Entering the Covid-19 Rabbit Hole
For a while last week it felt like a stroll through Wonderland, with the Federal Reserve Board "all in" and world leaders dropping nearly $5 trillion fiscal stimuli in the market’s lap as sugar-coated promises were whispered about this being the deepest – yet shortest – recession in modern-day financial history.
But with Coronavirus cases in the US rising exponentially, lethality projection rates soaring and secondary cluster fears gripping Asia and Europe causing county-wide lockdowns, it certainly feels we're nudging ever so closer to falling down the Covid-19 Rabbit Hole, with reports that the US death counts could reach 200,000.
Global cases increased by 26% since Friday (now 713,000), led by the US with 136,888 total cases (48% growth). Less talked about is where the virus is building now:
Now policy responses read like a playbook: cut rates to zero, purchase a more comprehensive array of assets than ever before, then pump fiscal spending with little regard to debt sustainability. This suggests we’re nearing policy fatigue where it becomes less effective and, as the surprise element diminishes, no one cares.
So, while policy responses in the US and Europe have been spectacular, allowing for markets to rebound last week, the coronavirus keeps spreading globally, all the while deepening fears of the economic and financial impact across countries. More market turmoil likely lies ahead.
If you've spent any time ocean fishing, you're probably aware of the term "sucker hole” – a colloquial term referring to a short spate of good weather that "suckers" sailors into leaving port just in time for a storm to resume at full force. Well, that's what last week's market felt like as we’re now about to enter a vortex of bad earnings, bad economic data and bankruptcies. Indeed, last week's animal spirits will be severely tested.
Oil and copper did not rally; the Vix isn't pulling back despite the S&P 500 being 10% higher last week.
With no visibility on the end of lockdown, the world is becoming increasingly branched, with business people wanting a quick reopen based on the thought that the solution to a problem produces a worse net result than the problem itself.
On the other hand scientists are pleading for caution in order to avoid overrun hospitals and potentially dealing with multiple rolling lockdowns. This brings about the possibility of triggering the ultimate policy destabilizing moment that no one wants to see: the President (emphasizing business priorities) and Governors (highlighting science priorities) locking horns. Fortunately the President says he’s extending virus guidelines to April 30.
The primary narrative
The spread of Covid-19 and the impact on oil demand will continue to pressure oil prices and the virus headcount numbers out of New York City are providing those especially poor optics this morning.
Oil prices have softened in the aftermath of the US package hoopla, suggesting the direction of travel skews lower as markets anticipate a 2Q that will inevitably see a large build in inventories as demand echoes the shutting down of major global economies.
There’s a relatively wide range of estimates on how much global crude storage capacity remains and on how quickly that capacity is filling.
However, when the storage capacity is filled, we should probably expect a response from Saudi Arabia, Russia and other essential oil producers. On the other, the longer their response takes the higher the risk of another steep decline in oil prices.
While WTI seems settled in the low $20s as a baseline for now, it's tough to rule out a drop into the teens – or lower – if Saudi Arabia and Russia stay the course.
Only then would the cash cost accelerate shut-ins and ultimately lead to a price rebound, but it would make for a horrible year for a good chunk of the world who are oil price takers.
On the supply side (which I think is less relevant today but a factor nonetheless), US oil companies seem to be reacting more quickly this time than they did in the previous downturn. Energy firms cut the most oil rigs since April 2015, removing platforms for a second week in a row as a coronavirus-related slump in fuel demand has forced a massive reduction in investment by oil and gas companies.
Drillers cut 40 oil rigs in the week to March 27, bringing down the total count to 624, the lowest since March 2017, energy services firm Baker Hughes Co. said in its weekly report.
There could be light at the end of the tunnel as several sources are reporting that refiners in the US and Europe are not buying Saudi Arabia's crude, despite the steep discounts being offered as part of Saudi efforts to pressure Russia and other global producers.
Excess supply was brewing even before the Saudi–Russia falling out and long before the collapse in oil demand. Indeed, this the most significant mismatch between supply and demand in modern history, suggesting these aggravating factors will limit any price recovery – even with a truce.
A shift back to 'risk-off' sentiment did little to support gold as the thought of distressed sales is still too fresh in traders’ minds. So, the market remained in tight ranges on Friday where all three sessions bore witness to profit-taking after steep gains last week. But US weakness helped to temper profit taking price declines.
But gold should shine through as risk sentiment weakens this time around. For the most part, the immediate need for equity margin call selling has already been done, suggesting there’s no apparent reason to sell gold in this environment, other than to book profits.
