Host Of Central Banks In Focus

Well, last week, tech stocks had their worst week since March, with stability far from returning.  While the jury is still out, most still view the pull back in tech stocks as a healthy correction following a prolonged period of gains, blaming increased options activity over recent months for the magnitude of the decline. The buy on dip mentality is likely to continue to prevail, though tech stocks have not yet show any sign of wanting to make a convincing pull back.   

Signs of nervousness are clear; equity volatility remains elevated, but many investors are still sitting on healthy gains over recent months.  Given the low cost of funding, low returns in government bonds, alongside continued strong demand for stay at home electronics and a vaccine that could still take months to arrive, it is hard to see the tech sector falling too far.   

The fall in the pound sterling has been quite dramatic over recent weeks, both against the US dollar and euro.  Fears over a collapse in trade talks with the European Union have intensified.  The sudden waking up of the market to these risks has been provoked by the prospects that the withdrawal agreement with the EU will be torn up, prompting threats of legal action by the EU.

Time is running out to get a deal on the table before the end of the Brexit transition period at the end of the year, but UK Prime Minister Johnson has said that the internal market bill is necessary to prevent “a foreign of international body from having the power to break up our country.” The new legislation is already facing a rebellion in parliament. Against this background its hard to see GBP rally, with the currency likely to be particularly volatile over the coming weeks.

Attention this week will turn to several central bank decisions, with monetary policy makers in Poland (Tue), US (Wed), Brazil (Wed), Japan (Thu), Indonesia (Thu), Taiwan (Thu), South Africa, (Thu), UK (Thu) and Russia (Fri) all scheduled to announce their decisions.  After months of policy easing globally, this week will look rather boring, with none of the above likely to ease further.   

The Fed FOMC meeting will likely capture most attention, but there is potential for disappointment if the Fed does not provide further details on its shift to average inflation targeting in its forward guidance, even as the accompanying statement and Chair Powell’s press conference are likely to sound dovish. The US dollar has continued to stabilize, aided by the drop in GBP, but a dovish Fed could limit further upside in the short term. 

Aside from central bank decisions attention will be on US election polls, which take on more importance as the election creeps closer.  US fiscal stimulus talks have hit a wall, with little chance of progress this week, while US pressure on China and Chinese companies is likely to continue to be unrelenting as elections approach.  On the political front the race to take over Japan’s prime minister following the resignation of Shinzo Abe will conclude this week (Wed).   

Data, Earnings, Central Banks and Virus Cases In Focus

Risk appetite took a turn for the better at the end of last week despite an array of the usual suspect risk factors (accelerating Covid-19 cases, US-China tensions, rich valuations). This kept the US dollar under pressure given the inverse relationship between equities and the USD over recent weeks.  Market positioning continues to show sentiment for the USD remaining negative (CFTC IMM data revealed that aggregate USD speculative positions have been net short for 15 out of the last 17 weeks, including the last 5).  Increasingly risks of a US fiscal cliff as stimulus programs run out, with Republicans and Democrats wrangling over more stimulus and US Presidential elections will be added to the list of factors testing market resilience in the days and weeks ahead.

This week there are several key data and events including China June trade data (Tue), China Q2 GDP (Thu), US June  CPI (Tue), US June retail sales (Thu), Australia June employment data and several central bank decisions including Bank of Japan (Wed), European Central Bank (Thu), Bank of Canada (Wed), Bank Indonesia (Thu), Bank of Korea (Thu), and National Bank of Poland (Tue).  Aside from economic data and events the path of virus infections will be closely watched, especially in the US given risks of a reversal of opening up measures.  Last but not least the Q2 earnings season kicks off this week, with financials in particular in focus this week.  Low real yields continue to prove supportive for equities and gold, but very weak earnings could prove to be a major test for equity markets.

On the data front, Chinese exports and imports likely fell in June, but at a slower pace than in the previous month, China’s Q2 GDP is likely to bounce, while US CPI likely got a boost from gasoline prices, and US retail sales likely recorded a sharp jump in June. Almost all of the central bank decisions this week are likely to be dull affairs, with unchanged policy decisions amid subdued inflation, although there is a high risk that Bank Indonesia eases.  The EU Leaders Summit at the end of the week will garner attention too, with any progress on thrashing out agreement on the recovery package in focus.  Watch tech stocks this week too; FANGS look overbought on technical including Relative Strength Index (RSIs) and more significantly breaching 100% Fibonacci retracement levels as does the Nasdaq index, but arguably they have looked rich in absolute terms for a while.

