Good Morning.. What a day for the new governor of the Bank of England to start his new job; good luck mate; you are going to need it. Limit down in S&P futures, even after a massive coordinated move by central banks which have now gone all-in to try and save not only the global economy but the very financial system itself, which as discussed here for many weeks, was creaking and about to spring a leak. It is big and it is coordinated but will it work? I certainly hope so but I am monitoring the credit/funding space closely but also sovereign CDSs which may continue to spike. We are caught between a potentially lower USD as the US yields tumble but it is not yet clear if the USD demand/shortage is satisfied. I remain short EUR but have a very tight stop. The danger here is that many central banks have done all they can and the ECB and BoJ look rather helpless in all this. Can either of them ever see rate in positive territory and can the Fed and others ever push rates back up? This week is going to be no easier than last week, so adjust accordingly. Is it only Monday?

Keep the Faith..

Details 16/03/20

US stocks have an 18% round trip in 2 days; but this is not over even after the Fed cut to zero and coordinated central bank action sees central banks go all-in: What next?

There was a massive ramp higher into the US close of Friday in an illiquid run that saw the S&P reverse all the previous days losses and a lot of this very late in the session. What was worrying earlier was the fact that numerous governments had committed to big spending plans and more central banks, including the BoC cut rates hard. But stocks initially failed to rally and as I said a few weeks back, there will be good news days and bad news days. The issue for me is that we are probably nowhere near “peak virus” yet and until we are, we are likely to get a few more shocks and markets are uber-sensitive to bad news now. The damage from shutting China and Europe is going to be massive on the global economy and the consumer is scared; this is not the time for non-essential shopping. But it is also possible that we see the US start to shut down as the WSJ suggests schools will now start to close. Businesses have already been cost cutting due to the trade war between the US and China but now face the double whammy of a supply AND a demand shock. With margins so tight and huge debt piles, businesses can only turn to job shedding for further cuts and shed they will. Forget this passing in a month or so.

The central banks now realise this and it spurred aggressive action and a coordinated statement over the weekend. The actions seemed to send more of a warning signal to markets that they are extremely worried and S&P futures opened down and dropped straight into limit down. The Nikkei was down 2.5%, HK down 3.2% and Shanghai 1.8% when I last looked. Bonds took off as the Fed said they would increase QE asset purchases by $700bln. The US 10yr yield is down 26bps and 30s down 30bps. Even with this, the USD is mixed with USDJPY trading below 106.00 again but EUR failing to rally far. The Fed expanded repurchase operations, dollar swap lines with foreign banks and a credit facility for commercial banks to ease household and business lending. This is big stuff but stocks keep falling. But for me, I think a lot of this was aimed at bond and funding markets as the world did not need a stronger USD which was exactly what we were looking at with the stress in the bank funding markets. It will be interesting to see if the FRA-OIS spread narrows now and more importantly stays there. Powell will also be hoping that some liquidity is retuned to USTs, as that was getting scarce.

The Fed has cut close to zero but are unlikely to go negative. The popular phrase “lower for longer” will become “even lower for even longer”, with policy rates uncomfortably close to zero for much of the 2020s. This is not a good outcome for the yield curve or the global economy. The BoE have also said they will not go negative and probably for good reason which leaves the ECB completely stuffed with a policy that has negative impacts. Neither the EU or Japan have reaped any benefit from negative rates and they are now stuck with them. It is not even clear yet if the Fed can cut to negative by law. Negative rates seem to send an alarm signal to consumers and savers rather than push them to spend. Germany is saving more now that rates are negative because they are fearful of why the ECB needs to do that. The Fed chairman stressed that monetary policy was not the primary tool to respond to the sudden economic impact of a pandemic, and that the US central bank’s moves were primarily intended to support basic market function. There is the admission that something was breaking. “Monetary policy has a role, and it really is our original role: providing liquidity to financial systems when they’re under stress. And that’s really part of what we did today,” he said. “The other role was to support demand through lower interest rates, and we did that.” We shall see.

The Fed reacted to a number of concerns many of which were technical but also the rising USD. So what damage would a US dollar shortage bring? Spoiler alert; a lot! The global payment system is short of dollars and many are hoarding USDs now. The plumbing is breaking and if there is a scramble for the USD then we know there IS a problem in the banking system. The FRA-OIS spread has been screaming this at us. Something is wrong.

