Market Quick Take - February 26, 2021
Summary: US Treasury yields spiked aggressively higher yesterday in the wake of record weak demand for 7-year treasuries at an auction, wiping out risk sentiment and sending global equities into a new and more profound and global spiral lower. Sentiment was sufficiently shaken this time to also trigger unease and selling in commodities markets, and the US dollar rose steeply across the board. Fed action to ease some of the technical reasons behind the rout likely forthcoming in a matter of days.
What is our trading focus?
- Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) – a new ugly route in US equities yesterday saw the broader S&P 500 index nearly 2.5% lower on the day, and the more sentiment-sensitive Nasdaq 100 Index over 3.5% lower on the day, driven by a massive spike in treasury yields that accelerated the recent trend higher in yields. For the Nasdaq 100 next levels lower are the 100-day moving average near 12,500 and then the prior major top a bit lower at 12,420. A more profound route would see a 12,070 Fibonacci support an important possible focus. The S&P 500 areas of interest lower include 3,772, the 61.8% retracement of the recent major rally wave, followed by the major low all the way down at 3,656 if things get that bad before the Fed tries to engineer a bounce.
- Hang Seng (HK50.I) - down 3% in today’s session as risk is cascading from the US session and higher US rates into other equity markets. Rising interest rates for now seems to be hurting emerging market equities but our view remains the same, that rising inflation will be net positive for emerging market equities as it will coincide with rising commodity prices. Technically the Hang Seng futures look ugly with 28,000 as the next major support level.
- Bitcoin (BITCOIN_XBTE:xome) and Ethereum (ETHEREUM_XBTE:xome) - the crypto market couldn’t escape the case of bad nerves across all other asset classes yesterday, as is often the case when market volatility gets white hot. Bitcoin price action clearly likes to focus on big round levels, for example the 45,000 level that was hit briefly on the recent sell-off, but the major level lower has to be the 40,000 area that provided resistance on the way up. Price action in Ethereum is mimicking Bitcoin directionally and will likely continue to do so as long as market sentiment elsewhere remains negative.
- EURUSD – the EURUSD rally above new local resistance was brushed back lower, although this pair trades with low beta to the backdrop of wildly gyrating sentiment. The move taken in isolation, however, suggests a reversal that could set up another test lower to 1.2000, a move below which would put the ice on the longer term bull market for now. But let’s not get ahead of ourselves and see how quickly the Fed arrives at the scene of the accident (more below on that in What are we watching next?) to address the spike in US yields.
- AUDJPY – the Aussie and the yen were the two different extremes of strength and weakness, respectively, within the G7 currencies until yesterday’s rather violent reversal, when suddenly even commodities prices came under pressure as well as safe haven bonds, such that, while the US dollar rose in nearly a straight line, the yen largely followed suit, showing that when the volatility spikes become extreme and begin to shake the steep recent upward trend in commodities prices, AUDJPY can serve its role as a classic “risk barometer” in these markets – like to prove a high beta pair in any further turmoil here in risk sentiment.
- Gold (XAUUSD) has pushed back lower toward the recent key range lows near 1,760 as the steep rise in real yields on US treasuries after yesterday’s route and he stronger US dollar are a double whammy for the precious metal, which was already falling steeply against commodity-related currencies recently on the general rise in yields. However, the spike in real yields to an 8-month high has now brought it back in line with current gold price. The next level of note lower is 1,700 level as gold will likely only find support (and perhaps impressively so) when the Fed makes a strong move to address the spike in yields with new measures.
- Selloff in US Treasuries accelerates (TLT, IEF). Yesterday’s selloff in Treasuries accelerated as the 10-year yields broke above 1.5% activating convexity hedges from MBS investors causing a fast rise of yields to 1.61%. A very weak 7-year note auction sparked the bearish sentiment in Treasuries, with least foreign demand since 2014. Although Treasuries reverted some of the losses by the end of the day, we believe that 10-year yields will consolidate above 1.50% before resuming their rise to 2%.
- European Central Bank intervention needed (IS0P, BTP10). European Sovereign bonds continue to bleed, and the credit space is about to follow. Sovereign yields across Europe rose by 10bps yesterday and the BTP-Bund spread rose above 100. Schnabel said that the rise in yields can hurt the recovery and we expect the ECB to take the matter under control as soon as next week, during the ECB monetary policy meeting. There is however the chance that the ECB might act faster if the selloff accelerates before Thursday.
