There once was a banker named Jay
Who, for a few weeks, had his way
Stock markets rose nicely
But that led precisely
To things that have now gone astray

Protagonists now can’t discern
What’s safe or what assets to spurn
Their hunt for more yield
Has finally revealed
That risk is attached to return

Apparently, when the Fed cuts rates, it is not a guarantee that stock prices will rally. That seems to be yesterday morning’s lesson in the wake of the Fed’s “surprise” 50bp rate cut. After a brief rally, which lasted about 15 minutes, the bottom fell out again as investors and traders decided that things were actually much worse than they feared. In addition, Chairman Jay did himself no favors by opening the kimono a bit and admitting that there was nothing the Fed could do to directly address the current issues.

This is a real problem for the global central bank community because the Fed was the player with the most ammunition left, and they just used one-third of their bullets with a disastrous outcome. Ask yourself what more the ECB can do, with rates already negative and QE ongoing. They have no more bullets left, just the whispering of sweet nothings from Madame Lagarde to Eurozone FinMins to spend more money. If the data turns further south in Europe, which seems almost guaranteed, I would look for a suspension of the Eurozone rules on financing and deficits. After all, Covid-19 was not part of the bargain, and this is clearly an emergency…just ask Jay. Japan? They are already printing yen as fast as they can to buy more assets, and will not stop, but are unable to achieve their goals.

Arguably, the only central bank left that matters, and that has room to move is the PBOC, which has already been active adding liquidity and trying to steer it to SME’s. But if the pressure continues on both the Chinese economy and its markets, they will do more regardless of the long-term debt problems they may exacerbate. We have clearly reached a point where every central bank is all-in to try to stop the current stock market declines. And you thought all they cared about was money supply!

So, what about a fiscal response by the major economies? After all, to a man, every central bank has explained that monetary policy is not the appropriate tool to address the current economic and market concerns. As Chairman Jay explained in his press conference, “A rate cut will not reduce the rate of infection. It won’t fix a broken supply chain. We get that, but we do believe that our action will provide a meaningful boost to the economy.” A cynic might conclude that central banks were trying to force the fiscal authorities’ collective hands, but in reality, I think the issue is simply that, at least in the G7, fiscal issues are political questions that by their very nature take longer to answer. Getting agreement on spending money, especially in the current fractious political environment, is extremely difficult short of a major crisis like the financial market meltdown in 2008. And for now, despite all the press, and some really bad data releases, Covid-19 has not achieved that level of concern.

Is that likely to change soon? My impression based on what we have seen and heard so far is that unless there is another significant uptick in the number of infections, and especially in the mortality rate, we are likely to see relatively small sums of money allocated to this issue. Of course, if economic activity is impeded by travel restrictions and supply chains cannot get back in business by the end of March, we are likely to have a change of heart by these governments, but for now, its central banks or bust.

So, this morning, after yesterday’s rout in US markets, things seem to have stabilized somewhat with most Asian equity markets flat to slightly higher, European markets ahead by about 1% and US futures currently sitting ~2% stronger. Part of the US showing is undoubtedly due to yesterday’s Super Tuesday primaries which showed former VP Joe Biden build on his recently recovered momentum to actually take a slight delegate lead. There is certainly some truth to the idea that part of the US markets’ recent malaise was due to a concern that Senator Sanders was poised to become the Democratic nominee, and that his policy platforms have been extremely antagonistic to private capital.

But despite the equity market activity, which on the whole looks good, there is no shortage of demand for Treasuries, which implies that there is still a great deal of haven demand. Yesterday, the 10-year yield breached 1.00% for the first time in its 150-year history, trading as low as 0.90% before rebounding ahead of the close. But here we are this morning with the yield down a further 5bps, back to 0.95%, and quite frankly there is nothing to indicate this move is over. In fact, futures markets are pricing in another Fed rate cut at their meeting 2 weeks from today, and another three cuts in total by the end of 2020! While German bunds have not seen the same demand, the rest of the European government bond market has rallied with yields everywhere falling between 1bp and 8bps. And don’t forget JGB’s, which have also seen yields decline 2bps, heading further into negative territory despite the BOJ’s efforts to steepen their yield curve. Certainly, a look at the bond market does not inspire confidence that the all clear has been sounded.

And finally, in the FX markets, the dollar remains under general pressure as the market continues to price in further Fed activity which is much greater than anywhere else. Yesterday’s cut took US rates to their narrowest spread vs. Eurozone rates since 2016, when the Fed was in the process of raising rates. It is no coincidence that the euro has recovered to levels seen back then as well. The thing about the dollar’s current weakness, though, is that it seems to be running its course. After all, if the interest rate market is pricing for US rates to fall back to the zero-bound, and there is no indication that the US will ever go negative, how much more room does the euro have to rally? While yesterday’s peak at just above 1.12 may not be the absolute top, I think we are much nearer than further from that point.

A quick look at the EMG bloc shows that today’s winners have largely centered in Asia as those currencies respond belatedly to yesterday’s Fed actions, although we have also seen commodity focused currencies like ZAR (+0.8%), MXN (+0.7%) and RUB (+0.5%) perform well on the rebound in oil and metals prices. I expect that CLP, BRL and COP will also open well on the same thesis.

While yesterday was barren in the US on the data front, this morning we see ADP Employment (exp 170K) and ISM Non-Manufacturing (54.9) as well as the Fed’s Beige Book at 2:00pm. Monday’s ISM Manufacturing data was a touch weak, but it is getting very difficult to read with the Covid-19 situation around. Was this weakness evident prior to the outbreak? I think that’s what most investors want to understand. Also, I would be remiss if I didn’t mention that Chinese auto sales plunged 80% in February and the Caixin PMI data was also disastrous, printing at 27.5.

For now, uncertainty continues to reign and with that comes increased volatility. We have seen that with a substantial rebound in the equity market VIX, and we have seen that with solid rebounds in FX option volatility, which had been trading at historically low levels but are now, in G7 currencies, back to levels not seen since December 2018, when equity markets were correcting and fear was rampant. My take there is that implied vols have further to rally as there is little chance we have seen the end of the current crisis-like situation. Hedgers beware!

Good luck
Adf