Return Of The Queen

Risk sentiment was generally buoyant Tuesday, as market participants watched Janet Yellen make the case to US lawmakers for nearly $2 trillion in additional fiscal stimulus.

It wasn’t a particularly hard sell. Although Republicans are likely to rediscover their inner fiscal hawks now that they needn’t fear any backlash from Donald Trump and his defunct Twitter account, some in the GOP are probably feeling a bit despondent following recent events, which left the party tarnished and splintered.

With thousands of Americans still dying from COVID-19 each day, and millions still jobless, standing in the way of Biden’s relief plan may not be a politically viable option for the GOP. Given that Democrats will control both chambers, a sense of fatalism could creep in among some Republicans, who may see compromise as preferable to stonewalling. And when it comes to the deficit, you’re encouraged to remember that even before COVID, the GOP presided over a worsening of America’s finances each year under Trump.

Given that, pretensions to fiscal rectitude will come across not just as cruel in the face of mass joblessness and a hunger crisis, but as disingenuous in the extreme. And, again, there’s a sense in which resistance is futile for Republicans. Taking the olive branch (which Biden is keen to extend) may be the best face-saving strategy, especially as it relates to more virus relief.

That’s not to say the final version of Biden’s plan won’t be watered down or otherwise diluted. It’s just to say that more stimulus is coming, and markets will look to the details for direction when it comes to pressing bets on the pro-cyclical rotation which, even if it stalls tomorrow, will have proven more durable in its most recent manifestation than usual.

And then there’s vaccine rollout, which may be the real pro-cyclical catalyst. “The dual policy puts from monetary and fiscal policy succor, and the vaccine rollout, as logistically challenging as it looks to be, still points to gleaming days ahead,” AxiCorp’s Stephen Innes said Tuesday. “Indeed, it should be the Biden administration’s vaccination policy… that continues to resonate with investors.”

JonesTrading’s Mike O’Rourke struck a similar tone. “The reflation trade behavior is also consistent with the reopening trade [so] don’t expect an all out reversal,” he wrote late Monday, adding that “instead, the corrective moves in the trade likely represent opportunities, especially if Biden can make good on the goal of 100 million vaccinations in 100 days.”

Still, the “sell the news” vibes may manifest from time to time as market participants realize that even if enough Republicans are on board with Biden, old habits die hard when it comes to attitudes around the purported “limits” of spending. That means the figure (below) is likely to terrify more lawmakers than it should.

“Regardless, the market may be recognizing that the printing and spending it hoped would epitomize 2021 will be more challenging to achieve than originally expected,” O’Rourke went on to caution.

Getting back to Yellen, Rabobank’s Michael Every penned a few remarks that echoed the discussion from “As Yellen Takes Treasury Reins, Dollar Bears Emboldened.“

“Yellen will reiterate she wants the market to set exchange rates. Underlining again how poor communication and/or understanding is, the media reported verbatim that her stance means she is in favor of a strong dollar because she will add that ‘the US doesn’t seek a weaker currency to gain competitive advantage,'” Every wrote, before noting that “this overlooks the fact the USD has been going down for months knowing Yellen would be Treasury Secretary and say this kind of thing.”

The figure (below) neatly encapsulates the entirety of 2020’s zeitgeist vis-à-vis the dollar and it also underscores why risk assets were able to sustain one of the most rapid recoveries from a bear market plunge in recorded history. 

If the market “determined” the path of the dollar should look like that, then Yellen’s message (that she’ll allow the market to keep calling the shots) could be construed as bearish for the greenback or, perhaps more aptly, as confirmation bias for already determined bears, whose minds are made up and whose positions are entrenched.

For Every, there are a handful of ways the dollar could rally, and all of them are worth considering. We could see a stronger dollar, he said, if “US fiscal spending prompts a sustainable recovery, allowing the Fed to raise rates without the 2s-10s spread screaming out ‘It’s a trap!” or if fiscal stimulus stateside “is too small and the US slips into deflation, pushing real rates higher.”

Other ways the dollar could rise, according to Every, include,

If the rest of the world suddenly sees a burst of inflation and won’t raise rates to match; if the rest of the world, by keeping fiscal policy too tight, ends up with a deeper relative downturn than the US, requiring even more aggressive monetary policy and/or risk-off worries out of EM back into USD; and also if anything geopolitical happens to see a USD short squeeze.

Now that you mention it, that’s a pretty long list of potentially bullish dollar narratives. Consensus doesn’t want to hear it right now, that’s for sure. And perhaps that’s the most bullish signpost of them all.