There has been plenty of focus on the rally in Chinese equities over recent weeks and that will continue this week.  Last week Chinese stocks had their best week in 5 years and the CSI 300 is up close to 19% year to date.  Stocks have been helped by state media stories highlighting a “healthy” bull market, but the rally is being compared to the bubble in Chinese stocks in 2014/15, with turnover and margin debt rising.  At that time stock prices rallied sharply only to collapse.   However, Chinese equity valuations are cheaper this time and many analysts still look for equities to continue to rally in the weeks ahead.  China’s authorities are also likely to be more careful about any potential bubble developing.

Fed, ECB, BoJ In Focus This Week

Three major central banks meet to decide on monetary policy this week, but after massive and unprecedented actions over past weeks, there is likely to be little new in terms of additional policy measures announced by the US Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BoJ) in the days ahead.  Key data this week include US Q1 GDP, the April US ISM manufacturing survey and China’s April purchasing manager’s index (PMI).

The Fed has thrown everything but the kitchen sink at Covid-19 to combat the severe economic and market impact emanating from the virus.  This included aggressive rate cuts, unlimited asset purchases (Treasuries, MBS), purchases of commercial paper, loans to small businesses, easing rules for banks and provision of US dollar swap lines with other central banks to help ease global USD demand pressures.  Aside from some fine tuning, there may not be much else the Fed will do at its meeting on Wednesday. Meanwhile the US ISM survey (Fri) is likely to post a sharp decline (consensus 37.0).

Markets have reacted well to the measures announced and implemented so far, but as noted there is a growing disconnect between the rally in equity markets over recent weeks and rapidly worsening economic data.  US Q1 GDP data (Wed) this week will likely reveal some of the damage, with a 4% q/q annualised fall in GDP forecast by the consensus. Q2 GDP will be even weaker however, as most of the weakness in activity will have taken place in April and will have likely continued into May and June.

The ECB continues to face pressure to do more as Eurozone activity continues to plunge.  So far the main thrust of the ECB’s measures are EUR 750bn of bond purchases and loosening of restrictions on such purchases.  However, sovereign spreads, especially in the periphery (especially Italy) are under pressure and the ECB may need to act again soon though perhaps not as early as the meeting this Thursday.  The ECB will also likely shift the onus of further easing to fiscal, especially the proposed “recovery fund”, which continues to fuel major divisions between European countries.

Last but not least the BoJ meeting on Monday will probably be the most active in terms of new measures, but on balance they will probably do little to move markets.   At the last meeting the BoJ significantly increased the amount of ETFs they would purchase, which to some extent has helped the Nikkei 225 rally over recent weeks.  At this meeting the BoJ is unlikely to alter its negative interest rate policy, but is likely to remove its JPY 80 trillion cap on JGB purchases and announce an increase in corporate bond purchases along with other measures to ease credit.

On the data front China’s official manufacturing PMI is likely to remain around or just above the expansionary threshold of 50 as much of China’s supply side of the economy opens up.  However, the ability to retain expansion at a time when global demand and therefore China’s export markets are collapsing, will prove difficult.  China’s authorities appear to be increasingly realising this and have stepped up support both on the fiscal (via special bond issuance) and monetary side (targeted cuts in various rates), but so far the scale of easing has been limited and Q1 growth was especially weak.

Waiting For The Fed To Come To The Rescue

COVID-2019 has in the mind of the market shifted from being a localized China and by extension Asia virus to a global phenomenon.  Asia went through fear and panic are few weeks ago while the world watched but did not react greatly as equities continued to rally to new highs outside Asia.  All this has changed dramatically over the last week or so, with markets initially spooked by the sharp rise in cases in Italy and Korea, and as the days have progressed, a sharp increase in the number of countries recording cases of infection.

