Inflation expectations rise, OPEC+ rollover expected

Inflation coming? Whilst regular readers may spot a familiar thread, which I have pulled at on various occasions, we are starting to see signs of inflation coming through. Yields have started to shoot higher along with US 10-year breakeven inflation expectations, with the latter rising to 1.84%, the highest since May 2019 amid signs Washington could yet move on a stimulus package.

Five-year average inflation expectations are at 2.25%. Benchmark 10-year US yields climbed to 0.95%, approaching the November peak again. Gold rallied on higher break-evens and lower real yields, now up to $1,840 on the old 38.2% retracement support of the Mar-Aug rally and approaching the key $1,850 support-turned-resistance.

Democrat leaders Nancy Pelosi and Chuck Schumer got behind a $908bn bipartisan deal and said they would use this as a basis for a relief bill. It puts more pressure on the GOP to agree to a relief bill before Christmas. Given the CDC is warning off the “most difficult time” in US public health history over the winter, financial relief will be vital until vaccines are rolled out.

More stimulus heaped on what’s already been delivered combined with a mass reopening of economies next year will deliver a pro-cyclical high that will create inflation. As discussed on multiple occasions, whilst there are barriers, the conditions for inflation are there: pent-up demand, a savings glut, the vast increase in the money supply and enormous liquidity put that is underpinning global financial markets, as well as central banks openly saying they will let economies run hot: the Fed’s average inflation targeting explicitly calls for an overshoot, which may allow inflation expectations to become unanchored.

Central banks are not positioned or possessing of the necessary fibre to deliver an increase in interest rates at a level required to suck the money back out of the system in the recovery phase. The recent US PMI surveys for November showed the quickest rise in selling prices yet recorded, with the rate of inflation hitting a record high in the service sector and a 25-month high in manufacturing. Whilst inflation was the dog that didn’t bark after the great financial crisis, it may be about to bite. Post-GFC growth in money supply was absorbed by banks to bolster liquidity and capital requirements. And there was no coordinated fiscal stimulus alongside the monetary policy support. This time the growth in M2 money is being mainlined into the economy’s veins.

Britain’s decision to rollout the Pfizer/BioNTech vaccine in the coming days is being treated as a positive and supportive of the reopening/rotation trade that was the major market theme of November. This saw the FTSE 100 rise over 1% yesterday and the index now looks reasonably well supported above 6,400.

As discussed yesterday, UK equities are fast becoming a consensus buy with cyclical weighting and relative cheapness to peers making them look more attractive as the economy bounces back next year thanks to vaccines. European markets were lower in early trade on Thursday with the FTSE outperforming remaining broadly flat. US futures were a tad lower after the S&P 500 rallied 0.2% to another record high in a mixed session on Wall Street on Wednesday that started off in drab fashion before the lower-dollar, higher-yield risk-on trend took hold and bulls drove the index to close at the high of the day at 3,669.

Yesterday afternoon saw a sharp and sustained move lower in the dollar, boosting major peers like the euro and sterling. EURUSD advanced beyond 1.21 with little resistance in the way to 1.25. GBPUSD trades towards the top of the recent range at 1.34. Uncertainty over whether Britain will secure a free trade deal with the EU is preventing a breakout. Upside pressure will lead to a burst through to 1.40 if there is a deal announced, which could occur in the next few days. Currently, the noises from Brussels, and notably Paris, are not so reassuring. France is leaning very hard on Barnier not to concede too much or they will veto a deal – you have to think this is bluff: Merkel would send Macron to the naughty step if he played de Gaulle and scuppered 4 years of negotiations for some Breton fishers.

Oil moved higher yesterday afternoon amid signs of greater consensus around achieving a deal today as the full OPEC+ cartel convenes to figure out how to proceed with supply restraint in the first half of 2021. OPEC and allies are said to be leaning towards a rollover of current cuts with a gradual increase in output.

Under the current production cuts agreed earlier this year, output is scheduled to increase by around 2m bpd from January, however, it is widely anticipated that OPEC and allies led by Russia will extend the current 7.7m bpd in cuts for another three months. Dissenting voices from the likes of the United Arab Emirates ultimately should be brought around by kingpin Saudi Arabia. A deal of some kind to extend current levels of output restraint is essential to keep WTI north of $40, with Jan contract currently trading above $45.

EIA inventory data showed a slight fall in US crude stocks, but gasoline and distillate inventories rose due to slacker demand for end products. Although crude inventories fell by 679k barrels, gasoline stocks and distillate inventories rose by 3.5m barrels and 3.2 million barrels respectively. Expect this trend to continue as slack demand persists over the winter. As we’ve been warning, near-term demand pressures will need to be overlooked by markets to sustain prices as inventories seem set to build over the next couple of months.