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.

Nervousness Creeping Back – US dollar firmer

Last week ended on a sour note as concerns over second round virus cases intensified; Apple’s decision to close some US stores in states where cases are escalating added to such concerns. This overshadowed earlier news that China would maintain its commitment to buying US agricultural goods.  Although on the whole, equity markets had a positive week there is no doubt that nervousness is creeping back into the market psyche.  Indeed it is notable that the VIX equity volatility “fear gauge” ticked back up and is still at levels higher than seen over most of May.

Economic recovery is continuing, as reflected in less negative data globally, but hopes of a “V” shape recovery continue to look unrealistic.  In this respect the battle between fundamentals and liquidity continues to rage.  Economic data has clearly turned around, but the pace of improvement is proving gradual.  For example, last week’s US jobless claims data continued to trend lower, but at a slower pace than hoped for.  A second round of virus cases in several US states including Florida, Arizona and the Carolinas also suggest that while renewed lockdowns are unlikely, a return to normality will be a very slow process, with social distancing measures likely to remain in place.  Geopolitical tensions add another layer of tension for markets.  Whether its tensions between US/China, North/South Korea, India/China or the many other hot spots globally, geopolitical risks to markets are rising.

The USD has benefitted from increased market nervousness, and from US data outperformance, with US data surprises (according to the Citi economic surprise index) at around the highest on record.  JPY has bucked the trend amid higher risk aversion as it has regained some of its safe haven status. GBP was badly beaten last week selling off from technically overbought levels, amid fresh economic concerns and a dawning reality that a Brexit trade deal with the EU may be unreachable by year end.  EUR looks as though it is increasingly joining the club on its way down. Asian currencies with the highest sensitivities to USD gyrations such as KRW are most vulnerable to further USD upside in Asia.

Data highlights this week include the May US PCE Report (Fri) which is likely to reveal a bounce in personal spending, Eurozone flash June purchasing managers indices (PMIs) (Tue) which are likely to record broad increases, European Central Bank meeting minutes (Thu), which are likely to reflect a dovish stance, and several central bank decisions including Hungary (Tue), Turkey (Thu), New Zealand (Wed),  Thailand (Wed), Philippines (Thu).   The room for central banks to ease policy is reducing but Turkey, Philippines and Mexico are likely to cut policy rates this week.

 

 

Opening Up

Attention is squarely going to be on efforts to open up economies in the days and weeks ahead.  Most US states are opening up to varied degrees while the same is happening across Europe.  The risk of course is that a second or even third wave of Covid-19 emerges for some countries, as is being seen in some parts of Asia, for example Korea where renewed social distancing measures have been put in place after a fresh cluster of cases in clubs and bars there.

However, governments will need to weigh up these risks against the growing economic costs of lockdown, which will by no means be easy.  Even as social distancing and lockdown measures are eased, it will likely be a gradual process, with activity likely to remain under pressure.  This is when the real test for markets will take place.  While markets have clearly been buoyed by unprecedented stimulus measures, especially from the Federal Reserve, which could continue for some time, fiscal injections will run their course over the next couple of months.

As revealed in April US jobs data at the end of last week the costs in terms of increased unemployment has been severe. The US unemployment rate hit a post war high of 14.7% while 20.5 million people lost their jobs.  This news will be echoed globally. Markets were expecting bad news and therefore the reaction was limited, but the data will nonetheless put more pressure on policy makers to keep the stimulus taps open.  Discussions are already in place between US Republican and Democrats over a new package, though disagreements on various issues suggest a deal may not happen soon.

Another spanner in the works is tensions between the US and China.  The US administration has become more vocal on blaming China for the virus, over recent weeks.  This had threatened to undermine the “phase 1” trade deal agreed a few months ago.  However, there were some soothing remarks on this front, with a phone call between senior US and Chinese officials last week, highlighting “good progress” on implementing the deal.  Despite such progress, it may not calm tensions over the cause of the virus, especially ahead of US elections in November and markets are likely to remain nervous in the weeks ahead.

This week there will be more evidence on tap to reveal the economic onslaught of the virus, just as many countries are finally flattening the virus curve itself.   Q1 GDP releases will reveal weakness in several countries.  Chinese activity data including retail sales and industrial production as well as credit metrics will give further evidence of the virus impact and how quickly China is recovering.  If anything, China’s recovery path will likely show the pain ahead for many economies that are easing lockdown measures.  In the US, inflation data and retail sales will garner attention.  In terms of central banks attention will be on the Reserve Bank of New Zealand (RBNZ). While no change in policy rates is likely a step up in the RBNZ’s asset purchases may take place.

 

 

 

 

Confidence Dives, Markets Shattered

COVID-19 fears have proliferated to such a large extent that confidence is being shaken to the core.   Confidence in markets, policy makers and the system itself is being damaged.  Today’s moves in markets have been dramatic, continuing days and weeks of turmoil, as panic liquidation of risk assets and conversely buying of safe assets, is leading to intense asset market volatility.  Economic fears are running rampant, with the failure of OPEC to agree a deal to prop up oil prices over the weekend adding further fuel to the fire.  Consequently, oil prices dropped a massive 30%, leading to a further dumping of stocks.

When does it end?  Confidence needs to return, but this will not be easy.  Policy makers in some countries seems to have got it right, for example Singapore, where containment is still feasible.  In Italy the government has attempted to put around 16 million people in quarantine given the rapid spread of the virus in the country. However, in many countries the main aim has to be effective mitigation rather than containment.  I am by no means an expert, but some experts predict that as much as 70% of the world’s population could be infected.  Washing hands properly, using hand sanitizers, social distancing and avoiding large gathering, appears to the main advice of specialist at least until a cure is found, which could be some months away.

In the meantime, markets look increasingly shattered and expectations of more aggressive central bank and governmental action is growing.  Indeed, there is already significantly further easing priced into expectations for the Federal Reserve and other major central banks.  This week, the European Central Bank is likely to join the fray, with some form of liquidity support/lending measures likely to be implemented.  Similarly, the Bank of England is set to cut interest rates and implement other measures to support lending and help provide some stability.  The UK government meanwhile, is set to announce a budget that will contain several measures to help support the economy as the virus spreads.

It is also likely that the US government announces more measures this week to help shore up confidence, including a temporary expansion of paid sick leave and help for companies facing disruption.  What will also be focused on is whether there will an increase in number of virus tests being done, given the limited number of tests carried out so far.  These steps will likely be undertaken in addition to the $7.8bn emergency spending bill signed into law at the end of last week.

All of this will be welcome, but whether it will be sufficient to combat the panic and fear spreading globally is by no means clear.  Markets are in free fall and investors are looking for guidance.  Until fear and panic lessen whatever governments and central banks do will be insufficient, but they may eventually help to ease the pain.  In the meantime, at a time of heightened volatility investors will need to batten down the hatches and hope that the sell off abates, but at the least should steer clear of catching falling knives.

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.

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