Mizuho Daily – Cats, Concession & (USD) Confusion

Market analysis and insights by Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,

Of Cats & Concessions

Your scribe will resist the temptation to  characterize the staggering 3.7% Nasdaq rebound, which is still down 2.1% on the week (-6.7% from a month ago), as a dead cat bounce. Afterall, significant global growth upgrades by the OECD (to 5.6% from 4.2%) for 2021, led by massive US growth upgrades, spur optimism; even if the revisions are not revelatory.

But equally, to nonchalantly declare a switch to “risk on” on the drop of a hat appears careless. Instead there appears to be a degree of concession, rather than bullish conviction, about the breathtaking surge in Nasdaq; which was led by the likes of Tesla, Amazon and Apple.

Concession that ostensibly is on several dimensions. Most notably, a partial reversal of “rotation” trades as UST yields concede ground (10Y yields down at 1.52-1.53% from ~1.6%). And with commodities also easing alongside sharp UST yield curve bull flattening, concession appears to be from a broader reflation angle (albeit only at the margin).

What’s more, respite from rising yields and reflation may lend some credence to notions of the sell-off in “stay home” bets being overdone; a concession to buy the dips. But this is mostly an opportunistic tactical reaction; and not a strategic positioning.

Here’s why. First evidence of short covering suggests the rebound may be exaggerated. That is to say, while it may not be an out and out dead cat, it is not quite a raging bull either.

Second, the risk of ultra-high valuations caught wrong-footed by rising yields have merely been mitigated, not resoundingly negated.

Third, reflation narrative amid pandemic recovery is merely being fine-tuned not overturned.  In fewer words, not much has changed overnight.

And so a sustained reversal of reflation trades, including higher UST yields and rotation into cyclicals on recovery hopes, has no convincing bases as things stand. Which is to say, that it is premature to declare inflection from correction or resumption of liquidity fueled euphoria.

At best, there is confusion, if not conflict, in balancing optimism (re-calibration) from recovery prospects against stimulus-driven highs.

Getting a grip on markets is like herding cats.

USD Confusion

Speaking of cats (and markets), FX markets could also be struggling with pinning down a USD view given that there is more than one way to skin this (USD dynamics) cat.

For a start, challenges in assessing USD impact from the ebbs and flows of the reflation tide is accentuated by lack of clarity on Fed’s reactions to, and threshold for, rising yields.

And the primary confusion about USD reaction/expectations are anchored in the conflict between;

i)  US leading the way out in the global recovery (USD positive) and;

ii) relatively exceptional monetary and fiscal stimulus that the US is committed to (USD negative).

Our best guess is that USD dynamics are not cast in stone; or for that matter neatly fitted into any one mould either.

But there are three key factors that could help shape USD views.

First, UST yields; and specifically, real UST yields. The main take-away is that USD is most likely to maintain the positive correlation to real yields. That is, if real UST yields are rising, USD is likely to follow suit more durably (compared to nominal yield triggers).

Second, the USD continues to be a gauge of risk aversion. So USD will rise on risk off and ease back when risk sentiments are positive. This “RORO” (“risk on, risk off”) USD overlay is the exception to yield triggers (as low yields and stronger USD may coincide on “risk off”).

Finally, whether the ‘USD Smile’ has shifted from the left half (stronger USD on more negative outcomes) to the right half (stronger USD on more positive outcomes).

While we suspect the ‘USD Smile’ continues to function mostly in the left half, justifiable doubts sow confusion.

Source: Mizuho Bank Ltd