There is a feeling of sanguinity coursing through global markets as a year of absolute chaos finally draws to an end. Most stock markets suffered their briefest bear market ever only to stage a meteoric recovery and emerge much stronger, oil prices turned negative for the first time in history, and the once-beloved US dollar is now trapped in a relentless downward spiral.
If there is a lesson to be learned from all this, it is that when governments and central banks join forces to fight a crisis, the stimulus response is so overwhelmingly powerful that it eclipses everything else in financial markets. When sovereign bonds go from being a risk-free asset to becoming a return-free risk, equities and commodities are bound to shine bright. There is simply no alternative.
Will the consensus get it right in 2021?
Looking into 2021, the burning question is whether this cheerfulness will continue to dominate as vaccines are fully deployed and the global economy heals its wounds. The vast consensus within the financial community is that it will.
Equities are widely expected to continue grinding higher, powered by the improving economic environment and the aftershock effects of the tsunami of stimulus that was unleashed this year. Likewise, the dollar is anticipated to go even lower as US inflation accelerates faster than other economies, keeping real interest rates deeply negative.
While it is difficult to argue with the equity thesis, as there is no alternative to stocks that offers any decent returns, the dollar narrative doesn’t look quite as solid. It is true that fading safe-haven demand for the reserve currency coupled with deeply negative US rates seems like a recipe for disaster, but then again, much of this has already played out and most other major economies are much weaker fundamentally.
In the classic way of thinking, interest rate differentials are the single most dominant force for the FX market. However, coming out of a crisis, perhaps relative economic performance will matter even more. The euro area is still in dire straits, while the US is doing much better and is also further ahead in the vaccination race. If America once again proves to be a fundamentally stronger and more productive region, this economic divergence may dawn on investors soon. Capital is ultimately attracted to growth, not deflation.
Commodity currencies plow higher, gold shines
It was another quiet session as many traders are still away, yet the aussie and the kiwi both capitalized on the softer US dollar to reach new multi-year highs. Both Australia and New Zealand are virtually covid-free, and the recent rally in commodity prices paints a brighter picture for these export-heavy economies.
Having said that, the aussie looks riskier than the kiwi here, as Australia has diplomatic tensions with China to worry about. Beijing slapped tariffs on several Australian products this year after Canberra supported a global inquiry into the origins of the coronavirus. The aussie has been surprisingly resilient so far, but if this trade brawl escalates any further, a sharp reality check may be in order.
Gold was back in vogue too. The US dollar sinking to multi-year lows and real US yields turning back down was just what the doctor ordered for the yellow metal, which is about to end the year almost 25% higher.