The sell off in markets has been dramatic, even compared to previous routs in global equity markets.  It is unclear whether fading the declines is a good move given that the headline news flow continues to worsen, but investors are likely to try to look for opportunity in the malaise.   The fact that investors had become increasingly leveraged, positioning had increased significantly and valuations had become stretched, probably added more weight to the sell-off in equity markets and risk assets globally.  Conversely, G10 government bonds have rallied hard, especially US Treasuries as investors jump into safe havens.

Markets are attempting a tentative rally in risk assets today in the hope that major central banks and governments can come to the rescue.  The US Federal Reserve on Friday gave a strong signal that it is prepared to loosen policy if needed and markets have increasingly priced in easing , beginning with at least a 25bps rate cut this month (19 March).  The question is now not whether the Fed cuts, but will the cut be 25bp or 50bp.  Similarly, the Bank of Japan today indicated its readiness to support the economy if needed as have other central banks.

As the number of new infections outside of China is now increasing compared to new infections in China, and Chinese officials are promising both fiscal and monetary stimulus, China is no longer the main point of concern.  That said, there is no doubt that China’s economy is likely to tank this quarter; an early indication came from the sharp decline in China’s official manufacturing purchasing managers’ index, which fell to a record low of 35.7 in February, deep into contraction territory.  The imponderable is how quickly the Chinese economy will get back on its feet.  The potential for “V” shape recovery is looking increasingly slim.

Volatility has also risen across markets, though it is notable that FX volatility has risen by far less than equity or interest rate volatility, suggesting scope for catch up.  Heightened expectations of Fed rate cuts, and sharp decline in yields, alongside fears that the number of virus cases in the US will accelerate, have combined to weigh on the US dollar, helping many currencies including the euro and emerging market currencies to make up some lost ground.  This is likely to continue in the short term, especially if overall market risk appetite shows some improvement.

Markets will likely struggle this week to find their feet.  As we’re seeing today there are attempts to buy into the fall at least in Asia.  Buyers will continue to run into bad news in terms of headlines, suggesting that it will not be an easy rise. Aside from watching coronavirus headlines there will be plenty of attention on the race to be the Democrat Party presidential candidate in the US, with the Super Tuesday primaries in focus.  UK/Europe trade talks will also garner attention as both sides try to hammer out a deal, while OPEC will meet to deliberate whether to implement output cuts to arrest the slide in oil prices.  On the data front, US ISM manufacturing and jobs data will be in focus.

Pause In The Risk Rally?

The rally in risk assets has extended into 2020 amid a stabilization in economic data, the Phase 1 trade deal and a persistent easy monetary policy stance by major central banks.  The sharp decline in volatility in most asset markets has also contributed to the rush to buy such as assets including equities and high yielding debt.  While the market is becoming increasingly susceptible to shocks given the increasing positioning in risks assets, the near term may be a period of consolidation rather than any reversal.

Attention this week will focus on US Q4 2019 earnings.  So far, with around 9% of S&P earnings released, the majority (around 70%) have beaten expectations.  In a 4 day US trading week this week there are a number of earnings releases that will help provide further clues to whether the US equity rally can be sustained in the weeks ahead.  The S&P 500 is already up around 3% this year, extending a 30%+ gain last year. This has echoed gains in most global equity markets.  Investors should be nervous, but there is little to suggest a reversal soon.

There are a number of data and events to focus on this week including central bank meetings in the Eurozone, Canada, Norway, Malaysia and Indonesia.  Unsurprisingly the Bank of Japan left policy unchanged today and the other are unlikely to change their policy settings except perhaps Indonesia, which may cut.  Aside from these central banks a series of manufacturing surveys (Markit PMIs) will garner attention.

In Asia, trading activity may slow as Chinese New Year approaches while impeachment proceedings against US President Trump in the Senate will also likely distract attention for many.  Another issue that has taken on increasing prominence is the outbreak of a virus that appears to have originated in central China.  Concerns have grown that the coronavirus could spread quickly especially as millions of Chinese migrate (estimated at around 3 billion trips) over the Chinese new year holidays.

Overall, nervousness over the virus alongside holidays in the region is likely to lead to consolidation in markets any even profit taking following a strong rally in risk assets over recent weeks and months.  Positioning indicators suggest that USD positioning has fallen sharply, suggesting also a risk of USD short covering in the current environment.  This all point to a pause in the risk rally in the days ahead.

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