- Junk bonds are still in positive territory despite all other bonds are underperforming (HYG). Junk rose by around 1% since the beginning of the year while investment grade bonds fell by 3.2%. This has been possible because investors are looking to build a buffer against rising yields amid rising interest rates. However, we believe things are about to turn. This week the correlation between junk and Treasury yields have turned negative, meaning that as rates continue to rise, the bigger is the risk for a selloff in junk too.
- Ark Innovation ETF (ARKK:arcx) - the main fund of Ark Invest was down 6% again yesterday and data suggests cross correlation between the positions in the ETF is surging towards one indicating a very risky situation for Ark Invest’s biggest fund. The Tesla-Bitcoin-Ark risk cluster could turn into a nasty tailspin with a negative feedback loop causing a huge drawdown in the overall fund and create carnage in US biotechnology stocks.
What is going on?
- Danger level of further volatility is high as “correlations go to One” - yesterday showed the classic danger from a portfolio risk perspective of a significant rise in volatility levels across asset classes due to a shock – in this case the spike higher in US Treasury yields. These shocks that expand volatility and intraday trading ranges see risk managers requiring a broad reduction of market exposure, or deleveraging. In these windows of heightened market angst, investors discover that correlations between portfolio holdings suddenly become much tighter (for example, all stocks moving up and down more together, and even pro-cyclical commodities suddenly moving up and down with stocks, etc.). Traders and investors should respect this risk and the implications for their P&L swings, perhaps looking for reduction of exposure or ways to hedge.
- The commodity rally may pause as yield spikes and speculators reduce risk. Falling equities and rising volatility, both in stocks and bonds, could become the catalyst for consolidation across the commodity sector. Despite strong fundamentals the sector is not immune to outside developments that may challenge the record speculative long built up during the past many months. We firmly believe that inflation will eventually rise by more than expected, thereby stabilizing, or perhaps even sending real yields deeper into negative territory. However, with many individual commodity positions at elevated levels, and RSI’s pointing towards overbought markets, the prospect for a correction, or at best a consolidation, will probably prove beneficial for medium-term prospects.
What are we watching next?
- How quickly does the Fed arrive at the scene of the accident and “do something” – and is this mostly technical for now? - Some portion of the recent volatility in treasury markets is due to technical reasons as the US financial system deals with the US Treasury plans to bring down the bulk of its $1.6 trillion held with the Federal Reserve, which banks have a hard time absorbing due to various regulatory limits. While long yields have ripped higher, there are signs of distress due to the Treasury’s moves at the shortest end of the yield curve, where the shortest yields have traded near record lows and the overnight repo yield even went negative yesterday, a rare event, triggering potential mayhem for money market funds if it stays below zero. The Fed can quickly address some of these issues with new technical moves removing regulatory limits and taking other action, but the outstanding longer-term issue of enormous treasury issuance that by later this year, the market can’t possibly absorb remains. For now, the key question for traders is – how quickly does the Fed act – already today or not until next week? Generally, the Fed moves quickly if equities correct more than 5% - as of yesterday’s close, despite all of the focus on the volatile speculative names, the big S&P 500 Index was only down some 3.7%. But as well, rather aggressive rises in Fed rate hike expectations starting already in late 2022 after yesterday’s action could prompt Fed comments against this notion very soon. And will markets find full relief and get back into full speculative mode or trade with more caution, finding that this recent episode has laid bare some major fragilities?
Earnings releases to watch this week – earnings releases yesterday from HP, Beyond Meat, Doordash, and Airbnb were all to the good side yesterday reinforcing that companies have quite well despite the challenging conditions due to Covid-19. Today, BASF’s has already reported earnings with a weak guidance for 2021. Next up is Berkshire Hathaway’s annual report tomorrow with high anticipation of Buffett’s views on what happened in 2020 (he has been quiet) and his views on potential inflation.
- Today: Deutsche Telekom, BASF
- Saturday: Berkshire Hathaway
Economic Calendar Highlights for today (times GMT)
- 0800 – Switzerland Q4 GDP
- 0800 – Spain Feb. Flash CPI
- 0830 – Sweden Q4 GDP
- 0830 – Sweden Jan. Retail Sales
- 0900 – Norway Feb. Unemployment Rate
- 1100 – UK Bank of England Haldane to Speak
- 1330 – US Jan. Advance Goods Trade Balance
- 1330 – US Jan. PCE Inflation
- 1445 – US Feb. Chicago PMI Survey
- 1500 – US Feb. Final University of Michigan Sentiment
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