Having seen the S&P briefly trade into negative territory on the year, there was a sense of buy on dip opportunity that gripped US investors, even in the face of broadly negative coronavirus headlines.
Also, there's been quite a turnaround in fixed income after the US Treasury markets were solidly bid into the European session on the back of "safe-haven" demand, and as inflation expectations/break-even moved lower in consort with an enormous fall in commodity prices, But as risk shifted into positive gear, the yields on US 10-year treasuries lifted. And the robust results from Apple beating its Q1 estimates, as well as Q2 guidance estimates, should help carry the US market's positive tone into the Asia session.
Overall there’s no smoking gun in terms of one single headline, but Zhong Nanshan, a Chinese respiratory expert, is being quoted by Xinhua as saying the coronavirus outbreak could reach a peak in 10 days or so. And the South China Morning Post, citing an expert, says Hong Kong researchers have already developed a vaccine for the coronavirus, but need time to test it.
I was amazed by the amount of bandwidth getting exhausted over this virus scare and how it could negatively affect investors' psyche, but I should have been focusing on the TV effect after some of the more influential market TV commentators spent the past 48 hours talking about "when to buy the dip", it seems to have resonated.
S&P e-minis traded positive all day yesterday – through Asia, Europe and into the US session – which seems to have spurred the dip-buying fervor. But I think this is further proof that big investors believe the bulk of the US market risk is concentrated in stocks not directly exposed to the current market worries in no small degree.
There was a lot of fear factor playing out in the bond market over the past 48 hours as investors thought US inflation could become unanchored due to the toppling commodity prices and push towards the Fed letting the doves fly. But the market remains well above the absolute fear zone. The carnage in the oil patch in late 2014 through 2015 was much more of an issue, and trade war fears pushed break evens toward crisis levels last summer. So far the virus effect has palled in comparison as inflation break evens have fallen, but not by much.
But the market is so finely tuned these days that, in a matter of 24 hours, its self-correcting mechanism takes hold without the need for central bank policy. One of the more undervalued market self-correcting mechanisms is how quickly financial conditions loosen. From last Friday’s tops to peak fear yesterday, the bond markets shaved off a whopping 15 basis points on ten-year US yields which offset the stronger dollar and decline in the equity market – both large negatives for financial conditions.
On the US economic data front (which fortunately didn't fall through the cracks) investors were left to digest a positive smorgasbord of US consumer confidence and home price data. This reinforced the ongoing Fed narrative that consumer spending can carry the load and sustain the expansion through the continuous soft patch in investment.
Now it's pivot time to the FOMC where the Repo market appears to be not overly stressed, but there could be some marginal guidance there. But there will also be questions about the Fed's response to the virus; Powell should stick to the mantra "will respond as necessary" and that "it is a transitory shock." This should be enough to reassure investors that the Fed has ample policy wiggle room and to also remind them that epidemics are transitory, and so are the market fallouts.
Oil prices stabilized very much in line with risk sentiment and oil prices were further bolstered by the API report which showed US crude stocks fell as traders continue to trudge through the unenviable task of figuring out the potential demand devastation impact from the coronavirus.
The big elephant in the room remains China, given oil price sensitivity to a plethora of mainland economic factors – jet fuel demand notwithstanding. And since we don't have a sturdy handle on that yet, as investors need some evidentiary data to compile, prices could remain under the cosh even if we do see short-covering rally attempts.
Oil seems to have stabilized (for now) following a drop of about 10% top to bottom since news of China's coronavirus outbreak. This is slightly puzzling given rapid containment efforts by the Chinese government, but China's impact on the global economy and oil demand has grown significantly since the 2003 SARS outbreak.
So, there's a lot of ground to be made up. If risk markets continue to sidestep the jump on the nCoV cases – a big if – this might give rise to a sooner-than-expected transitory rebound in prices. At that point traders would start tripping over themselves to get topside exposure.
But, failing a bounce on that, the likelihood of a supply response from OPEC – and possibly sooner than the planned March meeting – should provide some semblance of a floor until oil traders receive concrete evidence that containment is working and that infection rates are slowing. So maybe the bottom is in?
Gold falls as risk appetite rises as the equity market sell-off reverts as investors were quick to move back into shrug mode; a moderate recovery in risk sentiment was enough to put gold back on the defensive.
The rise in bond yields, with the yield on the US 10-year Treasury moving up to 1.65% from 1.60% previously, weighed on gold.
This week gold was very much an equity market play so most of the damage done to gold prices appeared to be triggered by the comeback in equity markets overnight.
The FOMC is in focus, but with the recent virus scare it's improbable the Fed will stray too far from their current mandate while not wanting to upend the apple cart by commenting on the Repo market with sentiment arguably still fragile.
On the virus front, Chair Powell will likely hammer home the transitory nature of the virus, which will not be particularly bullish for gold.
Still, there remain a plethora of risks that suggest gold prices could easily and quickly regain lost ground suggesting bid in dip mantra will continue to resonate.
But in 12 hours the market has swung from 70:30 $1600 before $1560 to now 80:20 $1560 before $1600 as gold investors remain extremely impressionable by the moves in US equity markets.
The key Asia bell-weather fear gauge, the offshore Yuan, continued to advance and pare losses overnight, apparently triggered by Xinhua and SCMP headlines. Long USDCNH was the market preferred defense strategy with onshore markets closed so positioning was massive long.
Even yesterday, the strong adverse reaction on the CNH had macro names piling into long Yuan positions, probably thinking that the exaggerated sell-off didn't reflect the actual mortality rate that’s currently in line with the common flu.
And while it doesn't feel like a hold on to your hat moment for a short-term reversal and short squeeze on USDJPY, the relatively tame market reaction to the big jump in new nCoV cases is encouraging. And when combined with the taming of the Yuan beast (USDCNH topped and reversed), it might bring out more ASEAN currency risk-takers from a state of self-imposed hibernation (my hand goes in the air), which should be positive for local currency risk.
In G-10 you’d expect the risk reversal to play out in AUDJPY, so that could be a bellwether for the day. Mind you, G-10 and ASEAN FX traders’ duration thresholds have compressed to about 2-4 hours in this environment, so I think the market could remain a bit whippy.
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Ongoing rate curve repricing and risk asset reaction perfectly illustrate how worryingly reliant investors have become on easy money policies