Swissquote: Cable tests 1.40 ahead of UK inflation, reflation trade continues

17 februari 2021

By Ipek Ozkardeskaya, Senior Analyst, Swissquote

The major US indices renewed record before closing on a softer note on Tuesday. Technology stocks led losses, as Nasdaq eased 0.34%. Asian indices were mostly sold and activity in European futures hint at a flat start.  

At the current levels, warnings of bubble are everywhere. It becomes increasingly difficult for investors to turn a blind eye on them. So there are actually two forces that fight each other in investors’ heads right now.  

First, the FOMO, the fear of missing out the actual stock rally or to step out too early, as the aggressive positive trend in stock markets seems like a tornado that throws everything on its way higher despite the red flags. The rules of the trading game have changed completely. Stock trading has become a sort of a carry trade where investors look for short-term profit on riskier asset. Given the solid price momentum, the stock valuations, the underlying fundamentals or the business outlook don’t matter anymore. All that matters is the possibility of a further rise in stock prices to make profit and leave - hoping that the wind won’t change direction too soon.  

The second force is the fear of entering too late, and the wind changing direction. Because everybody knows that the stock prices have gone well ahead of themselves and the downside correction will likely be strong. One thing is clear, entering long the stock market at the current prices is more of speculation than investment.  

The reflation trade

The trendy investment strategy of the moment is reflation, it consists of buying stocks that should see a boost from the much-awaited economic recovery, cyclical stocks and dumping defensive holdings and long-term sovereign bonds.

In this sense, the commodity stocks could become interesting as a post-Covid trauma play, even more if they increase dividends to attract those investors looking for regular payout in an abnormally low-yield investment universe. In this respect, BHP Billiton and Glencore, which are the world’s leading mining companies announced to raise dividends on the back of a mix of promising factors - starting from a strong rebound in commodity prices and a promising futures.

Glencore also announced record trading profits thanks to profitable bets on oil prices and brought its debt level down to the target range decreasing its default risk.

Strong positive outlook backed by prospects of economic recovery and firm commodity prices, so Glencore, BHP Billiton, and why not some gold miners, such as Anglo American, Fresnillo if you want to give a sense to your stock investments in the actual non-sense environment.

UK inflation: a non-event

The UK will release the January inflation figures on Wednesday, but the data will likely be a non-event, as the British inflation is expected to have eased to 0.5% year-on-year in January versus 0.6% printed a month earlier as a result of strict lockdown measures and the limited economic activity. A soft inflation read will likely keep the Bank of England (BoE) hawks contained, but will hardly revive the BoE doves which had cleared the skies at the BoE’s latest MPC meeting, after the bank said it expects significant rebound in growth from the next quarter.

Cable is now threatening the 1.40 resistance against the US dollar on the back of a soft US dollar and some relief that Brexit didn’t go as bad as feared. In pound, we are now seeing the buy leg of the sell-the-Brexit-fears-buy-the-post-Brexit-relief trade and we may see a further rise before we see a medium-term top.

Therefore, sterling has more to recover from pre-Brexit years, and looking for a further medium-term recovery to 1.45/1.50 is not far-stretched. In fact, Friday’s GDP data showed that a slightly better than expected growth in the last quarter of 2020, bringing the yearly slump to -7.8%, which is not brilliant but at least has the merit of being better than the previous month read of -8.7%. So the pound will likely continue trading the post-Brexit recovery, unless we see significantly ugly economic data.

US retail sales: anything is ok

In the FX, the US dollar is stronger ahead of the January retail sales data, expected to have risen by 1.1% month-on-month versus 0.7% decline printed a month earlier. A strong figure could revive the inflation expectations and accelerate the reflation trade, while a soft figure would turn the attention to Joe Biden’s $1.9 trillion fiscal aid package and keep the risk appetite on a firm footage, as well.

Of course, the solid risk appetite is bad for gold. The yellow metal slipped below the $1800 per oz mark as a result of a solid risk appetite and rising sovereign yields. The death cross formation, where the 50-day moving average slips below the 200-day moving average, hints at the possibility of a deeper downside correction. But we should see some buying interest approaching the $1750/60 December support, as the rising inflation expectations and worries of a market bubble burst keep some investors on track for amassing gold at the dips.