In Q2 we learned to behave
Like primitives stuck in a cave
In order to stem
The virus mayhem
And millions of lives, try to save

But Q3 has shown that we crave
More contact than lockdown, us, gave
Thus, it’s not surprising
Infections are rising
And now we’ve achieved second wave

If I were to describe market behavior of late, the word I would use is tentative. Investors and traders are caught between wanting to believe that the nonstop stimulus efforts on both fiscal, and especially, monetary fronts will be sufficient to help the economy through the current economic crisis (conveniently ignoring the extraordinary build up in debt), and concerns that there is too much permanent damage to too many businesses to allow for a swift recovery to a pre-Covid level of activity. Adding to the fear side of the equation is the resurgence in the number of infections worldwide, especially in places that had seemed to eradicate the virus. News from Hong Kong, Australia, China and India shows that the virus is making a resurgence, with several places recording more cases now than when things started five to six months ago. And of course, we have seen the same pattern in states that were first to reopen here at home.

Meanwhile, the medical community continues its extraordinary efforts to find a vaccine, with several promising candidates making their way through trials. Perhaps the best medical news is that it seems doctors on the front line have learned how to treat the disease more effectively, which has reduced the number of critical cases and helped drive down the fatality rate. Alas, an effective vaccine remains elusive. Ironically, the vaccine’s importance in many ways is symbolic. The idea that there is a way to avoid catching the bug is certainly appealing, but if the flu vaccine is any harbinger of the outcome, a minority of people will actually get vaccinated. So, the vaccine story is more about a chance for confidence to be restored than about people’s health. Perhaps this sums up the state of human affairs these days better than anything else.

And yet, while no politician anywhere will allow confirmation, it certainly appears that we are seeing a second wave of infections spread worldwide. From the market’s perspective, this has been a key concern for the past several months as a second wave of economy-wide shutdowns would end all hopes of that elusive V-shaped recovery. And the only way to justify the current levels of asset values is by assuming this crisis will pass quickly and things will return to a more normal framework. Hence the trader’s dilemma. Is the worst behind us? Or is a second wave going to expand and delay the recovery further? Perhaps the most telling feature of this market is the changed relationship between the S&P 500 and the VIX index. Prior to the Covid-19 outbreak, an equity rally of the type seen since late March would have seen the VIX index collapse toward 15, the level at which it traded for virtually all of 2019. But this time, 30 has become the new normal for the VIX, a strong indication that investors are paying for protection, despite the cost, as there remains an underlying fear of another sharp decline beyond the horizon. Hence, my description of things as tentative.

Looking at markets this morning, tentative is an excellent descriptor. In the equity space, Asian markets were mixed, with the Nikkei (-0.3%) on the weak side with the Hang Seng (+0.5%) was the strong side. But given the type of movement we have seen lately, neither really displayed anything new at the end of the week. European markets are also mixed with the DAX (+0.5%) the best performer while Spain’s IBEX (-0.5%) is the worst. Again, a mix of performances with no evident trend. US futures are currently pointing higher although only the NASDAQ (+1.0%) is showing any real strength.

Meanwhile, Treasury yields have slipped again, with the 10-year down to 0.60%, its lowest level since mid-April and just 4bps from its historic low. That is hardly a sign of economic confidence. In Europe, the picture is mixed but yields are essentially within 1bp of where they closed yesterday as traders are unwilling to take a view.

Finally, the dollar, too, is having a mixed session, although if I had to characterize it, I would say it is slightly softer overall. The euro is higher by 0.3% this morning as there is hope that the EU Summit, which began a few hours ago, will come to an agreement on their mooted €750 billion pandemic plan that includes joint borrowing. Of course, the frugal four still need to be bought off in some manner but given the political determination to be seen to be doing something, I would look for a watered-down version of the bill to be agreed. However, the best performer today is CHF (+0.5%) in what appears to be some profit taking on EURCHF positions after the cross’s strong rally this week.

In the emerging markets, IDR is the big underperformer today, falling 0.5% overnight as traders position for future rate cuts by the central bank. While they cut 25bps yesterday, they also came across as more dovish than expected implying they are not yet done with the rate hatchet. On the plus side, ZAR (+0.6%) is top of the charts as investors have been flocking to the front end of their yield curve after a much lower than expected inflation print. The view is that the SARB has further to cut which will drive front end yields down, hence the buying. (The dichotomy between the two currencies is fascinating as both are moving on rate cut assumptions, but in opposite directions. Hey, nobody ever said FX was rational!) But we are seeing more gainers than losers as the CE4 track the euro higher and several APAC currencies also moved modestly higher overnight. Remember, one of the emerging narratives has been the dollar’s imminent decline on the back of the twin deficits and lost prestige in the world community. So, every time we see a day where the dollar declines, you can be sure you will see stories on that topic. And while the twin deficit story is certainly valid from a theoretical basis, it has never been a good short-term indicator of movement in the currency markets.

On the data front, yesterday saw US Retail Sales print at a better than expected 7.5%, but Initial Claims fall less than expected, with still 1.3 million first time claims. As I have mentioned, that number continues to be the timeliest indicator of what is happening, and it is certainly not declining very rapidly anymore. Today brings Housing Starts (exp 1189K) and Building Permits (1293K) at 8:30 and then Michigan Sentiment (79.0) at 10:00. Neither of these seem likely to have a major market impact. Rather, as earnings season progresses, I expect the ongoing reports there to drive equity markets and overall risk appetite. For now, nobody is very hungry for risk, but a few good numbers could certainly change that view, pushing stocks higher and the dollar lower.

Good luck, good weekend and stay safe
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