- Despite the S&P’s biggest down day since October, the future looks bright
- Risk-off panic becomes increasingly self-fulfilling
- Fed meets market’s expectations i.e. no taper
- In the face of risk-off Armageddon, oil prices remain well supported
- Gold is down and remains stuck in a tight range
The S&P was down 2½% heading into the close – the biggest down day since October. Nerves about vaccine rollouts weighed on sentiment and significant volatility among some stocks targeted by retail investors.
Yes, the future looks bright, but the moment is hell.
It’s been a gruelling 24 hours as turmoil reigned over equity markets with reopening narratives getting pushed back well into Q2 due to messed up vaccination and rollout strategies. And, adding to investor pain, there are worries around a subtle hawkish shift in policy from the PBoC. And to rub even more salt in the wounds, macro markets went into complete flux mode on reports that ECB officials believe markets are underestimating the chances of a rate cut spurring desynchronized global growth fears.
Investors had been optimistically shooting for a Spring Break reopening, hoping Governments would start lifting restrictions on economic life once the most vulnerable 20-25% of the population are vaccinated. For now, at this stage of the rollout game that’s little more than a pipe dream. Delays in the rollout of Covid-19 vaccines, coupled with lingering lockdown measures, marked a malocchio of the market’s worst held fears.
Vaccine distribution is the most crucial deliverable to get out of this mess.
And while the US stimulus debate is taking the second chair to the vaccine rollouts, a break in the bi-partisan impasse, or even by the reconciliation process could come at a most welcome time.
VAR meltdowns are the worst of all panic events
In a most unvirtuous circle, the risk-off panic became increasingly self-fulfilling as risk control mechanisms kicked in when early covering in consensus shorts, at massive losses mind you, then gave way to selling high flying technology longs from the Hedge Fund community, in the main to cover margin calls triggering a cascading house of pain effect across broader markets.
We remain in a market dominated by risk-on risk-off proclivities, and even more so as we reach peak vaccine impulse melding with incredibly uncertain economic outlook – not to mention being near the end of the fiscal runway. Still, we’re 100 % landlocked in a liquidity-driven environment where all boats rise with YTD performance of US equities and US dollar lower, all suggesting significant co-movement between risk-on asset classes.
It would be easy to codify the rise in risky asset classes since the post-election risk premiums evaporated simply as risk-on. But, of course, the more significant characteristic has been the rotation within asset classes towards the YTD laggards and ‘reopening’ sectors across the board.
So, a negative view on any one of these risk-on asset classes will almost inevitably also lead to negative opinions across the entire risk-on spectrum, including cyclical commodity prices like oil. Any further headline disappointment, be it vaccine rollout or even US stimulus, could prompt further de-risking over the coming days, despite the still-intact longer-term bull narrative.
I’ve been cautious on markets over the last week and remain so. It always feels horrible to be part of a broader camp looking for a more significant selloff, and it seems with everyone looking for an equity market pullback, their wishes did come true. But it won’t be easy to get back in the saddle with any conviction until the vaccine distribution mess gets sorted as it delays everyone’s plans for a brighter day.
While recent Covid-19 news and snail-paced vaccine rollouts have been horrifyingly discouraging, the big picture does not change in terms of markets outlook. Namely, an unprecedented amount of monetary and fiscal stimulus, a structural shift towards much more spending, a potentially unmatched economic rebound – whether starting in Q2 or Q3 – and a reasonable chance of inflation for the first time in several decades. Once the systematic correction gives way, things could brighten up again.
As we move back into the “look through” trade environment, supported by monetary and fiscal puts, investors are quickly rediscovering that not all growth assets are created equal in a Covid downtrodden economic climate, and the forever fickle FX market is testament to the thesis that nothing goes up in a straight line.
As the markets had widely expected, the Fed made very few changes to the statement. But for investors’ concerns, relevant messaging can be summed up as a single-issue event: no taper. Fed Chair Powell looks to have come with the express intention of conveying just that one message.
However, on the drop of time around coronavirus risk in the Fed statement (they dropped “medium-term”), Powell said they did that because in their view there are vaccinations now. So if there’s one hawkish feature to this press conference, this is it.
The sole reason for the massive balance sheet expansion – Covid-19– will be mostly gone in 6-9 months. And since monetary policy works with long and varying lags, it is, or rather will soon be, time for central bankers to consider policy normalization.
In the face of risk-off Armageddon, oil prices – thankfully for broader markets – remain well supported due to OPEC’s dogged determination to stay in damage control mode, adjusting supply constraints to alleviate the projected oil demand level attrition in Q1.
And mercifully for risk markets, not just oil bulls, crude stocks were down 9.9Mb, bullish vs consensus for a +0.4Mb build in crude, the five-year average of +4.5Mb and more significant than the -5.3Mb draw reported by the API yesterday.
Because stocks are in the midst of a VAR type meltdown, oil prices aren’t necessarily as exposed to the market’s risk-on risk-off proclivity around Game Stop and High Tech de-grossing. But oil prices do remain precariously perched and extremely sensitive to any news about snail-paced vaccine rollout.
Perhaps one factor that has been slightly unnoticed is the substantial rise in energy prices and cyclical commodity prices triggered by expectations of a hyper reflationary environment over the next twelve months and has resulted in a significant increase in market-based inflation expectations, where this unmistakable reflationary exuberance was getting expressed in FX.
The broad recovery in risk assets via oil prices since November has not only affected market-based inflation expectations but boosted every asset class on the street.
I think “risk markets” can thank their lucky stars that Saudi Arabia’s crystal ball outlook was clear as a whistle, and their proactive production cut measure buttressed investors from a more significant meltdown.
The global FX market went into a defensive posture, expressing and hedging the risk-off views through high beta to risk currencies. Given the Canadian dollar’s tight correlation to the S&P 500, the Lonnie quickly became a favoured short form both hedgers and speculators.
The stars aligned for EURO bears as the single currency was simultaneous getting hit with the risk-off ugly stick, overtly dovish ECB member chatter and extended EU lockdowns. But this all-over-the-place communication from the European Central Bank suggests some manoeuvring is going on behind the scenes and doesn’t put ECB President Christine Lagarde in a favourable light.
EURUSD is bounced off 1.2050 support for now as the shift to negative rates remains unlikely given what would happen to the banking system. That being said, the ECB’s verbal currency threats haven’t explicitly included their method for pushing back before, so the odds of a rate cut have gone up ever so slightly.
EM stocks and currencies struggle under the weight of snail-paced vaccination rollouts, both domestically and in the developed market, driving US dollar safe-haven demand.
In USDAsia, some USD buying has gone through the market since New York opened after a relatively quiet, tight-ranged session in Asia. Flow-wise, there has been some buying of USDIDR, USDPHP, USDKRW and USDCNH in social size and small two-way interest in USDINR.
The ringgit and the rest of Asia FX remain ensnared in relatively tight ranges as the big picture does not change its outlook. Namely, an unprecedented amount of monetary and fiscal stimulus. A structural shift towards much more spending, a potentially unmatched economic rebound – whether starting in Q2 or Q3 – and a reasonable chance of inflation for the first time in several decades
With the FOMC only holding the interest course, it wasn’t enough to boost gold, especially in the face of a more robust “safe-haven demand” for the US dollar. Compounding matters, gold is getting sold again, albeit lightly to cover margin calls weighing on sentiment.
Although gold is down, we remain stuck in a tight range. Still, the trend is looking less and less constructive, as the yellow metal struggles to recover from the selloff that took place at the start of the year, and with the historically bullish January seasonality soon to be taken out of the equation.