The stock market had been for many
A place to make many a penny
But lately they’ve seen
Bright red on their screen
It’s best if they practice their zen (ny)

Meanwhile though the Fed seems quite clear
A rate cut will not soon appear
The market is stressing
And Jay will be pressing
For twenty-five quite soon this year

It’s not clear to me whether the top story is the dramatic decline in global stock markets or the increasing spread of Covid-19. Obviously, they are directly related to each other, and one would have to assume that the causality runs from Covid to stocks, but if you read the paper, stocks get top billing. Coming a close second is the bond market, where 10-year Treasury yields (1.20%) have hit new historic lows every day since Tuesday while discussion of other markets takes a back seat. And, oh yeah, it looks like Turkey and Russia might go to war in Syria!

As is often written, the two great drivers of financial markets are fear and greed. Greed leads to FOMO, which is a pretty solid description of what we have seen, at least in the US equity markets, since 2009. Fear, however, is what happens when excessive greed, also known as complacency, meets the notorious black swan, in this case, Covid-19. And historically, the longer the period of greed, the sharper is fear’s retaliation. With equity markets around the world having fallen by 10% or more this week, there is no question that we could have a session or two where things steady. And given what the futures market is now pricing with respect to central bank activity, it seems reasonable that the market will respond positively to those imminent actions. But I fear that there is a lot of excess in this market, and that stock prices everywhere can fall much further before this is all done.

Let’s look at futures market pricing for central banks this morning vs. last week and last month. This is the number of 25bp rate cuts priced by the end of 2020:

Source: Bloomberg

Part of the difference is the fact that only the US and Canada have room for more than 2 cuts before reaching the zero-bound, but the market is screaming out for central banks to come to the rescue. This should be no surprise as central banks have been doing this since 1987 when Chairman Greenspan, the maestro himself, stepped in after Black Monday and said he would support markets. It is a little bit late for central bankers to complain that they cannot help things given their actions, around the world, for the past thirty years, which has really stepped up since the financial crisis in 2008. At this point, if equity markets crater this morning in the US (and futures are pointing that way with all three indices currently lower by 1.3%), I expect an “emergency rate cut” by the Fed before stock markets open on Monday. One man’s view.

So how about the dollar? What is happening there? Well, the dollar is having a mixed session this morning, stronger vs. a number of emerging market currencies, as well as Aussie and Kiwi, but weaker vs. the yen and Swiss franc, and a bit more surprisingly, vs. the euro. The euro is an interesting case, and a situation we have seen before.

Consider, if you were a hedge fund investor and looking to fund positions. Where would you seek to fund things? Clearly, the currency with the lowest interest rates is the place to start. Now, knowing the history of the Swiss franc, and the fact that it is not that large a market, CHF is likely not a place to be. But euros, on the other hand, were a perfect funding vehicle, hugely liquid and negative interest rates. And that is what we saw for months and months, hedge funds shorting euro and buying MXN, INR, ZAR and any other currency with real yield. Well, now in the panic situation currently engulfing markets, these positions are being closed rapidly, and that means that hedge funds are aggressively buying euros while selling those other currencies. Hence, the euro’s performance this week has been relatively stellar, +1.35%, although it has recently backed off its highs this morning and is now unchanged on the day.

And where did we see this before? Prior to the financial crisis in 2008, JPY was the only currency that had zero interest rates and was the funding currency of choice for the hedge fund community. Extremely large yen shorts existed vs. the same high yielding currencies of today. And when the crisis struck, hedge funds were forced to buy yen as well as dollars driving it much higher. This was the genesis of the yen as a haven asset, although its consistent current account surplus has done a lot to help the story since then.

As to the rest of the FX market today, yen is the top performer, +0.75%, and CHF is also ahead of the game, +0.2%, but the rest of the G10 is under pressure. The laggard is NZD (-1.1%) as the first Covid-19 case was identified there and markets anticipate the RBNZ to cut rates soon. In the EMG space, with oil crashing again (WTI -2.6%), it is no surprise to see RUB (-1.5%) and MXN (-1.0%) lower. But today’s worst performing EMG currency is IDR (-2.05%) after the first Covid cases were identified and talk of rate cuts there circulated. Interestingly, CNY has been a solid performer today, rising 0.3%, although remember, it is under tight control by the PBOC.

On the data front today we see Personal Income (exp 0.4%), Personal Spending (0.3%), Core PCE (1.7%), Chicago PMI (46.0) and Michigan Sentiment (100.7). While PCE had been the most important data in the past, I think all eyes will be on the Chicago and Michigan numbers, as they are forward looking. Also, of tremendous interest to the market will be tonight’s China PMI data, with estimates ranging from 30.0 to 50.0. My money is on the low side here.

Two things argue for a bounce in equities in the US today, first, simply the fact that they have fallen so much in such a short period of time and a trading bounce is due. But second, given their significant decline, portfolio rebalancing is likely to see buyers today, which can be quite substantial in the short run. But a bounce is just that, and unless we see dramatic central bank activity by Monday, I anticipate we are not nearly done with this move.

Good luck and good weekend
Adf