In one of the most melodramatic starts to the trading year, January saw markets tripping out of their respective starting gates on fears of economic slowdown from both the U.S. and global economies. There was however, a noteworthy “risk-on” bounce-back in markets as central bank support in Japan and whispers of further stimulus from the ECB ignited a one-way, positive trading trend heading into month end.
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Markets enter February temporarily basking in January’s late staged comeback. Yet, we begin a new month wearing old clothes. A market returning to its fundamentals is paramount and will require even fractional stability in oil prices, China demonstrating its will to cut capital outflows in an effort to stabilize the yuan, no worse than feared global equity earnings, and a continued resilience in the U.S. consumer, wage and inflation growth environment.
Interest Rates – What a Difference One Month Makes
In December, the ECB surprised markets by limiting its new stimulus to a modest rate cut and an extension in the duration of its current QE program while failing to increase the pace of monthly asset purchases. This action led to a sharp rise in European yields and commensurate drop in bond prices as markets responded to the new information. Yields also rose in the U.S. where the Federal Reserve processed it’s much anticipated rate increase, the first in nearly a decade.
In contrast to Europe and the U.S., Japanese interest rates fell as the Bank of Japan boosted stimulus by expanding purchases of shares in companies that increase new hiring and investment.
In January, everything reversed as worries about global GDP, emerging markets, China, and faltering oil prices drove yields lower (higher bond prices) throughout the month. In January 10-year yields dropped -37 basis points (bps) in the U.S. to 1.92%, -30 bps in Germany, -43 bps in the U.K., and -26bps in Spain.
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It’s difficult to imagine a February repeating the bond rally witnessed in January. The hot question for the month ahead: Are U.S. 10-year Treasuries overbought and due for a much needed downside break? With the Bank of Japan joining the “negative camp” and underlying emerging-market concerns, the market acknowledges the overbought environment for bonds, but it can’t seem to justify a sharp retraction anytime soon.
Currencies – U.S. dollar and the Path of Least Resistance
Like bond markets, major currency markets experienced major reversals due to fears over global growth, Brexit, and dwindling commodity prices.
For the month of January commodity currencies including the Canadian dollar, the Australian dollar, the South African Rand, and the Brazilian Real continued their steady months long decline. Surprisingly, the Euro ended the month virtually flat – this, after shedding nearly 6% of its value over the previous months.
The Japanese Yen faltered -0.81% - most of the move coming on the very last trading day of the month. Governor Kuroda, with the majority of his board members, cut the interest rate to -0.1% for excess reserves of ¥10 trln-to-¥30 trln, and for only new reserves that are deposited at the BoJ.
The Bank of England’s failure to placate investors during its latest meeting combined with its exposure to “Brexit” caused its currency to shed 3.09% in January. The Russian ruble tumbled down a 3.50% pathway on oil while the Mexican peso shed 5.69% on the month.
February currency price action will be largely dictated by uneven global growth metrics, oil price dynamics, persistent emerging-market concerns, along with interest rate differentials among major currencies. Further, given the late-January surprise action by the BoJ, expect both ECB and FOMC headline risks to dominate the intra-day price action.
Energy – A Dramatic Second-Half Climb
Although markets witnessed a sharp mid-month turnaround, petroleum products – once again – finished negatively in January.
After falling 11% in December, West Texas Intermediate crude, the U.S. benchmark, fell to a decade low of $26.50 before rebounding albeit finishing yet another month in negative territory, down 8.5%. The seven-day bounce-back from $26.50 to its month ending price of $33.62 caught trader’s well off-guard, forcing a wave of late month short covering.
Natural gas prices fell by more than 20% during the first half of December as warmer-than-normal weather in North America and record natural gas inventories drove prices sharply lower. Prices then reversed, rallying sharply to close with a monthly gain of nearly 5%. January saw prices at 2.334, slowly decline to a 1/19 low of 2.09, only to reverse course and finish the month at 2.298.
Like most petroleum products, gasoline staged a come-back of sorts in January although still managed to stall out with a 15.0% loss. Gloomy sentiment and abundant refinery runs continue to act as the drag anchor on gas prices.
Going forward in February, petroleum markets will be wrestling with the bullish drivers of non OPEC production declines and vibrant consumer demand versus the potential negative overhangs of a persistent strong U.S. dollar, a sudden drop in Middle East fuel subsidies, or OPEC production trends persisting to the upside.
Metals – A Market Returning to Fundamentals?
The price of gold experienced meaningful price swings in January, and wound up closing the month with a 5% gain. Over the past few months gold has been without a foundation to whether it’s a commodity or a currency?
The perception and prospect for gold shifted in January as the market came to terms with the immense amount of Asian demand along with lower interest rates and central bank divergence – all of which provided a much needed tailwind for gold.
Copper prices continue to see-saw. After rallying more than 4% in December – reversing a 7-month trend that saw copper prices drop by 29% - copper ended the month of January with a 3.5% loss, wiping out nearly all of December’s hard-fought gain.
Deep supply cuts seemed to have stabilized aluminum prices in January. After hitting an intra-month low price of 1450.00 on 1/12, Aluminum abruptly reversed course, finishing the month managing a 3.0% gain.
For industrial and base metals, February’s results will be heavily influenced by global industrial production data, any signs of demand growth, along with Chinese steel and aluminum export figures. Golds prospects will depend largely on Asian demand, central bank divergence, and the temperature to golds safe haven status.