· Reflation rotation should start to kick in in earnest
· Gold breaks above $1800, sell the dollar as you may please
· Failure of an OPEC+ agreement is a massive risk to this view
Of course, assuming the US Congress delivers a surprise holiday present to the market in the form of a stimulus deal. But I say throw caution to the wind and run with it.
A 10bp selloff in US Treasury 10y yields driven by higher inflation expectations is driving broad-based US dollar weakness, particularly in high-yielding emerging markets.
The extent to which central banks push against steeper yield curves depends on the makeup of the move between real yields and inflation break-evens in gauging whether financial conditions are tightening.
A willingness to increase asset purchases is a common theme from central bankers, echoed this week by the RBA in its entire policy decision on Tuesday.
US Fed Chair Powell also said the risk of doing too much is less is far greater than the risk of not doing enough in his Senate testimony.
As for actual inflation picking up and central banks turning more hawkish, the Fed’s new framework allows the economy to ‘run hot’ in theory. More immediately, US market-based inflation expectations are rising, as measured by break-evens.
Since the Trump administration allowed the presidential transition process to start on Nov. 24, the US 5y5y inflation swap’s yields have broken out of a range (2.08%-2.20%) to new highs for 2020 (2.25%), and the highest since May 2019. Which was the clear-cut dollar sell call.
Higher market-based inflation expectations are consistent with pro-reflation trades outperforming, including a rotation from tech to value in equities and selling the USD virtually against anything you want.
Gold reclaims $1800 level
Gold closed comfortably back above $1800 overnight, bouncing back from November’s lows to snap the lower highs/lows series last week.
A rise in inflation expectations (breakeven higher) prompted by signs of inflationary pressures in global PMI reports was encouraging. Month-end expiries and the Comex roll have been dealt with, and the look-see above the 200-day moving average gave optimism. The market should refer to the seasonality strength into December. Positioning is cleaner, and snap rallies we have seen in the last 24 hours might be the feature in the next weeks.
OPEC+ members fail to agree
The failure of an OPEC+ agreement in postponed talks on production that resumes Dec. 3 is a near-term risk to this dynamic. The consensus expectation is for a three-month extension to current production quotas due to rising by 2mbd on Jan. 1, 2021.
Front-month Brent is down 3.8% since the November high, although implied volatility remains low. The biggest fissure is between Saudi Arabia and the UAE. The latter opposed an agreement to an extension without more stringent oversight of output cuts from other members.