Market Quick Take - March 27, 2020

Please see our Special Edition podcast and an article we penned pulling out some of the key themes for investors wondering how to position themselves both through this crisis and for the long-term in its aftermath.

The narrative now will be that if market conditions are normalizing and policymakers have gotten ahead of the curve, risk assets will continue higher driven by liquidity while safe haven long sovereign bonds should drop (the irony of QE), unless the long end is already being controlled via de facto yield-curve control.

In a sign of stability the US dollar fell 3.5% this week, the biggest drop in 10 years. We have seen the strong dollar, what we have called the Killer Dollar, as a major sign of liquidity constraints, the falling dollar has been a strong tailwind for the market the last two days.

What is our trading focus?

• USDJPY – the USD has rolled over across the board in recent sessions, and with USD funding pressures easing from the Fed’s aggressive opening of swap lines.
• EURJPY – the euro crosses are taking on added interest as the EU struggles to support the “debt mutualization via coronavirus bonds” as noted below – this could wear on the euro’s relative performance to a potentially hard-charging JPY (see above on USDJPY).
• US500.I (S&P 500) – US equities are up 17.6% in three trading days. The one month forward return on S&P 500 post a 10% gain over three days has historically been around 6% on average, so technically there arguments for further gains here. Also rebalancing of strategic asset allocation portfolio and pension funds is also adding substantial flow into equities
• EXX1:xetr (European banks) – yesterday’s rally saw utilities rise as much as financials which was odd as we would except financials to be a high beta play to positive sentiment. If the rally can continue today we expect financials to begin showing its high beta characteristics and lead the gains.
• 10YBTPJUN20 (Italian 10-year government bonds, or BTP’s) – we put Italian BTP’s back in the spotlight after a disastrous EU meeting late yesterday failed to produce signs that the EU core ex France is opposed in principle to debt mutualization, even as the ECB operates aggressively to buy Italian bonds.
• 10YUSNOTEJUN20 (US Ten Year Treasury) – weak economic growth is traditionally a strong supported of long US treasuries, while aggressive QE from the Fed in the past has been associated with weakness. The long end of the curve has gone very quiet and further strength might indicate that policymakers need to do even more to bring support or that yield-curve-control is in effect, which injects volatility elsewhere – a key development to watch.

What is going on?

The EU is struggling to support the “debt mutualization via coronavirus bonds” narrative that has developed in recent days. A failure of the EU to show solidarity beyond coordinating a healthcare response could reopen the existential angle on EU sovereign bonds, though the ECB is already abandoning prior rules on purchase distribution and aggressively purchasing Italian bonds. The German-Italy 10-year yield spread below 160 basis points on yesterday’s market close. The spread is opening in orderly fashion for now.

Oil price still languishing – articles abound discussing the physical reality on the ground that the world is running out of places to put oil production. Shutting in production can cause damage down the road to production potential.

Covid-19: US Covid-19 cases are the most in the world now on more widespread testing and the US death toll crossed 1,000 yesterday and the center of the pandemic could be shifting to the US.

What we are watching next?

Crossed the BULL/BEAR line in risk sentiment – now what?– yesterday’s rally took out the prior day’s highs – our bull bear line, so around 2550 in the S&P future and suggests a constructive bounce-back rally is in progress as long as this level holds – it was also the low as of this writing in the Asian session in the after hours consolidation of yesterday’s rally. Now the focus shifts to the 38.2% retracement of the entire sell-off wave from the all-time top to the lows – which is at 2641 for the June S&P future.

Quarter end rebalancing still a thing until next Tue – many have pointed to huge potential of rebalancing flows back into equities because of lopsided performance for bonds vs. equities in March and for Q1 are circulating – we’ll feel more comfortable in assessing the quality of this rally once we are in April.

The missing piece – Oil – We firmly believe the energy market is the only market with true price discovery. Oil has dropped 60% during this crisis. That 60% represents to us the absolute worst case scenario. One in which global societies are not able to slow-down or stop the Covid-19 virus. The virus can be deadly, but so is this the total lock-down. If the global economy is not moving back to towards some sort of normalcy by May, then further drops to that number are likely. For now though we remain constructive for a ‘fragile stabilization’ scenario

Calendar today (times GMT)

• 1230 – US Feb. PCE Inflation
• 1400 – US Final Mar. University of Michigan Confidence – it will be interesting to see the magnitude of the negative adjustment from the preliminary number as a sign of how Covid19 is impacting confidence

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