Trillions of dollars of financial transactions occur every single day but what if there is a break in the chain? Liquidity is another issue as volatility hits highs not seen since 2008. What concerns me is the cratering liquidity across all asset classes as the ongoing systemic shock is rapidly draining dollar funding from the system and which the Fed, as of late Friday afternoon, has been unable to resolve despite trillions in repo and QE backstops announced over the past 48 hours.

Let’s see if the latest boost helps. Otherwise the scramble for dollars is here. The loss of liquidity in the world’s deepest bond market (US) is a massive concern surely. This from Bloomberg, for which I am grateful; “The deepest bond market in the world is struggling with a lack of liquidity to a degree that veteran asset managers say they’ve never seen before.” If that doesn’t concern you then nothing will, or you just don’t want to look. The inability to trade decent size in the US bond markets has never been seen before; I would think. That is just scary. Central banks have just had their “whatever it takes” moment but the question is whether that is enough now. With the Fed so alarmed over this, should we be expecting more from the likes of Trump and here in the UK from Johnson? Trump said the US would buy huge amounts of oil but that, today, is down 6% as of writing this and how does that help?

Europe is now the epicentre of the virus and vast swathes of it are being shuttered with many economies already fragile at best. Equity investors have seen reliable hedging vehicles turn on them leaving them naked long equities while the banking system is creaking under the strain of what is looking more and more like a massive USD shortage (hence the short EUR positions last week). (I am not sure about the EUR here but the stop is a tight one.) We are stuck with considering much lower US yields but the danger that the USD shortage is not cured. The Fed has thrown billions at this and yet the demand keeps coming. Bond yields around the globe rallied at a time when the opposite is expected but hopefully the Fed has arrested this for a while. Can the world take a run higher in yields at a time of clear stress the global economy? I don’t think so and the Fed clearly thought so too with a new round of QE coming. All economies stand to be impacted by this and I am pretty sure that the US is going to have some shocking wake up calls soon too with regard to the virus. They were late starting the reaction to the virus but they are now committed to testing and that will likely throw up thousands of infections. Spain and Italy have totally closed their countries down and more may close borders and the ECB has a peashooter to deal with this; not a bazooka. Is this an existential threat to the EU? If Italy, Spain or any others feel they are being left behind then look out as the relationship could be damaged beyond repair over this. I will also be keeping an eye on Sovereign CDSs as we may start seeing some of those start to jump.

Companies across the spectrum are going to need government aid and banks are going to have to stay strong with regard to NPLs as right now liquidity is everything. Are the banks as safe as we are told by the central banks? If so, why on earth are there so many stress signals emanating from their funding markets? The problem is that the global recession is already here; we just need the confirmation in the numbers. Just last night from China we saw January-February combined industrial output down 13.5% y/y (vs. expected -3%), Jan-Feb combined retails sales down 20.5% y/y (expected -4%) and Fixed investment down 24.5% y/y for the combined two months, expected -2%. The data is starting to confirm just how damaging all this is.

Company earnings need considerable attention and with the global markets so extended before this struck, it may be a bit early for bargain hunting in stocks. Yes, there are going to be real opportunities but I am not convinced the big capitulation has completed and another wave may be on the way as the sea water rushes off the beach again. To my mind, bounces like Friday are an opportunity to get out not in. Look at the crash of ’29 where we saw some mazing spikes before a low was finally seen.

I sincerely hope a crash like that will never be seen again but if the funding/credit space blows up then all bets are off; the central banks cannot and probably will not let that happen but I have huge concerns about what they can do to save the lower end of the credit space, even after Sundays dramatic combined actions. But will central banks ever be able to move away from zero now? For me the message from the central banks is very clear; there WAS a problem in the funding/repo markets, liquidity was disappearing fast and equity markets looked likely to continue collapsing. They now realise the damage that this virus will do to the global economy and all the financial plumbing systems are straining. That in itself is scary but a few saw this coming. Again the big question is if going all-in can fix this. We still have a few months of potential bad news on infection rates and global economic data. Corporate earning are set to tumble. But possibly the most damaging aspect is the psychological damage done to the global consumer.

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Strategy:

Macro:.

Short EUR @ 1.1195.. Stop above 1.1250.

Brought to you by Maurice Pomery, Strategic Alpha Limited.

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