A Virus Stole My Reflation Trade

Coronavirus is now hanging out at a chalet in Contamines-Montjoie resort in Savoie, in eastern France.

“[The] original case was brought to our attention last night, it is a British national who had returned from Singapore where he had stayed between January 20 and 23, and he arrived in France on January 24 for four days”, French health minister Agnes Buzyn said. 11 people who shared a chalet with the individual were hospitalized. Five of them tested positive. None of the cases are described as “serious”.

In addition to being somewhat unnerving, this is also unfortunate news for skiers. “Contamines is in the French Alps, close to the Swiss city of Geneva and the Mont Blanc peak”, Reuters explains. “The cases coincide with one of the busiest periods of the ski season for resorts in the area, as many French schools begin mid-term holidays”.

These are the kinds of headlines which have made investors reluctant to carry risk into the weekend for two Fridays running.

Despite a good January jobs report, US equities stumbled out of an otherwise blockbuster week, as stocks sank on Wall Street, where a palpable sense of angst lingered, made worse by news that China has delayed reporting of trade data for January. After an extended period of calm, things have become decidedly more “choppy” of late.

Friday’s action (both in equities and rates) underscores points made here on Wednesday and Thursday. Essentially, it’s getting harder to make a near-term fundamental case for chasing stocks or yields higher, even as there’s a flows-based rationale for why equities could “slingshot” to the upside in the event the news gets incrementally better, pushing various hedges and downside protection plays further out of the money into expiry.

“While not entirely out of the realm of conceivable outcomes, a departure point of <1.60% in 10-year yields limits the extent to which a single print can reset the market”, BMO said Friday, prior to the January jobs report release. “This isn’t to detract from the risk of a bearish impulse in the event of a stronger read on the labor market; rather the follow-through on any such selling pressure will be lessened by the ongoing nCov uncertainties”, Ian Lyngen, Benjamin Jeffery and Jon Hill, went on to write, adding that “it’s challenging to envision investors eager to carry a Treasury short into the weekend in light of the omnipresent headline risks”.

That assessment could scarcely have been more accurate. That is precisely how things played out Friday. Just read this summary of bonds from Bloomberg and you’ll see what I mean:

Treasuries bull flattened, paring initial payrolls-led drop leaving yields near lowest levels of the session into the cash settlement. A grinding rally over US session appeared to be driven by renewed concern the coronavirus will slow global growth as investors took safe havens ahead of the weekend. Early payrolls drop was soon unwound as focus shifted to the 2019 revisions. Yields lower by 5bp to 7bp across the curve with 2s10s, 5s30s flatter by 1.9bp and 0.8bp; 10-year yields ended around 1.577%, lower by 6.5bp on the day and back toward middle of weekly range.

There you go. All of that reinforces my “rangebound rates” call from mid-week.

Still, Friday’s losses in equities were hardly enough to take the shine off an otherwise fantastic (almost frantic) sprint back to new highs on the benchmarks. In fact, it was the best week for US equities since early June, when a month’s worth of tariff threats (in May, Trump ratcheted up levies on China, blacklisted Huawei and eventually threatened to slap tariffs on Mexico) forced market participants to come around to the reality of imminent Fed cuts, a realization that powered risk assets higher, especially once Fedspeak was confirmatory and Trump dropped the Mexico tariff idea.

But in the bottom pane you can see the problem. The virus scare was icing on the cake when it came to the return of the “duration infatuation”. We’ve now erased Q4’s reflation trade, at least as far as a hodgepodge of macro “canaries” are concerned.

Breakevens actually haven’t fallen as much as you might imagine they would given the circumstances, but crude’s worst losing streak since Q4 2018’s bear market collapse certainly doesn’t help.

Let’s all hope Kevin’s “mother of all stimulus” call plays out. Otherwise, this pesky virus may end up snow-balling into some kind of nasty deflationary bust.