Is mini reflation coming?

In this week's Macro Insight I discussed...

Stock markets broke down last week on inflation concerns and how they would impact Q3 earnings. GM announced a 33% drop in sales and Bed Bath and Beyond stock dropped 30% on lower forecasts. Jay Powell, who is under pressure due to trading scandals, also mentioned that inflation was appearing more persistent than initially thought. Debt ceiling and infrastructure bill gridlock has led to some market stress in T-bills and Biden could not guarantee the US would avoid default later this month. Finally, China Evergrande remains in headlines after missing more bond payments, but they have managed to raise some capital from selling a property management unit, which should improve their liquidity position. Beijing have said they will try to ring-fence rather than bailout the troubled developer.

SPX is showing bullish signs down at key support of 4270 with bullish momentum and volatility divergence as VIX fails to make new highs even as SPX made new lows. If support is broken, then the next level to watch is 4140 which also coincides with the 200d MA. Volatility markets were impacted by a large client trade that supplied end of December Vega exposure to the market, this likely kept a lid on implied vol last week. Positioning data still suggests that until we get back above 4400, things will remain choppy in the short term. The recent move down in spot has taken vol to elevated levels, well above close-to-close realised volatility. However, this level is justified due to extreme intraday volatility, at least for the moment. Once this subsides, I would expect a large leg lower in VIX.

With COVID cases clearly peaking in the US and across the world, a new anti viral treatment from Merck and some leadership coming from cyclical sectors, we see a chance for a rally into Thanksgiving. The rotation into energy and away from tech is likely to continue and if yields can stay in check (below 1.60 on 10Y) then we see the broad market trading higher. The risk on this view is that Q3 earnings are a major disappointment due to supply chain issues and rising wages denting margins. Buy-the-dip traders are yet to be able to lift the market back into the uptrend. We still believe corporate buybacks and FED liquidity provision, despite upcoming tapering, will be enough to support markets into year end. What happens in Q1 is another story!

We see a clear divergence between energy related Commodities and metals. Oil has broken to new highs on OPEC+ failing into increase production more than expected after the NatGas led energy crunch has bolstered demand. Copper remains heavy with China property market concerns lingering. Precious metals are trading poorly, as the USD remains strong and flows get redirected into crypto markets.

Filmed on on Tuesday 5th October 2021.


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