Macro Markets Are At An Inflection Point - It's All About Where The Dollar And Interest Rates Are Headed
- Macro markets are at an inflection point.
- After a countertrend rally in the U.S. dollar in February, we believe it will resume the multiyear downtrend soon.
- In addition, we believe interest rates will keep moving higher for the rest of the year, prompted by higher inflation expectations.
- Our detailed oil market fundamental analysis indicates that oil prices will keep moving higher as global oil storage moves into deficit territory to the five-year average.
Welcome to the inflection point edition of the Macro Daily!
Global macro markets are at a pivotal inflection point. February saw one of the worst months for anyone allocated in the "inflation themed" trade. While the UST 10-year yield made a new four-year high in February and was in line with our belief that rates are set to break out from a multi-decade downtrend, the U.S. dollar's (UUP) countertrend rebound pushed the euro and oil lower - and, along with it, emerging market equities (EEM) and energy stocks (XLE).
Despite the brutal beating in February, we strongly believe that the central themes in this year's market will continue to be:
- The decline in the U.S. dollar
- The rise in interest rates fueled by higher inflation expectations
Of course, these two big macro themes come from our micro assessment of the fundamentals of the oil markets (our bullish stance of $70/bbl WTI average in 2018), which has remained unchanged. In addition, inflationary factors remain very strong.
Macro markets are at an inflection point
In the world of macro, the initial trend change can bring about gut-wrenching pullbacks to test the resolve of the believers. Take, for example, the countertrend rally in the U.S. dollar that pushed some speculators to believe a technical bottom was in.
But, in our view, the people who believe the dollar had bottomed from here are missing the bigger 15-year trend that takes place in the currency and commodity markets.
Our view that the fall in the dollar is just the start of a multiyear downtrend was first expressed in this article. But every once in a while, like what we saw in February, markets can abruptly change direction, shake the core confidence of speculators, and quickly resume the downtrend they're in.
As a result, we do not see the recent dollar strength as having any longevity, and believe it will resume its decline soon.
To further back our view on the fundamental side, we believe commodity markets, which have historically moved inverse to the dollar, are in the midst of developing a multi-year uptrend.
Long-time readers of our articles should be very familiar with why we are bullish on oil prices. For 2018, we expect the global oil storage balance to keep decreasing while U.S. shale production increases. This will prompt the investment community to question whether if oil markets are in deficit and require all the growth U.S. shale can provide in the years ahead. We think this mentality will prompt a change from "U.S. shale will keep prices lower" to "U.S. shale production is needed to stabilize the market."
As for the oil markets, we are at a key technical and fundamental inflection point as well. We are about to exit the refinery maintenance heavy month of February, and bullish storage changes ahead could fuel the oil rally we believe will take place in 2018. In addition, technical charts indicate a major move that's about to happen in the next month.
Given our storage projections, we believe the move is biased to the upside:
Interest rates will keep moving higher
Interest rates have recently pulled back following higher market volatility and overextended spec short positions, but the bigger picture remains that interest rates will keep moving higher for the rest of this year.
There are very important implications to draw from higher interest rates. We wrote in an exclusive report recently titled "Global Markets Are Signaling Inflation Is Coming. What Does It Mean For Investors And Your Portfolio?" Interest rates are currently moving higher because inflation expectations are rising. Oil prices have moved above $60/bbl, and it's our view that it has much more upside to go for the rest of the year. The rise in oil along with other commodities will fuel higher inflation expectations and push higher interest rates.
While February offered a gut-wrenching punch to anyone allocating to inflation themed names, we believe the market's overreaction will prove to be unwarranted. We also believe the market is getting a big central theme wrong, which is that growth should not outperform value when interest rates are on the rise. But, unsurprisingly, we are seeing the disparity between growth and value move to levels not seen since 1999-2000.
Interestingly, we are also seeing famous value managers like David Einhorn report his worst relative performance to the S&P 500 since the 1999-2000 period.
Combining these extreme signals with our observation of the macro markets, we maintain our view that value will start to outperform growth at some point this year. The timing element is extremely difficult to calculate, but as we approach the extremes, there are just too many red flags showing up everywhere.
2018 may very well be the year of the macro
February offered the broader market a taste of what happens when low volatility strategies blow up. The extermination of levered ETNs like XIV should have been a big red flag to investors, but the recent market price action where technology stocks continue to be the safe haven for investors defy what macro markets are signaling.
Our view is that the U.S. dollar and interest rates will be the big drivers for global equities and commodities. Our detailed analysis of the oil markets indicates to us that 2018 will be another record year of storage deficit, which will start to translate into U.S. crude storage. The lack of builds for the first eight weeks of 2018 should have been apparent, and as we exit refinery maintenance season, we think the storage draws ahead will send signals to market participants that oil fundamentals remain undersupplied.
We continue to have a strong conviction that the U.S. dollar will decline throughout 2018, interest rates will move higher, and global commodities are at the start of a multiyear uptrend.
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