Macro Digest: Welcome to policy panic week

Macro

Steen Jakobsen

Chief Economist & CIO

Summary:  We are looking for global central banks to pull out the stops to bring support to the market this week, a move that may bring some relief after an ugly week for global markets, but one that may not last for long as the challenges for the earnings and the economy remain depending on the ongoing fallout from the coronavirus.


What:
Expect Fed to cut by 50 bps this week and for other G-7 banks to follow through in a ‘coordinated fashion’

Why:
Markets have fallen 15% and in very short order – more than enough for central banks to panic

Market impact:
There could be a sharp rebound as bottom-seekers and liquidity returns for a time – see the chart below for levels.

Action:
Going long short-term (March) calls on the S&P future – strike prices from 3050 up to 3150. Note that this is not a call on the longer term direction – see more below.

SPX w. Retracement levels:
A basic retracement from top to bottom would argue that a throwback rally could achieve a move back toward 3190 in the S&P 500 if we take the 61.8% retracement, even if the longer term outlook remains at risk for market bulls.

Source: Saxo Bank

The saying goes there are only two certainties: Death and taxes, but the market of course knows this is incorrect as there are really three: death, taxes and central bank panic. This week will see a repeat of all prior crises... a full liquidity Tsunami is about to hit the market with Fed expected to cut 50 bps priced fully in: April trades 106 bps with Fed funds at 150-175 bps!

Source: Bloomberg

More importantly, our long held view that US rates will go to zero is now almost fully priced in as seen here but Fed Fund targets as priced by markets. While ‘support’ through liquidity may be good for market stabilization we are medium and long term only making things worse as debt pile will grow and so will central bank balance sheets. Where in early 2018 we had chance to revert we are now fully down a one-way alley where either hyperinflation or global default are the only outcomes!

Just last week world central bankers were telling us again and again: It’s too early to draw any conclusions. Markets have zero respect for central banks and are now forcing their hands to intervene. 

Bank of Japan started this morning, indicating coordinated policy is near:

https://www.reuters.com/article/us-health-coronavirus-japan/boj-reassurance-on-coronavirus-bolsters-speculation-of-global-policy-action-idUSKBN20P018

We have taken profit on the long volatility play we suggested February 24th:

Quote:

The best way to hedge your downside here is to BUY VOLATILITY, which is still cheap. We suggest 8000, 8300, 8500 puts in March  (Please ask GST-sales to help you price)

We suggest following portfolio for coming period:

  • 20% Long volatility: mainly SPX, NASDAQ and DAX volatility
  • 20% Long gold, silver: main XAUUSD, XAGUSD
  • 40% Long fixed income: 25% TLT(ETF) + 15% VTIP:xnas USD
  • 20% Long SaxoCLIMATE basket

Conclusion and strategy for this week:

There is no doubt that the market is forcing Fed and G3 central banks to move. A full 50 bps cut is now fully priced by Fed, personally I’m looking forward to see ECB’s handling of this as lower rates clearly doesn’t make any sense (or change) to economic outlook!

The critical thing here to watch after the market reaction to the policy easing is the further development in coronavirus in Europe and the US.

Remember the virus is what has created the ‘angst’ in the markets but the real economic price is yet to be priced as companies, in particular SME’s, will be under pressure due to the lack of credit and broken supply chains. Most observers in China and globally calculate that the critical period starts some three months from the  outbreak if conditions have failed to normalize.

We are now two months into this crisis with Europe and the US only feeling phase 1, so clearly it’s going to be a race against time but also for central bankers and politicians to change the narrative which increasingly is becoming one of a ‘global recession’ - and this while the global credibility and communication of those same people as the lowest I have seen a too long career in the market.

Personally, I will maintain defensive exposure (small long through options on SPX).

I fully expect to only be constructive on the outlook for a market bounce for a mere week or so as this looks like a possible “third wave of five” in a bearish move in Elliot Wave terminology. And with economic data and corporate earnings warnings signaling that this needs to get a little worse before it gets better.

Don’t forget Super Tuesday tomorrow. Mayor Pete is out, and by Wednesday we will know how strong Bernie Sanders stands.

Safe travel this week,

Steen

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