The World is All In!!

Markets

The Fed’s all-in strategy has failed to lift sentiment. The S&P fell more than 12% Monday, European stocks were between 4 and 5% lower following losses in Asia. US 10Y yields fell 22bps to 0.74%. Oil fell by almost 10%. Those moves follow weaker-than-expected Chinese activity data for January and February, intensification of citizen restrictions in the US and Europe, and despite leaders of the G-7 nations vowing to do “whatever is necessary” to support the global economy.

Unlike most instances of a sharp downturn in economic activity, this one was seen coming. The Fed bazooka does mater, But – critically – while the Fed wishes it could fire at the left-side of the V, it can only hit the right side with its stimulus efforts. Swamping credit markets with cash is their crucial motivation as conveying the appearance of keeping both credit lines and lending facilities awash with money during a possible credit crunch amid an economic downswing of this magnitude is critical. But painfully as it is, when you shut an economy down, low rates do not have a simulative effect on consumption until the shock passes.

This is 2008, but with a completely different focus. Back then, it was banks, his time bank balance sheets as fine the buffers built in after the GFC are working. Furthermore, liquidity tools are all working.

But this isn’t a banking crisis; it’s a global economic crisis where virtually every global industry will be facing extreme pressure without a public bailout.

Speaking of bailouts, one thing that has always been key in the market eye was how policymakers deal with a plummet in air traffic, which has sent Airlines shares into a death spiral while taking credit markets along for the ride. He combined One world, SkyTeam, and Star Alliance members have called on governments and stakeholders to provide extraordinary support. The group said there should be a re-evaluation of landing charges to mitigate revenue pressures.

Fortunately, for the airline industry, the White House was listening as economic adviser Larry Kudlow says the administration is drafting a financial assistance package for the airlines that are expected to include direct assistance, loans, and tax relief.

He also says it would consider sending cash to households as short-term relief. Hong Kong did something similar a few weeks ago, which, it was suggested then, is how sufficient helicopter money might work in practice while getting cash in the hands of the folks that need it the most.

Measures of volatility and risk in credit & equity markets are back to levels last seen in 2008 even as the Fed steps in again. But don’t misinterpret peak volatility with a trough in risky asset classes – history implies otherwise.

US bank stocks are around 18% lower. Eight US banks have announced they are suspending share buybacks and will instead focus on supporting clients.

Oil markets

Oil prices lifted off the mat in late NY trade after 24 hours of “sell sell sell” as COVID-19 newsflow over the weekend was exceedingly grim as Europe, and now the US begin to aggressively step up their reaction to the spreading of the virus. And emergency Fed cut in rates to zero serves to highlight the gravity of the situation.

Oil market historians are quick to point out that this is only the 5th ever demand decline in the modern era. But what’s different this time is that we are experiencing simultaneous supply and demand shocks.

Presumably, the market is getting supported by physical bargain hunters, but those storage facilities are rapidly filling. If storage does fill, quashing that demand, oil prices are sure to collapse further, and the global markets will then have to hope that the dispute between Saudi Arabia and Russia is resolved before we reach that point of no return.

In addition, the bounce in Asia could also be due to the front running of a possible China stimulus. Many traders are buying into the thesis that China will unleash the mother of all stimulus once China sees the virus through and people return to work

But Oil traders are hardly confused by the latest developments. On top of simultaneous supply and demand shocks, the market continues to move linearly as reports of global containment measure and more travel restrictions roll in. All of which suggest rallies will fade

And more damningly for oil prices is that perhaps the markets have underpriced the extent of the economic carnage as Covid-19 moves like a wrecking ball through the global economy.

When social distancing becomes and acceptable and widely used expression in everyone’s phrasebook, I don’t think people around the world are all that eager to jump in trains, plains, or automobiles, even if they wanted to. While the fear of secondary outbreak will likely keep them hunkered down well beyond peak virus

Gold markets

Yesterday early morning gold gains on the Fed rate cut reversed as equities slump, but losses pared; bullion is showing some signs of stabilization. Still, gold declines remain linked to investor’s need for cash.

A constant question on every bullion investor’s mind is why is gold retreating when uncertainty and’ risk-off’ sentiment is rising? Gold’s recent declines are chalked up to margin-related selling as equities fell. But there is an added fear element: the need for capital preservation is becoming a primary thought in investors’ decision-making process. Holders of gold, whether it be physical, paper, or even scrap, are liquidating to boost capital levels. But this may only go on for as long as equities remain so weak. The rebound late in NY is impressive.

Precious metals flow appear to be driven exclusively by forced liquidation across the yellow complex. ETF accounts are the most active with platinum leading the volume (the market is long; investors wanted to get out) and silver (XAUXAG ratio puffed up to all-time highs). Gold, which had attracted so much determinative subscription, there was initially more selling across the board overnight. Still, gold prices have axiomatically rebounded as gold is a hedge for all-seasons crowed was likely motivated by the deluge of central bank easing, which has made credit lines both reachable and actionable.

Similar conditions were seen in the aftermath of the financial crisis. Gold was initially caught in the crossfire but soon embarked on a rally to all-time highs. The policy response has been fast, and the velocity of devastation in asset values is unprecedented. But If gold is to retain its risk-off appeal, the recovery needs to be quick.

Good news for the gold investors is that the risk parity and vol control segment of the markets are running out of equity market risk to pare as stock market exposure plunged to GFC lows.

Forex markets

G-10

 

Traders need a more compelling reason to short the USD. Zero rates and QE will be very efficient in weakening the dollar once global growth sentiment turns around. But dollar funding stress across a breadth of global markets as evidenced but widening in the cross-currency basis last week signal more USD buying to come. However, if today’s Fed action effectively alleviates some for that credit stress, this would be the first step to a weaker dollar, particularly against currencies where risk premia are extensive such as EUR and AUD.

Beyond China (at a stretch), there is scant evidence that life is returning to normal. On the contrary, more significant restrictions on international travel, proximate social contact, and intra-country transit seem likely, which will undermine economic growth, with equity markets and credit markets taking more pain. Suggesting the greenback is not going out of favor anytime soon.

EM Asia FX

Yes, the global economic outlook is miserable, but what’s more critical for Asia FX risk is China. Yesterday’s China high-frequency activity data was horrible and even worse than expected amid the virus pessimism, which should continue to weigh on sentiment as China GDP revisions get marked lower.

The Bankers Association of the Philippines says FX and fixed income trading will be suspended from Mar. 17. (Bloomberg)

Taking a page out of China playbook, the Philippines policymakers are imposing the ultimate circuit breaker but shutting down the PSE as the island effectively goes into lockdown containment mod. It sounds like a prudent measure, although ultimately curbing short selling for a month or so might have been the first order of the day.

But the US dollar liquidity crisis needs urgent repair QE announced by the Fed overnight will help increase dollar liquidity in the global financial system. Still, the money needs to flow down to the real economy. This could give time. The fact EM central banks were not offered up Swap lines by the Fed at this time for them exchange UST’s for cash at the Fed window makes things a bit more urgent for small markets like the Philippines.

If there is a currency run in other parts of Asia due to the USD liquidity crisis, we may see similar curbs across Asia, starting with short selling restrictions.

In my view, its the USD liquidity crisis, not the economic damage is the absolute wrecking ball through Asia FX.

As Asia sees the virus pass before the west, things return to normal in ASEAN currencies quicker that most of G-10.