The most critical question for the economic outlook is whether, and how quickly, the coronavirus outbreak will decrease, allowing for various countries’ "unlocked down" strategies to kick in. Corona curves are flattening but there remain health concerns about secondary breakouts, suggesting policymakers could push back tentative end-of-lockdown dates. Politicians need to walk a fine line in ensuring shutdown activity doesn't cause permanent or lasting damage to their domestic economies, even though ongoing travel restrictions could persist after the lifting of local constraints.
Fortunately, a “Phase 4" fiscal package from the US Congress is inevitable and could include aid to state governments, as well as some additional funding for assistance to small businesses, unemployment benefits and perhaps another round of helicopter payments to individuals.
While The Federal Reserve's new program for lending to mid-sized US businesses is still two or three weeks away from being implemented, Vice Chairman Randal Quarles said in a virtual forum organized by the University of Utah that actions taken by the Fed, Treasury and Congress are "designed to ensure that the hibernation period we can go through with the least amount of damage, and I believe we will do that."
Following the Easter weekend, markets will have much to tussle with over the week ahead. There are several critical Q1 earnings releases due in the US, along with meaningful economic data that’s expected to further reveal the horrific extent of the coronavirus's impact on the global economy. China's Q1 GDP release on Friday will be closely watched, along with crucial US data on housing, retail sales and industrial production for March. All of which suggests that, as investor focus turns to the real economy, a reality check or two remains on the cards where the markets could end up showing investors all the mercy of a Greek tragedy.
The pandemic is affecting policymakers' discussions too, with the IMF and World Bank's Spring Meetings taking place in a virtual format from Tuesday, while G20 finance ministers and central bank governors will also be via Webcam on Wednesday. From central banks, the market will dial in on monetary policy decisions from Canada and Indonesia, along with the Fed's latest Beige Book.
But the market might have one less fire to put out after the world’s top oil producer pulled off a huge deal to cut global oil output, putting an end to the vicious price war between Saudi Arabia and Russia.
Is sentiment too negative?
OPEC+ has agreed to historic production cuts that will take 10m barrels per day (bpd) offline as the coronavirus pandemic saps demand for crude. Still, there remain concerns the agreement could be a day late and a "barrel short" to prevent a decline in prices in the coming weeks as storage capacity brims. The voluntary cuts from the US, Brazil and Canada might not be large enough to offset the possible 25 mb/d (average between current 20-30 mbd estimated) demand loss in April due to the coronavirus and additional factors. Cushing crude inventory builds could drive a further collapse in May-June WTI time spreads.
But with traders possibly looking for a big bang at the start of today’s session only to open with a whimper, oil prices initially bounced higher but have subsequently performed a grand tack and are now stumbling out of the gates this morning, so far.
Price decomposition is a struggle
How much of the max demand devastation in the price is yet to be seen and how quickly will the sudden stop in demand filter back to the wellhead capping dynamics? Given the volatility in the price action of late, the decomposition of price movements is still challenging.
However, the market has likely priced out the extreme risk premium that had been baked into oil prices in the second half of March and much of the fundamental supply shock of recent weeks is still in the price. If about half of this year's price decline was about supply, in the best-case scenario a return to global supply levels from the start of the year should imply oil prices retracing about half of the sell-off. As such, there could be a meaningful upside move, subject to the quantified extent of demand devastation for April.
The Hacienda Hedge Snag
The deal had initially hit a snag over Mexico's reluctance to burden their share of the pie, which was 300,000 bpd more than they were willing to commit. Mexico's unwillingness stems from the well documented "hacienda hedge," aka the world's largest oil trade where Mexico hedges oil output forward to flatten out their financial risk, especially vs. state-owned Pemex, the world's most heavily indebted oil company. Mexico has hedged forward there 2020 Maya crude production at $49 per barrel vs. $ 25.79 at Thursday's close, suggesting their production regime remains price agnostic through 2020.