In both 2008 and 2020 gold has briefly been caught in the mix where good trades were being liquidated in distressed markets. But last week there were clear signs the market is warming up to the idea of central banks monetizing debt and leaving considerable excess liquidity in the banking system. But the key differentiator in 2020 is that QE is financing helicopter drops into households around the world. And, interestingly enough, QE is even being discussed in ASEAN markets even when interest rates are far from zero, which could be the harbinger for a new form of debt monetization policy around the globe.
GFXC Issues Statement on FX Market Conditions
The Global FX committee – made up of banks and other stakeholders – has issued a statement (unprecedented as far as I can tell). Effectively it just says: "Be careful – this is going to be a big and busy month end", only in slightly more technical language.
GFXC Issues Statement on FX Market Conditions
The dollar liquidity crisis appears over. It has taken more than $30 trillion in annualized bond purchases from the Fed, among others, but the dollar crunch now appears under control. US real yields have dropped almost 100bps in a few days and cross-currency basis has normalized. So, with policy rates converging to zero, traders are now looking to take the Asia "virus divergence" trade global. In other words, bet on those economies that will see the virus pass quicker and return to some type of economic normalcy.
Markets may be able to look through some pretty horrible economic data – like the non-reaction to the historic spike in US jobless claims last week – but will likely be sensitive to the news on the duration of shutdowns and any signs of second-round effects extending travel alerts and lockdown measures.
Last week the Dollar pulled back as risk assets rebounded, but our best guess – and that’s all most of us are flying on – is that the epic USD rally is not quite over. Month-end flow will complicate matters, but with US equities in the tank it's unlikely we’ll see USD demand from rebalancing flows kick in today.
The Ringgit will remain defensive due to secondary cluster fears, the negative economic effect of the MCO and the prospect of lower oil prices, which reduces the supply of petrodollars – a crucial stabilizer for the Ringgit.
When US CARES, markets listen
The S&P500 rose 6.2%, with smaller gains in Europe and modest declines seen through most of Asia. Oil prices rose 19%, gold was up 1%, and US 10Y treasury yields fell 4bps to 0.83%.
Given this all happened after 2 percent of the US labor force filed for unemployment insurance last week, it’s left more than a few economists and traders a tad confounded; perhaps that’s the fundamental nature of this shock. After all, the market seems happy that the number came in on the whisper and the rise in jobless claims could have been 'worse'.
The fundamental problem isn't the size of the print, it's how long this shock persists. Indeed, the biggest concern for the economy isn't the immediate impact of things like jobless claims, rather the longer-term effects. If the US economy moves into a protracted recession, the business and human costs are likely to be much higher than the impact of the virus itself.
US jobless claims numbers honestly shouldn't come as a surprise – this is not a recession pattern of job cuts where 10% is trimmed in a revolving design until businesses bottom out. Instead, this is one day fine, the next day everyone’s gone. And it’s a pattern that should reverse, to a degree, when the virus passes. With that in mind, the market is running with the assumption that while this tumult will be the deepest recession in modern-day financial history, it will also be the shortest.
Even although I'm short the SPX near current levels right now and another order in to sell higher, I honestly hope bullish is the case and will be more than happy to cut and run with the market for humanity's sake, if nothing else. But since it's impossible to gauge the ultimate economic impact or the duration of the Covid-19 pandemic for weeks, possibly months, and until that point the sustainability of any rally in stocks is questionable and I remain relatively risk-neutral, short SPX and short US dollar hedged.
The question is this: will the next 500-point move be higher or lower? For me, a break of 2700 says more topside to come whereas a move below 2500 means lower, so choose your position carefully.
Anyone running multi-asset portfolios knows the quick returns are probably to be made in equities right now, if you can catch the moves. However, why is this happening and why is the US outperforming Europe? It boils down to technology; the US has it, Europe doesn't.
Couple that with a "buy what worked before" mentality and funds are averaging in again on tech stocks that shouldn't much be affected by the virus – especially Microsoft and others that primarily focus on cloud computing which resonates now with the world working from home.
Overall there’s been a general shift to neutrality from the perfect bear market conditions late last week, which is a good thing.
Jobless claims were horrible – and there's no way to sugar coat that – but the market never lives in the present. The Fed's bazookas appear to be filtering through and that's a massive positive the market is running with. By their policy design, the US dollar is starting to back off its rush and, most importantly, signposts targeted by Fed policies have begun to show signs of less stress.
