Prospect of Coordinated Central Bank Easing Lifts Markets
Summary: After a torrid week across global equity indices, which saw the fastest S&P 500 correction on record, the new week has begun on a more positive footing.
As COVID-19 infections in Italy, Spain, South Korea and Iran surged over the weekend, US case count suggests several community outbreaks and a weekend data release from China indicated contractionary activity levels - China’s official PMI plunged to a record low 35.7 – Asia trade was set for an ugly open. China’s worse than expected PMI decline will keep pressure on authorities to maintain liquidity and policy rate cuts this month. More accommodation will be needed, particularly for exporters as the global disruptions from the COVID-19 outbreak escalate. We expect ongoing RRR cuts and another 10bps MLF cuts, with ongoing fiscal support including subsidies for those industries most affected.
The worst China manufacturing PMI in history delivered a seas of red on the open, Aussie stocks fell more than 3% at one point, S&P 500 E-Minis slumped 2.1% and Aussie and Kiwi government bond yields hit fresh record lows.
However, as the rest of Asia came online the prospect of incoming coordinated easing from central bankers globally was mulled and a sharp turnaround came through. The Bank of Japan kickstarted the stimulus led rally, vowing ‘appropriate market operations’ to maintain stability and ample liquidity. The expectation that the Fed, the ECB, and even the notoriously reluctant RBA will join this party is helping to buoy risk assets further. The Fed statement from chairman Powell released Friday night only adds fuel to this fire. As we detailed previously, although monetary policy will not be an effective cure for a pandemic virus outbreak and the subsequent supply shock, the Fed will be forced to move in order to backstop confidence and ease financial conditions as the neutral rate of interest or r* falls meaning policy is too restrictive in real time.
After 6 days of heavy selling across global equity markets, the door is open for a relief rally and for markets addicted to easy monetary policy, the expectation of coordinated global interest rate cuts and liquidity provisions is as good an excuse as any. Even falling markets witness fierce upside rallies as shorts are squeezed and illiquidity drives larger trading ranges. Tactically this seems like the right play, but post any ensuing relief rally, the validity of any bounce remains a moving target. Particularly whilst a new information set is delivered every 24 hours, the jury is still out on whether the COVID-19 outbreak will be contained in the US and Europe. Following any relief rally, it is entirely possible (and likely) markets experience another wake up call as the realities of fractured supply chains, production bottlenecks and weak demand across multiple industries, continents and consumer groups, bites. We can no longer dismiss the implications of the virus outbreak to just tourism and trade and China supply chains. The global spread of COVID-19 is in its infancy so the ultimate impact is unquantifiable at this stage. For any forecaster or analyst to reach to any sort of conclusion, a lot of assumptions have to made, meaning a wide range of variability should be embedded into any anticipated outcome.
The VIX remains above 40, another reason to be wary of any bounce and a short term negative for equities. Whilst the present volatility regime remains in play, alarm bells are still sounding.