At Loggerheads

While yesterday there was no hope
The global economy’d cope
With Covid-19
Today what we’ve seen
Is those fears were just a mere trope

Meanwhile as the virus still spreads
Investors are at loggerheads
Should bulls buy the dip?
Can bears get a grip?
I guess it’s all up to the Fed(s)

This morning there is a tentative truce in markets between those terrified of a global pandemic and those who have been trained to BTFD (Buy the f***ing dip). Of course, the dip buyers have been the big winners over the past decade, which drives the real question, is this time different? The difficulty in answering this question is due to the fact that the last time there was truly a global pandemic, the Spanish flu of 1918; central banks did not control the economy. In fact, the Fed was just 5 years old at the time, and still coming to terms with its role in the US economy. Ultimately, the problem is that despite the extraordinary information dissemination capabilities that exist in the modern world, where every type of news is available in multiple formats almost instantly, nobody really has any idea what is actually happening in China. Do the infection and fatality numbers they release each day have any resemblance to reality? Can’t really tell. What we do know is that large portions of China remain essentially under lockdown, with Hubei province at a virtual standstill. The tension between preventing the spread of the disease and preventing a collapsing economy is extreme in Beijing. Alas, it is not hard to believe that in the end, President Xi will choose growth over health.

Nonetheless, yesterday’s proximate cause of the market rout seemed to be the sudden uptick in cases in Italy, which was a clear demonstration that the situation was not nearly under control. Although all markets remain tentative this morning, there have been no major dislocations…yet. Even so, for the time being, Covid-19 is going to be the primary story driving daily market activity.

One thing we learned yesterday was that there is growing dissention at the Fed as the hawks, led by Loretta Mester, are nowhere near convinced that cutting interest rates will do anything to solve a medical problem, while the doves, led by Neel Kashkari, think a 25bp cut, at least, is appropriate right now. With the next FOMC meeting slated for March 18, we still have nearly 3 weeks for this conversation to play out. And of course, so much will depend on just what happens with Covid-19. Wider disruption of economic activity due to further quarantines and lock-downs will almost certainly see further monetary policy easing, whether it is useful or not, as central bankers will not want to be seen doing ‘nothing’.

Another interesting thing to watch for is this week’s February Chinese PMI data, due to be released on Thursday night. It is quite interesting that Manufacturing PMI is currently forecast to fall only to 45.1 given the near total shutdown of Chinese activity since the Lunar New Year. Consider that the PMI questions ask if activity levels were “higher, the same or lower than in the prior month.”1 Can anyone asked those questions in China claim that activity was higher than the previous month? It beggars belief that the index can be anywhere near 45. Rather one would expect it to approach zero! My point is that depending on what gets released, it will help us further understand the reliability of the Chinese economic data.

Keeping this in mind, it is extremely difficult to have a strong view on anything right now. Generally speaking, haven assets remain better bid, although this morning’s price action is nowhere near as impressive as yesterday’s. For example, Treasury yields are little changed, still just below 1.37% (and just above the record low of 1.34% set in 2016), although German bund yields have fallen a further 3bps this morning and are sitting at -0.51%. We have also seen a bit of discrimination in the European government bond markets as the PIGS see their bond yields rise this morning, clearly not feeling the haven love of bunds or Treasuries. Also on the haven front, gold prices, which rallied sharply yesterday, trading up nearly 3% at one point, have given back about 0.75% this morning.

In equity land, the Nikkei, which had been closed Monday, fell 3.3% in a catchup move, but the rest of APAC markets had a more mixed performance. Australia’s ASX 200 fell 1.6%, but the Kospi in Korea rallied 1.2%. Even China had mixed results with Shanghai falling 0.6% while Shenzhen rose 0.5%. All told, fear was not quite as rampant overnight. But this morning, European shares, which had started the session in the green, have since turned lower led by Spain’s IBEX (-1.15%), but closely followed by the FTSE 100 (-0.85%), CAC (-0.7% and DAX (-0.6%). In other words, fear is once again creeping into investor’s minds. At this point in the session, US futures are pointing slightly higher, but only about 0.2%. Obviously we will be watching US markets closely when they open.

In the FX world, it has also been a bit of a mixed picture, with the pound actually today’s big winner, +0.3%, as it appears cable options traders are driving the move higher after getting paid out of substantial amounts of short-dated volatility by the leveraged community. The yen has also gained today after a very impressive move yesterday. When I wrote, the yen had just edged higher by 0.25%, but it was in great demand during the NY session and closed nearly a full percent stronger. On the down side, NZD and SEK are the leading decliners, down 0.3% and 0.2% respectively with the former reacting to a story about the RBNZ easing policy further while the latter suffers as a cross play SEKJPY with punters viewing the krone as the most vulnerable currency to the virus.

In the EMG space, KRW (+0.85%) is today’s big winner, following the Kospi higher on hopes that the worst aspects of the virus have passed. On the flipside, RUB is down by 2.0% in a catch up move after being closed yesterday for a bank holiday. Otherwise, the rest of the bloc is +/- 0.2%.

On the data front this morning we see Case-Shiller Home prices (exp 2.8%) and Consumer Confidence (132.1), neither of which seems likely to impact FX. Arguably, this is still a virus and equity driven market, and that is where to look to get the fear barometer and consider where the dollar may move for the rest of the day.

Good luck