Market Quick Take - April 22, 2020
Chief Economist & CIO
Summary: The sell-off in crude oil took on fearsome power yesterday as the most liquid front contracts in both WTI and Brent suffered enormous drops. Elsewhere, we continue to watch signs of the markets mounting concerns for Italian debt ahead of the crucial EU council meeting tomorrow, where a bad outcome could accelerate gathering bearish momentum in equities after the very weak session yesterday.
Markets suffered their worst sell-off in some thirteen days yesterday, in part on concerns that the massive slide oil will drive concerns for the broader credit markets from defaulting energy companies. Next up is the EU Council meeting tomorrow amid signs of mounting existential concerns as Italian sovereign yields rise.
What is our trading focus?
- 10YBTPJun20 – the Italian June, 10-year sovereign bond (BTP) future: the pressure has mounted further on Italian sovereign debt on the concerns that a new EU existential crisis is brewing. The BTP futures saw one of their worst days yet yesterday ahead of a crucial EU Council meeting coming up tomorrow.
- OILUSJUN20 (WTI crude) and OILUKJUN20 (Brent crude): after unprecedented carnage for the May contract in a pre-expiry run lower, albeit on low volume, the June contracts for both WTI and Brent suffered massive losses that are actually far more damaging for the market as these are the most liquid contracts – June Brent closed down over six dollars lower at 19.33 and June WTI closed down almost nine dollars lower at 11.57. In fact, the sell-off was the worst single day for all forward contracts out years into the future since the Saudi-Russia price war was engaged back in early March. Concerns are afoot of another wipeout akin to what happened over the expiry of the May contract.
- BNK:xpar (European banks) and XLF:arcx (US financials): banks will be under pressure as the latest developments in oil markets will trigger higher provisions from loan losses in Q2.
- EURJPY (and EURUSD) – Interesting that the euro exchange rate itself has so far been little affected by the existential concerns evident in, for example, the Italian sovereign debt market as we eye tomorrow’s crucial EU Council meeting. On that note – we will watch the 1.0800 area in EURUSD and the 116.25 area in EURJPY for signs of a breakdown in the euro.
- Nasdaq100 – the big US tech index suffered its worst session in thirteen trading days yesterday in a sign of a major sentiment shift. We continue to watch the relative strength of this index, the highest-flying of major US indices off the March low, as many of the major tech companies are reporting next week.
- USO:arcx (United States Oil Fund) – The world’s largest oil ETF remains troubled by its recent success in attracting flows from investors looking for a recovery in oil prices. We cannot reiterate enough how difficult and potential costly it can be to try to bottom fish “cheap” oil when the fundamentals are this poor as reflected through a very steep contango negative crude oil prices seen this week. The fund currently holds a disproportionate share of the open interest in WTI crude oil futures, something that added to the selling pressure yesterday when the fund rolled half its exposure from June to July and August.
- Gold Spot USD (XAUUSD) – is off yesterday’s lows but still in correction mode from last week’s highs. Rates are steady in the US but with inflation coming down there might be a scope for further declines as real yields could improve short-term. Longer term a potential sovereign crisis could fuel higher prices in gold.
- NFLX:xnas (Netflix) and SNAP:xnys (Snap) – Netflix delivered the expected jump in subscribers in Q1 and a positive free cash flow as expenses on content creation slowed. However, subscriber growth y/y in Q1 remained in line with previous quarters and the Q2 guidance was outright disappointing so Netflix shares could come under pressure in today’s session and have potential spill over effects into wider sentiment on technology stocks. Snap delivered strong Q1 numbers and shares were up 20% in extended trading but online advertising spending could come under severe pressure in Q2 as the US lockdown (their main market) happened later than in Europe.
What is going on?
The manager of USO, the largest oil-tracking ETF, stopped allowing the creation of new shares yesterday: This fund still holds a significant portion of front-end oil contracts in WTI futures, and to a lesser degree, Brent contracts, and significant changes to its holdings were likely a driver behind some of the freefall in prices this week, with further downside risk if the fund it unwound.
The German-Italy yield spread for 10-year sovereign debt spiked to 263 basis points yesterday, which takes it to its third-highest daily closing level this year and the highest since the ECB announced its emergency PEPP round of QE that would allow it to snap up more Italian debt than would have been allowed under the old QE rules.
What we are watching next?
Signals from EU leaders and the nature of the agreement at tomorrow’s EU council meeting – there are a number of proposed, highly technical solutions for how the EU will approach funding the massive need for supporting southern EU countries countries during this process. Our chief focus will be on the mood and signaling among leader more than the package itself and whether the meeting allays the markets’ pricing of existential concerns (spreads on EU debt, etc.).
Q1 earnings season: earnings to watch this week are Biogen (Wed), Delta Airlines (Wed), Intel (Thu), Credit Suisse (Thu) , American Express (Fri), Boeing (Fri). Next week the big focus will be on technology companies with our focus on Facebook and Google as we believe the market is not adequately pricing in the sharp decline in online advertising that has taken place. As of today 10% of the S&P 500 companies have reported Q1 earnings and EPS is down 30% y/y and revenue is up 2% y/y.
Economic Calendar Highlights (times GMT)
- 1100 – Turkey Rate Announcement – The Turkish central bank wants to cut its rate further to support the economy, but there is massive pressure on the Turkish lira – down over 10% this year versus the US dollar in carry-adjusted terms.
- 1430 – US Weekly DoE Crude Oil and Product Inventories – storage is topping out and the implied demand figures will be interesting to watch this week and in coming weeks as some portions of the US try to reopen for business.
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