The Bullish duration surprise
What the OPEC+ deal couldn't logistically accomplish in size it attempted to do in prolongation, with commitments of output reductions of 8 mb/d from June to December and six mb/d until April 2022 (implying extremely tight market overtime).
While these numbers remain greatly conjectural as OPEC+ will meet again in June, it does suggest the ongoing savage market rebalancing is increasingly likely to be followed by a sharp rebound in oil prices once demand starts to recover and a chunk of forced shut-in supply never comes back online due to bankruptcy.
The gravitational attraction of the Fed‘s unprecedented stimulus efforts should continue to outweigh the gravitational pull from distressed sales as asset volatility continues to decline, although a possible fall in oil prices could trigger more deflationary concerns, which are not great for gold prices. And while US jobless are still the most reliable US economic indicator, at last we’ll see some pertinent data this week in the form of US retail sales. The consumer data is expected to be pretty dreary with everyone in lockdown and should support gold markets where investors are focusing on the real economy.
Gold is trading in its recent range after it hit highs earlier the week. If the coronavirus economic situation worsens this week and the market goes into risk-off mode, this would give bullion further support to the topside.
Risk is trading softer this morning as oil prices failed to fire higher after OPEC+’s epic deal. And with bullish bets likely to pare ahead of a week dotted with economic potholes, US dollar bears may be tentative to step in front of early moves this morning until the dust settles, which is typical for an indecisive Monday opener.
Last week the Eurogroup ministers agreed on a package of measures aimed at shoring up EU financial engineering during the "corona crisis". These actions should significantly reduce certain tail risks related to bond market access, and therefore should lower the probability of a sharp Euro depreciation on EU break-up fears.
The Australian Dollar
The Australian Dollar has been the best performing G10 currency over the past two weeks, gaining over 4% versus the US Dollar.
For the most part, AUD/USD has closely tracked the S&P 500, or broad risk sentiment, in line with its typical historical beta. Still, many analysts will be quick to point out the Aussie move could be short-lived back towards mid-March levels if equities turn lower.
But the latest round of fiscal stimulus allows eligible people to access A$10,000 from their pension funds with no penalty between mid-April and fiscal-year-end, as well as in the next fiscal year (after June 30). In preparation for these withdrawals, domestic funds need to sell overseas equities and convert the returns to local currency, which should result in more upward pressure on AUD.
The Chinese Yuan
USDCNH is trading below 7.05 and supporting the corona divergence trade narrative where countries and currencies that took strict containment measures will see the virus pass quicker so their capital markets will benefit faster. But turning the focus to Fridays PBoC Fix where the yuan reference rate was pegged at 7.0354 v 7.0536 prior (most robust fix since March 18th) may suggest – on the surface anyway – that China is not considering using RMB as part of its policy toolkit to boost growth, which is bullish for the RMB.
The Malaysian Ringgit
While the market is moderately bearish;, with EM local currency flows stabilizing and investors looking for opportunities to redeploy capital, Malaysia remains a viable destination for bond inflows as real rates are high. Also, the market is far from pricing the 100bps of easing that I’m thinking will happen with the extended MCO, which should also trigger more MGS demand. The OPEC deal should be viewed supportive for the Ringgit as it removes a significant supply tail risk that was weighing on prices last month.
The Philippines Peso
As for the Philippines peso over the short term, the PHP has been the most resilient amidst virus and financial market stress. Small foreign portfolio positioning means less capital flight risk, and positive exposure to lower oil prices says less dollar funding vulnerabilities and adequate reserves have all helped with the Peso’s surprising upswing.
Here again, bonds look attractive with rates cuts expected and foreign market ownership is relatively small, suggesting more traders will start to position for secondary policy support from the BSP and, as such, should keep the Peso in favour.
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Ongoing rate curve repricing and risk asset reaction perfectly illustrate how worryingly reliant investors have become on easy money policies