So, while the jobless claims were gloomy, investors like what they see as the Fed’s bazooka shots appear to be hitting their targets.
The strength of the US dollar was a massive problem so the Fed expanded swap lines to other central banks and fortified them further. While there's usually a lag effect, judging from moves in the US dollar over the past few days the "dash for dollar" funding is at least lessening.
There are widening influences suggesting that the high-water mark for panic in financial markets has passed. A less inverted VIX curve, narrower US high-yield credit spreads for the energy and airline sectors, and lower implied FX volatility reflects the substantial policy action led by the Fed.
And with the final piece of the policy puzzle, the US CARES Act, about to be bridge ended, a much-needed social safety net for the millions lining up at the unemployment window will be provided. This will significantly assist in ameliorating Main Street’s biggest concerns as investors always favor humanity when it comes to risk.
The S&P 500 is up 6.2%, or just over 150 points. I don't think it's wise to chase this – primarily because the worst of the virus has yet to hit and only half of US states and a third of the US population are in lockdown. There's no reason to believe the US population should be less immune to the virus than everywhere else in the world, not to mention the notion that the world is quickly returning to work seems to be a flight of fancy; thousands of businesses and jobs will be lost, regardless of government handouts.
However, why is this happening and why is the US outperforming Europe? Tech. The US has it, Europe doesn't.
The latest coronavirus cases numbers from New York look ugly. At the time of writing it has 37,258 cases, up from 30,811 on Wednesday. That's easily the most significant daily increase so far and keeps the growth rate in the 20% range.
The oil market was smacked with the ugly stick overnight after the IEA executive director Fatih Birol said demand could drop as much as 20 million barrels a day, sending many oil quant traders into an "oh dear" state as a 7-10 million barrels per day hit was the running assumption for many.
Although the US CARES Act relief ally ensued as the Main Street parachute package, particularly the unemployment benefits, will likely delay oil product storage facilities cresting by another two to four months, all things being equal.
Still, over the short term, the spread of Covid-19 and the impact on oil demand will continue to pressure oil prices, and the virus headcount numbers out of New York City are providing especially poor optics.
There’s a relatively wide range of estimates on how much global crude storage capacity remains and on how quickly that capacity is filling. However, when the storage capacity is filled, we should probably expect a response from Saudi Arabia, Russia and other essential oil producers. On the other hand, the longer their response takes the higher the risk of another steep decline in oil prices.
While WTI seems settled in the low $20 as a baseline for now, it's tough to rule out a drop into the teens, or lower, if Saudi Arabia and Russia stay the course.
Only then would the cash cost accelerate shut-ins and ultimately lead to a price rebound. But it would make for a horrible year for a good chunk of the world who are oil price takers.
Gold performed in European trading, rallying notably in the leadup to the US opening and throughout most of US trading. Gold got a nice boost from a weaker USD, notably against the EUR.
Gold was a prime beneficially from the surge in US unemployment numbers, which argues for continued stimulus and monetary accommodation.
USD demand on the back of funding issues has eased further in the past 24 hours; accordingly, the USD has now started to slip back lower.
The expectation of Congress passing the US CARES act accelerated USD selling, where the hard-hit AUD-GBP and EUR were prime beneficiaries.
The EUR gained as the ECB formally scrapped its self-imposed limits on its bond-buying program. The ECB announced that issue limits “should not apply” to the new QE strategy.
A downgrade also aided the GBP moonshot after the Covid-19 lethality forecasts were revised down significantly by the Imperial Colleges, which in turn implies the virus is less dangerous in the UK.
The AUD gained on two fronts: its high beta to risk was evident overnight on the back of the US stimulus package and the $AU benefited greatly from the drop in cross-currency basis swaps costs thanks to the Fed emergency Swap facilities.
Also, the drop in volatility leaves the long USD position at risk into month-end; as such, there's been a considerable unwinding of long USD risk across the board overnight.
The Malaysian Ringgit
The drop in USD funding pressure is an absolute boon for the Malaysian Ringgit as the dash for US dollars in Malaysia was even more intense than that for regional peers. The fall in oil prices provided Malaysia with fewer petrodollars per barrel, and these oil dollars are usually considered a stabilizer for the Ringgit.
Factor in a generally better tone in the global risk markets and the Ringgit will open stronger today.
Soaring US yields trigger the wrecking ball effect as yields become a source of volatility for risk, rather than a source of support