While yesterday was, for most, scary
It seems the moves were temporary
This morning we’ve seen
Our screens filled with green
On hopes of response monetary

Meanwhile, as the virus expands
And spreads across multiple lands
The word out of Rome
Is, ‘all stay at home’
And please don’t go round shaking hands!

What a difference a day makes! After what was a total obliteration of risk on Monday, this morning we have seen equity markets around the world rebound sharply as well as haven assets lose some of their luster. While net, risk assets are still lower than before the oil war broke out, there is a palpable sense of relief in trading rooms around the world.

But is anything really different? Arguably, the big difference this morning is that we have begun to hear from governments around the world about how they are planning to respond to the Covid-19 pandemic epidemic, and more importantly, that they actually do have a response. The most dramatic response is arguably from Italy, where the government has locked down the entire nation. Schools and businesses are closed and travel within as well as in and out of the country is banned save for a dire emergency. Given how badly hit Italy has been hit by Covid, nearly 500 deaths from more than 9,000 cases, and the fact that the case load is increasing, this should be no surprise. At the same time, given the demographics in Italy, only Germany and Japan have older populations, and given the fact that the virus is particularly fatal for elderly people, things are likely to continue to get worse before they get better. I have seen two different descriptions of how dire the situation is there, with both calling the health infrastructure completely overwhelmed. Look for Germany to impose more restrictions later this week as well, given the growing spread of the virus there.

But from a market perspective, what is truly turning things around is the discussion of combined monetary and fiscal response that is making the rounds. Last night President Trump explained the administration was considering payroll tax cuts as well as direct subsidies to hourly workers via increased support for paid sick leave. In addition, the market is certain the Fed will cut at least 50bps next week, and still essentially pricing in 75bps. So, the twin barrels of monetary and fiscal policy should go a long way to helping regain confidence. Of course, neither of these things will solve the problems in the oil patch as shale drillers find themselves under extraordinary financial pressure with oil prices still around $34/bbl. While that is a 10% rebound from yesterday, most of the shale drillers need oil to be near $45-$50/bbl to make a living. But there is very little the government can do about that right now.

And we are hearing about pending support from other governments as well, with the UK, France and Japan all preparing or announcing new measures. However, as long as the virus remains as contagious as it is, all these measures are merely stop-gaps. Lockdowns have serious longer-term consequences and there will be significant lost output that is permanently gone. Recession this year seems a highly likely event in many, if not most, G10 countries, so be prepared.

And with that as a start, let’s take a look around the markets. As I mentioned, equities rebounded in Asia (Nikkei +0.85%, Hang Seng +1.4%, Shanghai +1.8%) and are much higher in Europe (DAX +3.6%, CAC +4.4%, FTSE 100 +4.2%). Of course, that was after significantly larger declines yesterday. US futures are sharply higher as I type, with all three indices more than 4% higher at this time. Meanwhile, bond markets are seeing the opposite price action with 10-year Treasury yields rebounding to 0.71% after touching a low of 0.31% yesterday. Bunds have also rebounded 12bps to -0.74%, and more importantly, both Italian and Greek bonds have rallied (yields falling) sharply. Make no mistake, the bonds of those two nations are not considered havens in any language.

In the FX market, yesterday saw, by far, the most volatile trading we have experienced since the financial crisis in 2008-09. And this morning, along with other markets, much of that is reversing. So we are looking at the yen falling 2.4% this morning, by far the worst performer in the G10, but also seeing weakness in the euro (-0.85%), pound Sterling (-0.7%) and Swiss franc (-0.85%). On the plus side, NOK is higher by 1.05% and CAD has regained a much less impressive 0.35%.

Emerging markets have also seen significant reversals with MXN, yesterday’s worst performer, rebounding 1.8%, ZAR +1.65% and KRW +0.95%. On the downside, RUB is today’s loser extraordinaire, falling 3.5% after Saudi Aramco said they would increase production to a more than expected 12.3 million bbls/day. But the CE4 currencies, which rallied with the euro yesterday, are all softer this morning by roughly 0.8%.

The one thing that seems clear is that volatility remains the base case for now, and although market implied volatilities have fallen today, they remain far higher than we had seen just a week ago. I think there will also be far more market liquidity to be involved in this market as well.

On the data front, the NFIB Small Business Optimism report has already been released at 104.5, rising from last month and far better than expected. Now this survey covers February which means that there had to be at least some virus impact. With that in mind, the result is even more impressive. The thing is that right now, data is just not a market driver, so the FX markets have largely ignored this along with every other release.

Looking ahead to today’s session, the reversal of yesterday’s moves is clearly in place and unless we suddenly get new information that the virus is more widespread, or that there is pushback on support packages and they won’t be forthcoming, I expect this morning’s moves to continue a bit further.

Longer term, we remain dependent on the spread of Covid-19 and government responses as the key driver. After all, the oil news seems pretty fully priced in for now.

Good luck
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