only willing to vote on it because she expects it to pass. We’ll have to see. An interesting dynamic for the markets would be the failure to raise the US debt ceiling, yet the US infrastructure bill passes. In this case, we could see a limited sale of risky assets as the market could envision a brighter future where the US government supports US economic growth with its own spending. We will be watching closely the future of US Treasury yields, as another reason for their rise this week has been weak demand for US sovereign bonds during recent auctions. If the debt ceiling issue is not resolved, we might see weaker demand that could trigger a feedback loop where bond yields continue to climb sharply for 10-year Treasury yields, the global benchmark, the current resistance is 1.5%, if so. then crossed 1.6%, a key level at the start of this year, could be the next target.
Energy demand goes crude
Elsewhere, markets have traded long positions in natural gas for crude oil, replacing scammed gas prices. The price of Brent crude oil is close to $ 80 a barrel, however, Brent’s first month contract sold slightly on Monday and was down 0.13%. The contract price the month before WTI is $ 75.50, a jump of 2% on Monday. Thus, the premium between Brent crude and WTI is narrowing, but it is also technical, with the price of Brent crude likely to come under pressure as it reaches a significant level like $ 80 per barrel. We expect the Brent crude oil futures price premium to remain steep due to the current UK energy crisis threatening the rest of Europe. If this spreads to the United States, the gap between Brent and WTI could narrow. See the table below. If you believe crude analysts at Goldman Sachs, $ 90 a barrel is possible before the end of the year, so there are a lot of people expecting more oil price hikes in the coming weeks. . It should be remembered that the gains in oil prices were triggered last month by the slow decline in Opec’s Covid production cuts. Thus, the price of oil is somewhat artificially supported. However, OPEC’s slow return to normal production is a powerful tool in keeping the price of oil high. For skeptics, or those who like to prove GS wrong, US growth is causing concern after a weaker reading of the Dallas Fed Manufacturing survey for September, which is more up to date than better than expected durable goods orders for. August. . The growth of China and the fallout from the Evergrande scandal are also causing great concern, which remains a major concern for financial markets even though the financial media may have lost interest this week. Right now, we believe that Opec’s production cuts combined with higher than expected demand for oil and goods after the end of Covid lockdowns around the world are reason to believe that the price of oil could increase in the coming months. Even though we see disappointing economic data in the coming weeks, we believe it will likely be temporary, so, I think I just convinced myself to love reflation trading again.
Oil majors profit from rising crude prices
Another way to gain exposure to the energy business is through an oil company, like BP. The stock price jumped more than 3% on Monday and has risen for most of this month. While much of the good news is written into BP’s price, we believe there may be more to be done in the long term. In the short term, there could be a setback when the government finally fixes the gasoline shortage, which we are told will be later this week.
Why the GBP could keep pace with the gains in USD
The forex market has been quite bullish today. The dollar is rising due to rising Treasury yields, which could be a prolonged trend. EUR / USD is lower as it brushes off news of Germany’s election and the fact that it could take months of haggling to confirm the new coalition government in the eurozone’s biggest economy. In contrast, the GBP / USD was up 0.3% on Monday, as the British pound ignored the UK woes and instead focused on the 16 basis point rise in UK 10-year gilts yields in the past. during the last three trading days. The market assumes that the UK and US central banks will move together when it comes to tightening their policy, so we could see the British Pound and the USD rise in tandem in the coming weeks. If you want to expose yourself to a stronger dollar, we’ll stick with the euro.